Allowance for Expected Credit Losses

3 Months Ended

Mar. 31, 2020

Credit Loss [Abstract]

Allowance for Expected Credit Losses

Allowance for Credit Losses

We recognize an allowance for credit losses in accordance with ASC 326 for financial assets held at amortized cost, AFS securities and off-balance sheet commitments. Further discussion of our adoption of ASC 326 on January 1, 2020, including the impact on our consolidated financial statements, is provided in Note 1.

When the allowance is recorded, a provision for credit losses expense is recognized in net income. The allowance for credit losses for financial assets represents the portion of the amortized cost basis, including accrued interest for financial assets held at amortized cost, which management does not expect to recover due to expected credit losses and is presented on the statement of condition as an offset to the amortized cost basis. The accrued interest balance is presented separately on the statement of condition within accrued interest and fees receivable. The allowance for off-balance sheet commitments is presented within other liabilities.

We have elected to not record an allowance on accrued interest for HTM and AFS securities. Accrued Interest on these securities is reversed against interest income when payment on a security is delinquent for greater than 90 days from the date of payment.

The allowance for credit losses may be determined using various methods, including discounted cash flow methods, loss-rate methods, probability-of-default methods, or other methods as determined by us. The method used to estimate expected credit losses may vary depending on the type of financial asset, our ability to predict the timing of cash flows, and the information available to us. We estimate our expected credit losses using the probability-of-default method for the majority of our financial assets and the discounted cash flow method for our structured products portfolio which are

included in investment securities held-to-maturity on the statement of condition.

We measure expected credit losses of financial assets on a collective (pool) basis when similar risk characteristic exist. Each reporting period, we assess whether the assets in the pool continue to display similar risk characteristics.

For a financial asset that does not share risk characteristics with other assets, expected credit losses are measured based on net realizable value, that is, the difference between the discounted value of the expected future cash flows, utilizing the effective interest rate, and the amortized cost basis of the asset. When the asset is collateral dependent, that is, when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral, expected credit losses are measured as the difference between the amortized cost basis of the asset and the fair value of the collateral, adjusted for the estimated costs to sell.

Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods, factors and forecasts then prevailing may result in significant changes in the allowance for credit losses in those future periods.

We estimate credit losses over the contractual life of the financial asset while factoring in prepayment activity where supported by data over a three year reasonable and supportable forecast period. We utilize a baseline, upside and downside scenario which are applied based on a probability weighting, in order to better reflect management’s expectation of expected credit losses given existing market conditions and the changes in the economic environment. The multiple scenarios are based on a three year horizon (or less depending on contractual maturity) and then revert linearly over a two year period to a ten-year historical average thereafter. The contractual term excludes expected extensions, renewals and modifications, but includes prepayment assumptions where applicable.

Loans

We segregate our portfolio of loans held for investment into two portfolio segments, the commercial and financing and commercial real estate loan portfolio segment. These two segments are further disaggregated into loan classes, the level at which we monitor and assess credit risk based on risk characteristics.

We further classify commercial and financing loans as loans to investment funds, senior secured bank loans also referred to as leveraged loans, loans to municipalities, and other. These classifications reflect their risk characteristics, their initial measurement attributes and the methods we use to monitor and assess credit risk. Please refer to Note 4 for additional discussion of the loan portfolio.

Securities

HTM and AFS investment securities are assessed for credit loss based on the security type discussed in Note 3. We monitor the credit quality of the HTM and AFS investment securities through the use of credit ratings on a quarterly basis. As of March 31, 2020, 99% of our HTM and AFS investment portfolio is considered investment grade.

Other Assets

The remainder of our financial assets held at amortized cost are disaggregated based on product type. We assess credit risk based on the entire balance within fees receivable.

Securities purchased under a resale agreement and securities-financing within our principal business utilized the collateral maintenance provisions included within ASU 2016-13, Financial Instruments - Credit Losses (ASC 326): Measurement of Credit Losses on Financial Instruments. An allowance for credit losses is recognized for any remaining exposure based on counterparty type.

Off-Balance Sheet Credit Exposure

The allowance for credit losses for off-balance sheet credit exposures, recorded in accrued expenses and other liabilities in our consolidated statement of condition, represents management’s’ estimate of credit losses primarily in outstanding letters and lines of credit and other credit-enhancement facilities provided to our clients and outstanding as of the balance sheet date. The allowance is evaluated quarterly by management. Factors considered in evaluating the appropriate level of this allowance are similar to those considered with respect to the allowance for credit losses on financial assets held at amortized cost. Provisions to maintain the allowance at a level considered by us to be appropriate to absorb estimated credit losses in outstanding facilities are recorded in the provision for credit losses in our consolidated statement of income.

Credit Quality

Credit quality for financial assets held at amortized cost are continuously monitored by management and is reflected within the allowance for credit losses. The allowance for credit losses as reported in our consolidated statement of condition is adjusted by provision for credit losses, which is reported in earnings, and reduced by the charge-off of principal amounts, net of recoveries.

We use an internal risk-rating system to assess our risk of credit loss for each financial asset. The risk-rating process incorporates the use of risk-rating tools in conjunction with management judgment. Qualitative and quantitative inputs are captured in a systematic manner and following a formal review and approval process, an internal credit rating based on our credit scale is assigned.

When computing allowance levels, credit loss assumptions are estimated using a model that categorizes asset pools based on loss history, delinquency status and other credit trends and risk characteristics, including current conditions and reasonable and supportable forecasts about the future. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. In future periods evaluations of the overall asset portfolio, in light of the factors and forecasts then prevailing, may result in significant changes in the allowance and credit loss expense in those future periods.

Credit quality is assessed and monitored at least annually, by evaluating various attributes in order to enable the earliest possible detection of any concerns with the customer’s credit rating. The results of those evaluations are utilized in underwriting new loans and transactions with counterparties and in our process for estimation of expected credit losses.

In assessing the risk rating assigned to each financial asset held at amortized cost, among the factors considered are the borrower’s debt capacity, collateral coverage, payment history and delinquency experience, financial flexibility and earnings strength, the expected amounts and source of repayment, the level and nature of contingencies, if any, and the industry and geography in which the borrower operates. These factors are based on an evaluation of historical and current information, and involve subjective assessment and interpretation. Credit counterparties are evaluated and risk-rated on an individual basis at least annually.

Management regularly reviews financial assets in the portfolio to assess credit quality indicators and to determine appropriate loans classification and grading in accordance with applicable bank regulations. Our internal risk rating methodology assigns risk ratings ranging from Investment Grade, Speculative, Special Mention, Substandard, Doubtful and Loss.

• Investment Grade. Assets consisting of counterparties with strong credit quality and low expected credit risk and probability of default. Ratings apply to counterparties with a strong capacity to support the timely repayment of any financial commitment. Approximately 83% of our loans were rated as investment grade as of March 31, 2020 with external credit ratings, or equivalent, of "BBB-" or better.

• Speculative. Assets consisting of counterparties that face ongoing uncertainties or exposure to business, financial or economic downturns. However, these counterparties may have financial flexibility or access to financial alternatives, which allow for financial commitments to be met. Assets rated as

speculative, which is approximately 17% of our loans as of March 31, 2020, primarily comprises our senior secured loans. Approximately 84% of those senior secured loans have an external credit rating, or equivalent, of "BB" or "B" as of March 31, 2020.

• Special Mention. Assets consisting of counterparties with potential weaknesses that, if uncorrected, may result in deterioration of repayment prospects.

• Substandard. Assets consisting of counterparties with well-defined weakness that jeopardizes repayment with the possibility we will sustain some loss.

• Doubtful. Assets consisting of counterparties with well-defined weakness which make collection or liquidation in full highly questionable and improbable.

• Loss. Assets which are uncollectible or have little value.

The following tables present our recorded investment in each class of loans by credit quality indicator as of the dates indicated:

March 31, 2020	Commercial and Financial		Commercial Real Estate		Total Loans
(In millions)
Investment grade	$	25,075	$	1,815	$	26,890
Speculative	5,413		—		5,413
Special mention(1)	64				64
Substandard(2)	12		—		12
Total(3)	$	30,564	$	1,815	$	32,379

December 31, 2019	Commercial and Financial		Commercial Real Estate		Total Loans
(In millions)
Investment grade	$	19,501	$	1,766	$	21,267
Speculative	5,008		—		5,008
Special mention	25		—		25
Substandard	9		—		9
Total(3)	$	24,543	$	1,766	$	26,309

 

⁽¹⁾ Includes approximately $25 million of impaired loans. Please refer to Note 4 for additional discussion of our impaired loans.

⁽²⁾ Includes approximately $10 million of impaired loans. Please refer to Note 4 for additional discussion of our impaired loans.

⁽³⁾ Loans to investment funds Include $8,685 million and $3,256 million of overdrafts as of March 31, 2020 and December 31, 2019, respectively.

The following table presents the amortized cost basis, by year of origination and credit quality indicator as of March 31, 2020. For origination years before the fifth annual period, we present the aggregate amortized cost basis of loans. For purchased loans, the date of issuance is used to determine the year of origination, not the date of acquisition. For modified, extended or renewed lending arrangements, we evaluate whether a credit event has occurred which would consider the loan to be a new arrangement.

(In millions)	2020		2019		2018		2017		2016		2015		Prior		Revolving Loans		Total(1)(2)
Domestic loans:
Commercial and financial:
Risk Rating:
Investment grade	$	4,511	$	438	$	5	$	120	$	200	$	—	$	—	$	12,273	$	17,547
Speculative	340		1,024		976		802		137		—		—		245		3,524
Special mention	—		10		29		25		—		—		—		—		64
Substandard	—		10		—		—		—		—		—		—		10
Total commercial and financing	$	4,851	$	1,482	$	1,010	$	947	$	337	$	—	$	—	$	12,518	$	21,145
Commercial real estate:
Risk Rating:
Investment grade	$	49	$	549	$	711	$	280	$	197	$	29	$	—	$	—	$	1,815
Total commercial real estate	$	49	$	549	$	711	$	280	$	197	$	29	$	—	$	—	$	1,815
Non-U.S. loans:
Commercial and financial:
Risk Rating:
Investment grade	$	3,642	$	—	$	—	$	—	$	—	$	—	$	—	$	3,886	$	7,528
Speculative	596		372		408		184		24		—		70		235		1,889
Substandard	—		—		2		—		—		—		—		—		2
Total commercial and financing	$	4,238	$	372	$	410	$	184	$	24	$	—	$	70	$	4,121	$	9,419
Total loans	$	9,138	$	2,403	$	2,131	$	1,411	$	558	$	29	$	70	$	16,639	$	32,379
Off-balance sheet commitments and guarantees:
Unfunded credit facilities	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	30,971	$	30,971
Indemnified securities financing	376,975		—		—		—		—		—		—		—		376,975
Standby letters of credit	—		—		—		—		—		—		—		3,273		3,273
Total off-balance sheet commitments and guarantees	$	376,975	$	—	$	—	$	—	$	—	$	—	$	—	$	34,244	$	411,219
Total financing receivables and off-balance sheet commitments and guarantees	$	386,113	$	2,403	$	2,131	$	1,411	$	558	$	29	$	70	$	50,883	$	443,598

⁽¹⁾ Any reserve associated with accrued interest is not material.

⁽²⁾ As of March 31, 2020, accrued interest receivable of $76 million included in the amortized cost basis of loans has been excluded from the amortized cost basis within this table.

The following table presents the activity in the allowance for credit losses by portfolio and class for the periods indicated:

	Three Months Ended March 31, 2020
	Commercial and Financial
(In millions)	Senior Secured Bank Loans			Other Loans		Commercial Real Estate		Held-to-Maturity Securities		Off-Balance Sheet Commitments		All Other		Total Credit Reserve
Allowance for credit losses:
Beginning balance	$	61		$	10	$	2	$	—	$	19	$	1	$	93
Charge-offs	(5		)	—		—		—		—		—		(5		)
Provision	27			—		2		4		3		—		36
Ending balance	$	83		$	10	$	4	$	4	$	22	$	1	$	124

Allowance for Loan Losses under Incurred Loss Methodology for the period ended March 31, 2019

The following table presents activity in the allowance for loan losses as of March 31, 2019 under the incurred loss methodology:

(In millions)	Three months ended March 31, 2019
Allowance for loan losses:
Beginning balance	$	67
Provision for credit losses(1)	4
Other(2)	(1		)
Ending balance	$	70

 

⁽¹⁾ The provisions for credit losses were primarily attributable to exposure to purchased senior secured loans to non-investment grade loans

⁽²⁾ Consists primarily of FX translation

Loans are reviewed on a regular basis, and any provisions for loan losses that are recorded reflect management's estimate of the amount necessary to maintain the allowance for loan losses at a level considered appropriate to absorb estimated incurred losses in the loan and lease portfolio.