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How CECL Impacts AFS and HTM Debt Securities

HTMvsAFSBlog-288687-edited

Collaborating author: Tracy Abruzzo

As CECL’s effective date draws nearer, many now recognize that CECL requires an estimate of the expected credit losses over the life of the instrument be recognized on Day 1 and subsequent reporting dates as a credit loss with the recognition of a corresponding Allowance for Credit Losses (ACL).

Financial institutions may not realize that under CECL, credit loss measurement differs depending on the debt security’s classification.  Debt securities are classified as Held-To-Maturity (HTM), Available-For-Sale (AFS) or Trading based on management’s investment intent. For the purpose of this blog we will focus on the difference between HTM and AFS debt securities. HTM debt securities are recognized on the balance sheet at amortized cost while AFS securities are recognized on the balance sheet at fair value. 

AFS securities are not technically in the scope of CECL, but the FASB used this opportunity to clarify the impairment guidance for them as well. The credit loss recognized on AFS debt securities will be limited to the difference between the security’s amortized cost and fair value. In other words, FASB established a fair value “floor” for AFS debt securities when recognizing credit losses. There is no such floor for HTM debt securities.  

We put together the below table to help you quickly understand how CECL impacts AFS and HTM debt securities:

Description HTM AFS
Asset measurement Amortized cost (no change from current accounting)

Fair value (no change from current accounting)

Credit loss measurment Lifetime expected credit losses Amount by which the present value of expected future cash flows is below the asset’s amortized cost (no change from current accounting)
Credit loss recognition Recognize entire credit loss through earnings and ACL Recognize credit loss through earnings and ACL but limited to the fair value of the asset

 

The discrepancy between AFS and HTM begs the question: Why did FASB establish a floor for credit loss recognition for AFS debt securities but not for HTM debt securities? Put simply, an AFS debt security can be sold at fair value to avoid realization of a credit loss so there is no economic sense in writing the security down below its realizable value.

For HTM debt securities, CECL changes the measurement of credit losses and requires that the entire credit loss be recognized through earnings with a corresponding ACL. The differing recognition limit introduced in CECL is supported by the difference in the measurement attributes of the different security asset classifications.

Ultimately, financial institutions will likely consider the fair value floor concept for AFS debt securities a benefit as it may result in a lower credit loss charge to earnings. Institutions will need to be wary of applying any CECL process developed for HTM securities to AFS securities.

 

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About Author

Keith St. Germain
Keith St. Germain

Keith St. Germain is a Director at CrossCountry Consulting. Keith has over 13 years of consulting experience, focusing on performance improvement within the Financial Services industry. This includes finance transformation, business process re-design, organizational and target operating model assessments, organizational change management and regulatory requirement responses. Click here to read Keith's full bio.

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