Allowance for Credit Losses (ACL) Summary – Accompanies the Current Expected Credit Loss (CECL) directive issued by the FASB

Share this post:

On February 20, 2020, the four US Banking regulators (OCC, FRB, FDIC and NCUA) issued the final policy statement for the financial institution adoption of CECL, the FASB (ASU 2016-13) change from an incurred loss (IL) reserving methodology to an expected loss (EL) methodology. This methodology is a forward looking reserve determination and is calculated by using rules applied to a calculation engine (model). This document is intended to focus on the ACL and will reference CECL as is appropriate.

By and large, the regulators have issued the ACL so that it does not vary from the CECL standards. A principal difference is that the ACL identifies the roles and responsibilities of the Board of Directors and Management, documentation as well as directing analysis and validation of the ACL model. These will be summarized first followed by the specific areas cited in the ACL document.


It is important to have the financial assets categorized by their accounting definition. Examples are listed in FASB Topic 326.

  • Describe the measurement of EL in line with FASB Topic 326 for
    • Loans held-for-investment (loan portfolio)
    • Off-balance-sheet (OBS) credit exposures
    • Overdrawn deposit accounts
    • Net investment in leases
    • Held-to-maturity (HTM) investments
    • Other – Other income, Reinsurance recoverables, Repurchase agreements
  • Financial assets not covered
    • Financial assets measured at fair value through net income
    • Available-for-sale debt securities
    • Loans held-for-sale
    • Insurance policy receivables
    • Loans and receivables between entities under common control
    • Operating lease receivables
  • Outline the design, documentation, and validation of the ACL process including
    • Internal controls
    • ACL maintenance
    • Board of Director Responsibilities
    • Management Responsibilities
    • Examiner reviews

Board of Directors (or a Board level committee) Responsibilities

  • Overseeing management’s significant judgments and estimates through the following activities;
    • Ensure there is qualified management to oversee all ACL and Provision for Credit Losses (PCL). ACL is balance sheet and PCL is income statement.
    • Reviewing and approving written policies at least annually
    • Reviewing management’s assessment of the loan review system and management’s conclusion and support for whether the system is sound and appropriate for the institution
    • Reviewing management’s processes and controls for credit quality
    • Reviewing management’s assessment and justification for the ACL and PCL
    • Requiring management to periodically validate the ACL and PCL methodology. This should be done by someone other than the institutions external auditor.
    • Approving internal and external audit plans for the ACL. Reviewing audit findings and monitor resolution of the audit items.

Management Responsibilities

  • Maintaining the ACL at appropriate levels and for documenting the analysis in accordance with GAAP and regulatory reporting requirements. This is the life of loan concept.
  • This must be done at the end of each period (most likely quarterly)
  • No specific approach is recommended and there are several to choose from.
    • Smaller FI’s will choose simpler methods (Weighted Average Remaining Maturity, WARM) and larger FI’s will choose a multistep process (cumulative loss + forecast + reversion, as an example)
  • Management’s evaluations will be reviewed by the examiners, which steps up the level of documentation and support.
  • Adopt written policies and procedures
  • Establish appropriate governance activities such as;
    • Review and challenge assumptions
    • Executing effective internal controls
  • Periodically compare credit loss estimates to actual write-offs at the portfolio and aggregate levels to confirm the ACL is sufficient to cover actual credit losses.
  • Periodically validate the loss estimation process. This should not be performed by external audit.
  • Engage in sound risk management of third parties involved in ACL estimation process.
  • Evaluate loss estimation models before they are deployed.
  • Document evaluations and conclusions.
  • Review policies and procedures at least annually.


Documentation Standards

ACL’s and PCL’s must be determined in accordance with GAAP.

  • ACL’s and PCL’s should be well documented, with clear explanations of the supporting analyses and rationale.
  • Describe management’s processes for evaluating credit quality and collectability, including reasonable and supportable forecasts about changes in credit quality.
  • Document processes that support the determination and maintenance of the ACL
  • Identify the roles, responsibilities and segregation of duties of senior management and others who are involved.
  • Process for determining the appropriate historical periods to use as a basis for estimating credit losses.
  • Process for addressing credit losses beyond the reasonable and supportable forecast.
  • Process for segmenting financial assets by similar risk characteristics.
  • Data capture and reporting systems
  • Description of the FI’s systematic and logical loss estimation processes, including
    • Management’s judgments, accounting policy elections
    • Determining when a loan is collateral-dependent
    • Determining fair value of collateral
    • Determining when a financial asset has zero credit loss expectations
    • Determining when a financial asset has collateral maintenance requirements (margin account, for example)
    • Description of qualitative factor support
  • Procedures for periodic independent review and validation
  • Write-off policies and procedures
  • Internal controls


Specific Topics

  • EL should be evaluated on a collective (pool) basis when financial assets share similar risk characteristics
  • Methods include loss-rate method (WARM, Vintage, Snapshot), PD/LGD, Roll-rate method, DCF method, Aging schedules, or another reasonable method for estimating credit losses.
  • Contractual term includes expected prepayments. Renewals, extensions and modifications are excluded from the contractual term unless there is a reasonable expectation of executing a TDR.
  • Historical information may be based on internal and/or external information and may be quantitative or qualitative.
  • Reasonable and supportable forecasts relevant to assessing the collectability of cash flows. Management is not required to incur undue cost and effort to collect data.
  • Reversion occurs when the contractual term extends beyond the forecast. Reversion typically refers to using historical loss rates.
  • Qualitative Factors (QF’s) are still to be used. Nine are still recommended, with additional ones for HTM securities. However, the QF may be included in the quantitative model and should be used only for unexpected events.
  • Collateral-dependency refers to a financial asset for which repayment will be provided through the operation or sale of the asset. For the ACL, the fair value of the collateral is the basis for measurement.
  • Troubled Debt Restructurings (TDR’s) can be estimated on the collective or individual basis.
  • Purchased Credit-Deteriorated Assets (PCD’s) are established at acquisition.
  • Financial assets with collateral maintenance agreements.
  • Accrued Interest Receivable is included in the amortized cost basis of a financial asset.
  • Financial assets with zero credit loss expectation such as Treasuries, and guaranteed mortgage-backed securities.
  • Off-Balance-Sheet Exposures are now measured over the contractual period of the credit. This ACL is recorded as a liability.
  • Available-for-Sale debt securities are measured using DCF. Credit loss occurs when fair value is less than the amortized cost.







John Hurlock

Executive Consultant

CEIS Review, Inc