Exam Procedures

The scope of review on the ACLLL account will depend on the size and complexity of a credit union’s loan portfolio. Generally, examiners will review the CECL methodology and the credit union’s compliance with full and fair disclosure requirements as defined in NCUA regulation § 702.113, Full and fair disclosure of financial condition. Additionally, management should be able to explain to examiners the application of life-of-loan concept in their CECL methodology.

In general, a best practice is to assess the ACLLL account after completing the credit risk review, particularly the delinquency and collection reviews. The following factors can all impact the adequacy of the allowance account balance:

  • Increasing or decreasing loan losses or delinquencies

  • Environmental factors (for example, micro and macroeconomic) impacting loans

  • Concentrations of certain loan types

  • New loan products

  • Delinquent loans requiring credit loss evaluation

Examiners may use the steps below to guide and document their review.

Prerequisites

  1. Review any EIC scope directives, either communicated via email or within the scope module. Related directives may include follow-up on any identified performance trends and prior exam concerns.

  2. Review the preceding examination report, the most recent audit report and any relevant internal audit reports for any findings or concerns related to the ALLL (before the transition) or to the ACLLL account. Audit workpapers may provide additional insight regarding GAAP compliance and the allowance policy. Issues identified in these reports or workpapers may require expanding the scope of your review to follow up on resolution.

  3. Review the Asset Quality Ratios and the Credit Loss Expense/Average Assets Ratio, formerly the PLLL/Average Assets Ratio, in Financial Analytics. Material changes in the asset quality ratios typically impact the required funding in the ACLLL account. The Credit Loss Expense/Average Assets Ratio will show the level of adjustments that the credit union has made to the ACL throughout the year. If the credit union is reporting loan losses each quarter but no CLE, this could be indicative of an overfunded or underfunded ACLLL account. While an overfunded ACLLL account may not seem like a problem, it is essentially understating the credit union’s net income for that period. Absent an overfunded ACLLL account to absorb current credit losses, the credit union would have had to fund the account through current earnings, resulting in a lower return on assets. Similarly, an underfunded ACLLL account also understates the credit union’s net income for that period and could signal deeper concerns about management purposely misstating income.

  4. Review the mathematical accuracy of the allowance methodology.

  5. Evaluate the ACLLL account in relation to delinquency and charge-off trends; note that the life-of-loan concept will likely increase this ratio, as compared to the allowance methodology.

  6. Review the Equity and Reserves Reconciliation tab of the MERIT analytics and determine if the ACL section indicates an out of balance error in the ACLLL.

  7. Notify examiners assigned on other loan review areas about any underwriting and collection deficiencies.

    1. Obtain a collective assessment of areas reviewed when an exam involves regional and other lending specialist for Credit Risk scope items.

    2. Verify that management promptly charges off uncollectible loans as discussed in Letter to Credit Unions 03-CU-01, Loan Charge-off Guidance.

    3. Verify the credit union has an effective loan review system and controls, commensurate with the complexity and risk of the loans. For more information, visit the Commercial Loan Administration topic in the Examiner’s Guide Commercial and Member Business Loans section of the Loans chapter.

    4. Verify that the credit union appropriately funds the ACLLL account before paying dividends as required by NCUA regulation § 702.113(d)(3). Obtain this information from the EIC or by reading board minutes.

People to Interview

Depending on a credit union’s asset size and complexity, the organizational chart may include various staff involved with implementing the approved CECL policy and methodology. Generally, the following staff will have responsibility for the ACLLL account.

  • CEO or Credit Union Manager

  • Chief Financial Officer

  • VP of Accounting

  • Accounting Manager

Examiners may also consider discussing the ACLLL account with the CLO, Lending Manager, and Collections Supervisor. These individuals often serve on credit union committees that evaluate the ACLLL account.

Documents to Review

  1. CECL Policy—Adequacy of policy

    1. Determine if the complexity and scope of the credit union’s ACLLL account evaluation process is appropriate given the size and complexity of the credit union’s lending activities

    2. Determine if the CECL methodology policy includes:

      • Segmenting loan pools based on similar risk characteristics, including overdrawn share accounts of all types (for example, courtesy pay)

      • Evaluating individual loans determined to be credit impaired, including borrowers experiencing financial difficulty

      • Using historical loss rates reasonable for the loan portfolio segment

      • Making qualitative (and environmental) adjustments identified by credit union management including adjustments for current conditions and reasonable and supportable forecasts

      • Creating and retaining support to document decisions, assumptions, data, and other important items

      • Establishing thresholds for determining status of nonaccrual of interest and loan charge-off

    3. Verify that the CECL methodology is a comprehensive, adequately documented, and consistently applied analysis of the credit union's loan and lease portfolio

    4. Review the reasonableness of:

      • Written processes to identify borrowers experiencing financial difficulty

      • Credit risk rating systems used to evaluate individual loans for credit impairment

    5. Review the CECL policy for compliance with GAAP

  2. Independent validation—Evaluate the credit union’s process for independently validating (by internal and/or external experts) the CECL methodology

  3. ACL movements—Review negative CLE account balances, if applicable

    1. A negative CLE balance occurs when the allowance account estimate is less than the allowance balance per the general ledger. In this instance, an entry debiting or reducing the ACLLL account and a corresponding credit to the CLE account occurs

    2. Credit unions may record negative CLE entries because allowance estimates decline as evidenced by declining delinquency and charge-off rates, though this position may be contrary to expected future conditions

    3. Management assumptions regarding qualitative factors and improved asset quality may contribute to changes in the CLE; for example, lower charge-offs and fewer nonperforming loans

  4. CECL Execution—Evaluate the ACL assessment or analysis as of the examination’s effective date

    1. Verify the credit union’s CECL methodology complies with board-approved written policy

    2. Review the credit union’s ACL calculation for accuracy

      • Determine the accuracy of loss rates, loan balances, and related ACL reserves for each segmented loan pool

      • Evaluate supporting documentation for any qualitative factors and assess for reasonableness—reasonableness includes assessing the logical connection within the qualitative factor of cause and effect and the probability of the effect

    3. Determine if the ACLLL account is appropriately funded by comparing the ACLLL account balance to the amount shown in the related ACL calculation

  5. CECL implementation—Evaluate the day-one adjustment to undivided earnings (retained earnings), if applicable, for compliance with GAAP (ASC 326-10-65-1(c))

Current Expected Credit Loss Questions to Consider

  1. Understanding—Why did management select their CECL methodology?

    1. What assumptions and data are important for accurate results and where do they come from?

    2. How did management change or refine the model for better results or more accurate results?

    3. Why is the segmentation of loans reasonable? (Are risks or characteristics of segments similar?)

    4. Is the data appropriate (relevant) for an accurate estimate?

    5. Does the reasonable and supportable forecast support the accuracy of the CECL estimate?

    6. How are prepayments used by the CECL estimate and are the related assumptions reasonable?

  2. Evaluating—Is the method of measurement appropriate and reasonable?

    1. Is the model’s documentation robust?

    2. Is the input data reliable?

    3. Is third-party data used appropriately for determining estimates? For instance, if an external prepayment study is used to develop WARM factors, does the study contain appropriate variables?

    4. Are assumptions reasonable to determine lifetime losses?

    5. Do adjustments to modeled outputs produce a more accurate estimate?

    6. Do qualitative adjustments reflect the current conditions and reasonable and supportable forecasts not already reflected in the historical loss information?

    7. Are judgments consistently applied across the model?

    8. Does bias exist within the estimate?

  3. Executing—Is credit union staff able to explain any increasing or decreasing ACLLL account trends? If so,

    1. Does the explanation sound reasonable?

    2. Is it supported by documentation?

    3. Is it confirmed by review of other scope items within the Credit Risk section?

  4. Trends—Is CLE to the ACLLL keeping pace with NCO trends? If not, why?

  5. Portfolio changes—If the credit union implemented any new loan programs, did the credit union consider any qualitative (or environmental) adjustments, given the lack of historical loss ratios?

Intersections & Implications

During the exam, an examiner makes every effort to fully understand a credit union’s methodology for determining the appropriate balance in its ACLLL account. Examiners may consult with credit union management and any outside accountant or auditor that advised senior management on the CECL methodology, policy, or practices.

A credit union's CECL policy should clearly state when an adjustment to the ACLLL account is not required based on an immaterial amount or percentage. The decision to establish a limit should consider the impact on income and net worth.

If an examiner concludes that the ACLLL account balance is not appropriate or determines that the CECL methodology is deficient, the exam report must include corrective action to address these deficiencies. NCUA regulations require federally insured credit unions to follow GAAP when filing financial reports. For specific financial statement disclosure requirements, refer to NCUA regulation § 702.113(b), Full and fair disclosure implemented. Credit unions must submit a corrected Call Report upon notification or the discovery of a need for correction. Refer to NCUA regulation § 741.6(a)(2), Financial and statistical report.

The review of the ACLLL account intersects with nearly every component of the credit risk review. Accordingly, the ACL review requires adequate time to assess that the account is fully funded in accordance with the credit union’s policy and GAAP, and that the account reflects the actual, current risk in the loan portfolio.

Last updated on August 25, 2023