“According to the OCC, of the $4.1 trillion in Shared National Credits commitments most recently outstanding, fully half matures in Years Four and Five; nearly 10% matures even later.”
This past June the Federal Accounting Standards Board (FASB) released the Accounting Standards Update 2016-13 — the major reform of how financial institutions will calculate loss allowances for most of their financial assets. Under the standard, financial institutions and others will move away from the longstanding incurred loss model to a new model called Current Expected Credit Loss (CECL).
Unprecedented Estimated Loss Determination
This revolutionary change will involve all banks, credit unions and other entities that report under U.S. Generally Accepted Accounting Principles (GAAP) and that extend credit. It will require the reporting entity to make unprecedented and continual Estimated Loss determinations on Commercial and Industrial (C&I) portfolios, along with its other assets, over as long a time frame as the reporting entity expects to hold them. For banks, this will mean the life of the loan or the loan pool.
In most cases, larger banks will want to use a familiar formula in judging C&I obligors and pools: Estimated Loss = Probability of Default x Loss Given Default; or, EL = PD x LGD. If banks cannot make “reasonable and supportable forecasts” that meet CECL standards by using this formula or other approved default models, they will need to revert to the use of appropriate loan-loss statistics, which will impose an even heavier burden on the bank.
A Scalable Solution for Implementing CECL
Due to the extraordinary challenges that banks will have to meet under the new standard, Rapid Ratings has introduced a solution for meeting CECL’s requirements. The Rapid Ratings CECL solution provides a quantitatively-derived Term Probability of Default series on tens of thousands of public and private non-financial companies in global coverage. Term PDs are updated as often as each company reports publicly or directly to us and include yearly projections going out 10 years.
Addressing the Private Company Loan Universe
Rapid Ratings is unique in its offering of Term PDs for private companies – a much larger universe on which institutions will be required to report and where solutions are lacking. Rapid Ratings calculates private company Term PDs using the exact same methodology and inputs as with public companies, providing the highest level of accuracy and consistency. Due to the confidential nature of private company financials, our clients receive private ratings only on those companies on which they provide us with financials or we solicit on their behalf.
Quantitatively-Derived Financial Health Ratings
Our Financial Health Ratings (FHRs®) are based exclusively on proven metrics using the company’s income, cash flow, and balance sheet statements. We use 22 separate, industry-specific models on non-financials, without size or geographic bias, thus differentiating Rapid Ratings from other providers that use country-specific, industry-agnostic models on private companies. Additionally, our firm takes no ratings fees or guidance from any company in coverage to ensure complete objectivity. The quantitative and objective nature of our ratings makes implementing CECL scalable to any C&I loan book. Our PD offering will make it easy for small and mid-sized banks, as well as larger banks, to be able to implement the PD x LGD model on C&I portfolios of any description.