FIFO 5 (referred to by FASB as “View A”): determines lifetime based on the application of all future payments to the current balance until it is extinguished.FASB has tried to take the appropriate steps to make the standard applicable on this issue by providing two main choices: It is based on expected payments after interest and fees have been paid. The key lifetime metric is the time it takes to run off a current outstanding balance. For the initial implementation of the allowance on credit cards, let’s first review some of the key elements that can be considered when determining “contractual lifetime.” For institutions looking for a simple yet robust approach: there is no “easy” button! We dissect the problem and attempt to provide a low-ingredient, theoretical recipe that allows institutions to start thinking about their own approaches. The industry as a whole is still struggling with the application of the CECL standard as it pertains to credit cards. ASU 2016-13 3 states: “… An entity shall estimate expected credit losses over the contractual term of the financial asset(s) …” – meaning that for assets without contractual maturities, the contractual life must be determined by using analytical approximation in some fashion. In this paper, we address the determination of the contractual lifetime value for credit card portfolios and similar assets that do not have a preset maturity date. However, for smaller institutions (less than $1 billion), the old method can remain largely intact, modified to account for the incremental CECL requirements. This longstanding practice is about to be impacted significantly. ![]() According to the FDIC Credit Card Activities Manual 2 the typical range of methodologies includes roll-rate, average charge-off methods, vintage analysis, regression analysis, and portfolio liquidation method. It can be less if an issuer can reasonably document that the life of the portfolio is less than 12 months. Under Generally Accepted Accounting Principles (GAAP) (FAS5 1), the standard practice for calculating allowances is to estimate projected losses over the next 12 months. It introduces reasonable and supportable forecast conditions, and requires the recognition of lifetime expected credit losses at origination or date of purchase. CECL is also based on historical and current information, but removes the “probable” threshold. The incurred model was based on current and historical conditions only, recognized losses over a loss emergence period, and only after the probable threshold was met. More granular disclosures of the potential risk in a bank’s portfolio are also expected.ĬECL replaced the previous incurred loss impairment model. ![]() Intended to improve financial reporting, it requires earlier recognition of expected credit losses for assets measured at amortized cost. In June 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, known as the current expected credit loss (CECL) standard.
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