This section contains information about the Current Expected Credit Loss (CECL) Calculation for FASB�s CECL guidelines.
OFS Loan Loss Forecasting and Provisioning application come with a seeded Run to support the computation of Current Expected Credit Loss (CECL) through any of the multiple methodologies available, as required by the Financial Institution. The CECL Run begins with subprocesses that help in data load, obtaining data from the multiple product processor tables. Post data load, certain key dimensions are non-standard or external data formats to standard or internal data formats, to improve ease of handling the accounts through common rules or metadata. The run then consists of processes that compute the Lifetime Expected Credit Loss values of both the drawn and undrawn portions of each account, using an approach based on the methodology assigned. Upon successful execution, the results are stored in multiple reporting tables - at both accounts and aggregate levels.
The aggregate tables then allow further computations to be performed to adjust the reserve required values based on a separate feature - Reserve Adjustment Computation.
The application also displays the execution status of the Run through the UI. For more details, see the Process Modelling Framework section.
NOTE:
The Preferred Segment Type Code must be updated in the Preference table for the successful execution of the Run. If you do not want to use Segments as a Dimension, the related Processes must be removed.
There are five major ready-to-use Methodologies available in the product. You can choose the methodology that is applicable for every set of accounts or instruments based on any combination of dimensions through a Rule, with the standard product feature of using Customer Type, Product Type, and Default status. The five ready-to-use methodologies are the following:
· Cash Flow
· Forward Exposure
· Provision Matrix
· Specific Provision
· Roll Rate
Collective Assessment: The CECL run can also determine the stage, collectively, at an aggregated level. For more information about collective assessment, see the Collective Assessment section.
For CECL calculation:
· Segments via the Segmentation Run and applicable only for Roll Rate methodology
· EIR, depending on the methodology
· Transition matrices, either via the Historical Transition matrix run or UI, and applicable only for Roll Rate methodology
· Loss rates via the Historical Loss rate run, and applicable only for Roll Rate methodology
· PD term structure, either as download or through execution of PD Model
· LGD Values, as a download, are required.
The methodology selection is dependent on three factors, which are, Customer Type, Product Type, and Defaulted Flag. The bank can modify the methodology selection process by either adding more parameters or modifying the existing ones. Based on these parameters, a different methodology can be assigned to different accounts, products, and so on.
The Cash Flow method makes use of the Contractual Cash Flow, taking into consideration any prepayments, behavior patterns, and so on. The Contractual cash flow is adjusted for Probability of Default (PD) and Loss Given Default (LGD) to compute the Expected Cash Flow (ECF).
The first step in the cash flow methodology is to validate if the contractual cash flows are available for the specific account. The Contractual cash flows can either be generated by the engine or obtained as a download.
NOTE:
If the Cash Flow is not available, the account is processed through the Provision Matrix methodology.
Before following the Contractual Cash Flow method, ensure that the following prerequisites are met.
· Contractual Cash Flows are expected to be available before the CECL computation process is executed. It can be either generated by Oracle's Cash Flow engine or by an external engine or provided as a download. While providing cash flow as a download in Stage Account Cash Flows, a given financial element must not be repeated for an account and cash flow date combination. For example, for any particular cash flow date, there can only be one Principal and Interest Cash Flow each.
The internal cash flow engine used is common across other OFSAA applications. For more details about Oracle's Cash Flow engine, see the OFS Asset Liability Management User Guide.
· PD and LGD values are expected either as a model output from the models hosted in the Enterprise Modeling Framework or directly as an input.
· PD Interpolation Batch
There are two distinct ways of calculating the CECL under the Cash Flow method depending on how the undrawn portion of a financial instrument is treated. They are:
· Calculation of CECL with Undrawn amount modeled within the Contractual Cash Flows
· Calculation of CECL with Undrawn amount treated separately and outside the Cash flow approach
The following sections detail the CECL calculation for accounts, both with and without undrawn amount, as mentioned in the preceding sections.
CECL is computed by considering the cash flows and the Probability to default for the entire life of the instrument. The Contractual cash flows are adjusted for PD and LGD to compute the Expected Cash Flow (ECF). The values of Contractual Cash flow and Expected Cash flow are then used to calculate the Cash Short Fall.
CECL is computed as the Net Present Value of Cash Short Fall.
The Effective Interest Rate (EIR) is used for discounting while calculating the CECL.
NOTE:
The PD for the lifetime or until the maturity of the account is considered.
Assigning the PD Values for Each Cash Flow Date or Bucket
The PD assignment happens within the CECL run as part of the Cashflow or forward exposure methodology. The cumulative PD matching the account's Term structure ID, Account's Rating, or DPD, and the bucket number (period) is populated against the account's cash flow - based on the cash flow bucket.
NOTE:
If Cash Flows are provided as a download, via stage account cash flow table, a single row for principal and interest cash flow each must be provided, on any cash flow date.
The forward exposure methodology involves the computation of the Forward Exposures, that is, forward-looking Exposure at Defaults or Forward EADs, at a different point in time in the future till the maturity of the instrument and then compute the Current Expected Credit Loss from them. The Forward Exposure values are calculated by the application using the Contractual cash flows which can either be generated by Oracle's CFE or by an external engine.
The application also has a feature to obtain Forward Exposure values and the corresponding forward dates directly as a download. If both Cash Flows and Forward Exposure values are not available, then the account is processed through the Provision Matrix methodology.
This section details the steps involved in forwarding the Exposure calculation.
Forward Exposure on each cash flow date is calculated from the cash flows generated or obtained as a download. The LLFP application calculates the Forward Exposure on each cash flow date as the Net present value of all future and current cash flows, discounted using the Effective Interest Rate (EIR) of the account or Cohort. Forward exposures are calculated till the last cash flow of the account.
The forward exposures and the PD up to the maturity of the account are considered and the Per Period Loss is calculated using Forward Exposure, Marginal PD, and LGD.
NOTE:
The Marginal PD for the entire lifetime of the account is considered.
After calculating the Per Period Loss, the CECL is calculated as the Present value of Per period losses.
The Effective Interest rate (EIR) is used for discounting while calculating the CECL.
Assigning the PD Values for Each Cash Flow Date or Bucket
The PD assignment happens within the CECL run as part of the Cashflow or forward exposure methodology. First, the cumulative PD matching the account's Term structure ID, Account's Rating, or DPD, and the bucket number is populated against the account's cash flow - based on the cash flow bucket. Next, based on the current and previous bucket numbers, the difference in the period, the marginal PD values are computed.
The LLFP application calculates the Forward Exposure on each cash flow date as the Net present value of all future and current cash flows, discounted using the Effective Interest Rate (EIR) of the account or cohort. The discounting period is as per the Cash flow dates and not as per the buckets.
That is, Forward Exposure on each cash flow date is calculated as the Sum of Present Value of all the Future Cash Flows and the Current date Cash Flow, that is, Cash flow corresponding to that date.
The forward exposures are then adjusted for PD and LGD to calculate the Per Period losses and the Current Expected Credit Loss of the account.
Present Value of Cash Flows in FSI_ACCOUNT_INCEPTION_RATES table is computed during EIR computation. If the EIR is obtained as a download, the PV of cash flows is also expected as a download. These values need to be updated in the FSI_ACCOUNT_INCEPTION_RATES table, for all features dependent on this value.
The Provision Matrix subprocess is separated into two tasks:
· Allowance Calculation
· Provision Calculation
In the Allowance Calculation task, the application uses the Provision Matrix method to calculate the Allowance for all accounts classified under the provision matrix methodology and accounts for which Allowance calculation was skipped by previous methods. This calculation is done on the Carrying Amount or the drawn amount. That is, the Allowance calculation is formulated using Carrying Amount and Provision Rate.
In the Provision Calculation task, the application uses the Provision Matrix method to calculate the Provision for all accounts that have an undrawn portion. This calculation is done on the undrawn amount. The Provision is calculated using Undrawn Amount, Credit Conversion Factor (CCF), and Provision Rate.
The provision matrices are provided by the banks as input into the staging tables. These provision matrices provide the provision rate that is applicable for a particular group of accounts based on the input factors associated with that account.
In the ready-to-use product, different Provision matrices are assigned to different groups of accounts based on the following factors:
Customer Type
· Product type
The provision rates can be computed for different instrument groups based on the historical data and adjusted for forward-looking factors using the Enterprise modeling framework.
Assigning Provision Rates for Corporate Accounts
The Provision Rates for Corporate accounts may be assigned using the ratings provided and the corresponding rates assigned are in percentage terms.
For example:
Rating |
Rates in % |
|---|---|
AAA |
1% |
AA |
3% |
A |
5% |
BBB |
10% |
BB |
20% |
B |
30% |
CCC |
40% |
CC |
50% |
C |
60% |
D |
100% |
Assigning Provision Rate for Retail Accounts
The Provision Rates for Retail accounts are assigned using Delinquency Past Due (DPD) bands and the rates are in percentage terms.
Rating |
Rate |
|---|---|
0-30 Days |
1% |
31-40 Days |
5% |
41-100 Days |
30 % |
The application uses Rules to determine the rates applicable for an account, based on the Stage, Product Type, and Customer Type. Rates are picked from matrices as in the examples provided.
Under this method, the LLFP application calculates the CECL using the values of EAD (current), PD, and LGD. The application calculates the Lifetime PD from the given PD term structures.
Allowance is calculated as the product of Carrying Amount, Lifetime PD, and LGD. Also, Provision is calculated as the product of Undrawn Amount, CCF, Lifetime PD, and LGD.
The total Expected Credit Loss is derived as the sum of Allowance and Provision.
The PD values are calculated from the interpolated PD term structures. The Lifetime PD corresponds to the Cumulative PD of the period corresponding to the account's maturity date.
The LGD value that is used in the Specific Provision method is obtained from the interpolated LGD term structure. The input LGD term structures are processed to calculate the LGD values at the bucket frequency. This processing is applied for accounts under the Specific Provision methodology also. After the LGD term structures are processed, each account is associated with an LGD value against the current period. As mentioned in the section on LGD processing, the current period value corresponds to the 0th period or the 0th bucket. This value, corresponding to the 0th period or bucket, is assigned as the LGD value that is used in the Specific Provision method.
Lifetime PD and LGD values are stored for reporting.
The roll rate methodology involves the computation of the Default Roll Rate and the Gross loss rate for an account based on the given Rating or Delinquent days band and its maturity.
NOTE:
To compute the CECL through the roll rate methodology, it is required to execute the Segmentation, Historical Transition Matrix, and Historical Loss Rate runs. If the Transition Matrices are provided as a download, the Historical Transition Matrix Run can be ignored.
The Current Expected Credit Loss of an account is computed as follows:
· Lifetime Allowance = Outstanding Amount * Lifetime DRR * Gross Loss Rate
· Lifetime Provision = Undrawn Amount * CCF * Lifetime DRR * Gross Loss Rate
During the Current Expected Credit Loss Run, the system computes the Roll Rate of an account by projecting the given transition matrices, computed or created through UI - as selected by you, into the future until the maturity of an account using the matrix multiplication process.
The probability of an account moving into the default rating on maturity from the current rating as of the given MIS Date is considered as the Default Roll Rate.
You can either execute the Historical Transition Matrix Run or use the Transition Matrix UI to generate a Transition Matrix. For more information about generating Transition Matrix through UI, see the Transition Matrix Definitions section.
During the Current Expected Credit Loss Run, the gross loss rate is computed as the average of the historical loss rates over a given period. The period over which the average is taken is based on the preferences set in the Application Preference table.
The Historical Loss Rate Run needs to be executed for the calculation of the Gross Loss Rate. For more information about the historical loss rate, see the Historical Loss Rate section.
The Provision matrix data model holds the lifetime provision rates against each Rating or DPD bands, within a matrix. The ready-to-use Provision Matrix assignment rule considers Product Type and Customer Type but may be reconfigured to consider other requisite account dimensions, Stage as a source dimension is not required, to assign a Provision Matrix.
After the consolidated CECL is calculated through any one of the multiple methodologies available, the Allowance and Provision values are determined. The Allowance and Provision values are calculated based on the Drawn and Undrawn portions of the accounts. For every Product type and Customer type, the application checks whether the Undrawn flag is Y or N. A Rule namely, the Undrawn Flag Assignment Rule handles the flag set for the Undrawn portion.
Under Cash Flow or forward Exposure methodology, depending on the inclusion of the undrawn portion in either the Cash flow or Forward exposure, the Current Expected Credit Loss value is apportioned as Allowance and Provision values, considering the carrying amount.
The Undrawn Flag Assignment Rule performs the check for the Undrawn flag across all the methodologies. After the check, depending on the value of the Undrawn flag, the following calculations are made:
· If the Undrawn flag is Y and the CECL > Carrying Amount, then:
§ Allowance = Carrying Amount
§ Provision = CECL - Carrying Amount
· If the Undrawn flag is Y and the CECL < Carrying Amount, then:
§ Allowance = CECL
§ Provision = 0
· If the Undrawn flag is N and the CECL > Carrying Amount, then:
§ Allowance = Carrying Amount
· If the Undrawn flag is N and the CECL < Carrying Amount, then:
§ Allowance = CECL
If the Undrawn flag is N, the Provision is calculated using the Provision Matrix method. For more details, see the Provision Matrix section.
The following are the allowance and provision calculations:
· Cash Flow and Forward Exposure - when Undrawn Flag is Y or N the Lifetime Allowance is computed as follows:
§ Lifetime Allowance = IF (Lifetime CECL > Carrying Amount, Carrying Amount, Lifetime CECL)
· Cash Flow and Forward Exposure - when Undrawn Flag is Y the Lifetime Provision is computed as follows:
§ Lifetime Allowance = IF (Lifetime CECL > Carrying Amount, Lifetime CECL - Carrying Amount, 0)
· Cash Flow and Forward Exposure - when Undrawn Flag is N the Lifetime Provision is computed as follows:
§ Lifetime Provision = Undrawn * CCF * Lifetime Provision Rate
· Provision Matrix Approach - when Undrawn flag Y or N the Lifetime Allowance and Provision are computed as follows:
§ Lifetime Allowance = Carrying Amount * Lifetime Provision Rate
§ Lifetime Provision = Undrawn * CCF * Lifetime Provision Rate
· Specific Provision - when Undrawn flag Y or N the Lifetime Allowance and Provision are computed as follows:
§ Lifetime Allowance = Carrying Amount * LGD * Lifetime PD
§ Lifetime Provision = Undrawn * CCF * LGD * Lifetime PD
· Current Expected Credit Loss Calculation
§ For all accounts, the Current Expected Credit Loss is calculated as follows:
Lifetime CECL = Lifetime Allowance + Lifetime Provision
· Apportioning CECL, Allowance, and Provision values from Cohorts to Individual accounts
§ The apportioning of all following the three parameters are performed:
Lifetime values of CECL, Allowance, and Provision
· Computation of final Reporting Values
§ The Reporting CECL, Reporting Allowance, and Reporting Provision values are computed as follows:
Reporting CECL = Lifetime CECL
Reporting Allowance = Lifetime Allowance
Reporting Provision = Lifetime Provision
The final CECL is computed from Allowance and Provision values as mentioned in the previous section. The Impairment Gain or Loss for the current period is computed by comparing the current reporting date's Allowance and Provision values with the previous reporting dates' Allowance and Provision values.
Impairment Gain or Loss = (Current Allowance + Current Provision) - (Previous Allowance + Previous Provision) + Current Write-off - Current Recovery
NOTE:
The Previous Allowance and Previous Provision values are expected as a download. If the Financial Institution computes Reserve Adjustments, the same must reflect in the Previous Allowance and Previous Provision amounts that are provided in the next FIC MIS DATE or period. This is necessary to arrive at the correct value of the Required Reserve.
To know more about Required Reserve computation, see the Computation of Required Reserve section.
The LGD Term Structure feature in the LLFP application allows you to change the LGD values over different periods by reflecting the changes in Loan value, collateral value, lien, and so on at an account level granularity. This also helps in obtaining more accurate CECL numbers while calculating the lifetime losses.
The processing of LGD Term Structures has the following four phases:
· Obtaining LGD Data in Staging
· Movement of LGD Data into Processing
· Processing LGD Data as Required for CECL Calculation
· Using LGD Data for CECL Calculation
LLFP application consists of a staging table to obtain the LGD term structures at an account level granularity, that is, every account is provided with a series of LGD values over a period of time at a specific frequency. However, within a series, the values must be of constant frequency. In certain cases, there could be accounts with only a single LGD value which assumes LGD is constant. The single LGD is considered as the current period LGD.
Because the LGD values are bound to change over every period, the term structure is expected to be given at every MIS Date.
The LGD Term Structures are transferred to the processing area and adjusted as required for CECL computations, simultaneously. While the LGD series (term structure) in the staging table could be at any given frequency, the same is converted to the bucket frequency and during this process, the number of periods for which the LGD values have to be calculated or interpolated and extrapolated is dependent on the time to maturity of the account.
The processing table contains the number of buckets as per the cash flow buckets in the Cash flow table, rounded to the nearest multiple of the LGD term structure frequency. For example, if the account has cash flows till the 45th Monthly bucket and the LGD term structure has four yearly periods, the number of periods in the LGD processing table is rounded off to 48.
NOTE:
Unlike PD; LGD does not start from Zero percentage from the initial period.
Interpolation of LGD for intermediate periods follows a linear interpolation method. Initially, the LGD of the current date, provided as the 0th period LGD, is considered. If there is no LGD against the 0th period, then the 1st-period LGD is made applicable to the 0th period. Then the LGD for the first period is taken into consideration and then the values are interpolated for the intermediate periods. The LGD for the first period applies to the last bucket of the first period and the LGD value for the second period applies to the last bucket of the second period. By using the linear interpolation technique, the LGD values are increased linearly from the 0th bucket to the last bucket of the first period and then further to the last bucket of the second period and so on.
The bucket-wise LGD values are assigned to the corresponding cash flows using the bucket ID stamped against those cash flows.
NOTE:
You need to load data to the LLFP LGD Term Structure Staging table.
For TDR Accounts, Reserves are calculated using a distinct approach. For this, the OFS Loan Loss Forecasting and Provisioning Application make use of the TDR flag. Whenever the flag is Y, the account is in the TDR category, the application calculates a separate reserve for TDR accounts.
For calculation of this reserve, Expected Cash Flows are expected as a download in Staging. Using these Cash Flows, which are present in the stage account Cash Flows table, the application computes the present value of these expected Cash Flows. The discount rate is calculated as EIR for Fixed-Rate Instruments and the Current Net Rate for Floating Rate Accounts.
Then the application computes TDR reserve as the difference between the carrying amount and the present value of these expected Cash Flows.
TDR accounts undergo the first level of aggregation but do not flow into the segment-level aggregate table.
Cash Flows provided in the staging area against a TDR account are assumed to be Expected Cash Flows and not Contractual Cash Flows. As a result of this, you must neither use Cash Flow based, nor Forward Exposure based methods for ECL computation.
TDR Reserve= Carrying Amount � PV of Expected Cash Flow
1. The carrying amount is the outstanding amount when the account gets flagged as �TDR�.
2. As of Date (AOD), Contractual Cash Flow is discounted with the EIR. The following functional Use Cases are referred for use of EIR.
a. When TDR Event and Repriced Event are different: For a Fixed Rate or Floating Rate Instrument, if the latest repriced EIR is available then the application uses it, otherwise it uses the origination EIR to discount the Expected Cash Flow.
b. Note: The latest Repriced Event should be earlier than the TDR Event.
c. When the TDR Event and the Repriced Event are the same: For a Fixed Rate or Floating Rate Instrument, the latest EIR which is available just before these (TDR/Repriced) gets used to discount the Expected Cash Flow.
In Scenario-based CECL Computation, Probability of Default, Loss Given Default, and Forward Exposures, through stage management forecasts, are provided for multiple scenarios. As the first step, you need to add the required additional scenarios in the Current Expected Credit Loss Scenarios table and modify the Probability Weights in such a way that the cumulative of all the weights is 100.
Subsequently, the PD Codes in the PD, LGD, and Forward Exposures tables must match with the values that you have defined in the Current Expected Credit Loss Scenarios table.
The number of different PD, LGD, and Forward Exposure sets must be equal to the number of Scenarios defined. While executing the ECL Run, OFS Loan Loss Forecasting and Provisioning application replicates the account information for the given number of Scenarios. For each set, the corresponding PD, LGD, and Forward Exposure values are used.
NOTE:
Scenario-based Forward Exposure is used only in the case of forwarding Exposure methodology, where Forward Exposure is obtained as a download. In the case of the Forwarding Exposure method where Forward Exposures are computed using Cash Flows, within the application, or Cash Flow methodology, the same set of Cash Flows are used, thereby making CECL across all Scenarios equal. Also, Roll Rate and Provision Matrix Methodologies yield the same CECL across all Scenarios.
Using the aforementioned different Scenarios, different CECLs are computed within the processing area. While moving data into the reporting structure, the weighted average of CECLs and other related values are computed based on the weights defined in the Current Expected Credit Loss Scenarios table.
NOTE:
For multiple scenarios, the existing data for an MIS Date from the PD Term Structure Detail, Periodic PD Rates, and Interpolated PD term tables must be removed. After this, the SCDs and Batches must be re-executed.
Following are the implications of using a Scenario-based CECL Computation method:
· Scenario-based CECL Computation is applicable only for Forward Exposure and Specific Provision methodologies.
· For Cash Flow, Roll Rate, and Provision Matrix methodologies, CECL for different Scenarios are the same.
· PD Model only generates a weighted average PDs. This may not be used for Scenario-based CECL computations.
· CECL Reconciliation cannot be performed on CECL runs, which are Scenario-based.
· The performance of CECL is impacted.
According to the CECL standards, financial institutions are now required to use an allowance approach when recognizing credit loss for AFS debt securities. Allowance is measured as the difference between the Security's amortized cost and the amount expected to be collected over the entire life of the security.
OFS Loan Loss Forecasting and Provisioning application compute the Expected Credit Loss of individual instruments or accounts using multiple models such as AFS Model, Survival Model, Roll Rate Model, Vintage Model, and Collateral Based Method. The application provides you the flexibility to compute the credit loss allowance for a different set of accounts or portfolios using different methodologies. Available-for-Sale Financial Asset Model is used to compute allowance for AFS Debt securities as per the CECL standards.
Following are the prerequisites for computing allowance for AFS debt securities:
· Fair Value: The fair value can be computed using the OFSAA applications or can be provided as a download by the financial institution.
· Intent to Sell: The intent to sell must be provided by the financial institution as a flag Yes or No in the OFSAA staging table.
· Cash Flow: Expected Cash Flows can be generated using the OFSAA application or provided as a download by the financial institution.
The first step in the AFS Model is to populate the staging tables with the aforementioned prerequisites. Asset Classification Type AFS or HTM, Intent to sell are mandatory inputs. Fair value and cash flows can be provided as a download or can be generated using OFSAA applications.
The second step in the process is to compute the overall impairment. This is done using a computation rule in LLFP. Overall impairment is calculated as the difference between the Amortized Cost and Fair Value.
As per CECL, institutions must recognize an allowance for credit losses by a charge to earnings for the credit-related computed of the decline in Fair Value. This allowance is subject to a fair value floor. OFS Loan Loss Forecasting and Provisioning has rules configured to check if the decline in fair value is due to credit-related factors. For example, the application has rules to analyze the rating notch movement. A rating downgrade by more than three notches will set the credit loss flag to Yes.
The final step of the process is to compute the Credit Loss Allowance. The present value of expected cash flows is computed in the application. The Effective Interest Rate (EIR) engine provides the capability to discount cash flows using the EIR of the asset.
Allowance for credit loss is computed as the difference between Amortized Cost and the present value of expected cash flows, subject to fair value floor. If Allowance for credit loss is less than the overall impairment, then the decline in fair value due to non-credit factors is recognized in the Other Comprehensive Income (OCI).
NOTE:
If the ECL of an account is calculated using the AFS method, that account will not be considered to calculate the change during Reconciliation.