Taking a qualitative approach and doing no discounted cash flow calculations produced a calm CECL debut for at least one investment manager.
At a recent NeuGroup meeting, the only investment manager whose company adopted the new accounting standard for estimating credit losses in the first quarter described a relatively painless process, giving comfort to some of his peers. The meeting, sponsored by BlackRock, included a presentation by Aladdin on FASB’s current expected credit losses (CECL) methodology. Aladdin offers risk management software tools and is part of BlackRock.
Qualitative vs quantitative. Among the CECL decisions facing corporates is whether to assess their credit investment portfolio on a qualitative basis or to use a quantitative approach that requires the use of models and, often, discounted cash flow (DCF) analysis. One of the Aladdin presenters said clients with larger portfolios often do a quantitative analysis or combine it with a qualitative approach.
- The NeuGroup member whose company adopted CECL uses a qualitative method as an initial screen; if the qualitative assessment indicates that a security is “not money good,” then a quantitative assessment will be performed. The company’s accountants are comfortable with this approach, he added.
- In response to a question, the member said that in the event of needing to do a DCF analysis he will have Clearwater run the analysis. In practice, this is unlikely because any security with a credit loss will likely have been out of compliance and sold, he said.
- The investment manager said his portfolio assessment includes making sure that every security is investment grade and then looking closely at any “outliers” that have dropped below a certain price level. He receives feedback and guidance from external managers when an issuer is downgraded. “Is it still money-good” is what he wants to know.
- One investment manager said the perspective offered by the member who doesn’t expect to have to do any DCF analyses provided some relief. “The additional work may not be as bad as I thought it would be,” he said.
- Another member of the group would like to see a survey showing if peers are taking a quantitative or a qualitative approach. He said the qualitative process described earlier “doesn’t sound vastly different from an “OTTI regime,” referring to the other-than-temporary impairment approach used to account for credit losses before the adoption of CECL.
Adverse or severe? Companies using models as they adopt CECL face other decisions, including which economic scenario to use—particularly challenging given the uncertainty created by the COVID-19 pandemic. An Aladdin presenter said the relevant scenarios today include:
- Severely adverse
The presenter said most, but not all, of the companies he’s seen are using the adverse scenario assumptions. That surprised at least one member who has run scenarios in preparation to adopt CECL. He said, “We asked ourselves, if this isn’t severe, what is?”
- That same member, in response to a question about what his scenario testing had revealed, said it was “super interesting to watch.” He said the company initially had no credit losses on its books; “now, suddenly it’s everywhere.” An Aladdin presenter later said CECL could have an impact on earnings for some companies that have adopted the standard.
Final thoughts. That said, the member whose company has adopted CECL said that “our general stance is that CECL is not targeted to us,” a sentiment that echoed statements heard in at least one of the meeting’s earlier breakout sessions on projects and priorities, where CECL was deemed “sort of a non-event for everyone,” as the NeuGroup leader in the group described it. We’ll see if that sentiment holds up through the next few quarters.