CECL Prep: Key Changes and Crafting an Implementation Plan.

Transcription

1 CECL Prep: Key Changes and Crafting an Implementation Plan. May 16, 2016 PRESENTED BY Aaron Lenhart Senior Risk Management Consultant Sageworks

2 Disclaimer. This presentation may include statements that constitute forward-looking statements relative to publicly available industry data. Forward-looking statements often contain words such as believe, expect, plans, project, target, anticipate, will, should, see, guidance, confident and similar terms. There can be no assurance that any of the future events discussed will occur as anticipated, if at all, or that actual results on the industry will be as expected. Sageworks is not responsible for the accuracy or validity of this publicly available industry data, or the outcome of the use of this data relative to business or investment decisions made by the recipients of this data. Sageworks disclaims all representations and warranties, express or implied. Risks and uncertainties include risks related to the effect of economic conditions and financial market conditions; fluctuation in commodity prices, interest rates and foreign currency exchange rates. No Sageworks employee is authorized to make recommendations or give advice as to any course of action that should be made as an outcome of this data. The forward-looking statements and data speak only as of the date of this presentation and we undertake no obligation to update or revise this information as of a later date. 2

3 About Sageworks.

4 Agenda. What is CECL? Recent Updates & Timelines Forming An Implementation Committee Importance of Risk Rating How to Prepare 4

5 What is CECL? FASB released proposal December 2012 CECL = Current Expected Credit Loss What s changed from Incurred Loss Model?» Forward-looking requirements» Probable loss threshold removed» Need for accessible, loan-level data» Longer loss horizon» Makes ALLL more institution-wide calculation Purpose: Quicker recognition of losses. Changes in ALLL reserve balances will reflect changes in credit quality and flow through earnings ( Fed Perspectives, 2015) 5

6 CECL Concerns. How are future, life-of-loan losses reasonably predicted? Even more subjective judgment is required Greater regulatory scrutiny Insufficient IT capabilities Lack/inaccessibility of data, especially for smaller credit unions Need to know where we are in the economic cycle 6

7 CECL Concerns. Implies we can identify when a downturn/recovery starts Implies we can predict the severity of a downturn Discourages longer-term lending Qualitative factors Will need to consider both current and future conditions Requires more collaboration between Credit/Finance 7

8 CECL Concerns. More difficult for members receiving financial statements to understand the financials of their credit union Decreased capital because of the increased provisions for loan loss Lack of adequate historical figures to construct a model to forecast expected losses accurately Potential for lower net income levels Source: CUs tell FASB: CECL plan brings excessive costs, decreased capital CUNA, March 23,

9 Recent CECL Updates. 9

10 Feb. 4 FASB Industry Roundtable. Participants from FASB, NCUA, ABA, ICBA, SEC, OCC, Fed, FDIC + more than a dozen financial institutions from $145M to $1.1B Participants were critical of the life of loan concept and voiced a need for more definitions and better examples CUNA President Jim Nussle, following the meeting» To be clear, CUNA does not believe the CECL model is appropriate for credit unions, and we believe the accounting changes of the standard will severely increase credit unions allowances» [The proposal] will result in lower apparent capital ratios at credit unions and banks. 10

11 CECL Transition Resource Group. Members announced on March 22nd:» SVP, CFO of Jeanne D Arc Credit Union $1.1B in assets» CFO at Mission Federal Credit Union $2.7B» EVP of TD Bank $246B» VP, Chief Accountant at BMO Financial Group $104B» Director of Accounting Policy at Wells Fargo $1.6T» Managing Director at Citigroup $1.3T» SVP at First Niagara Bank $39B» President, CEO at Standard Bank $466M Also, representatives from:» Allstate Insurance, KBW, PWC, Grant Thornton, Crowe Horwath, Deloitte, KPMG, EY 11

12 April 1 st Meeting, CUNA Highlights. Proposal s revised language provides additional flexibility, stating that there is no one methodology that entities must use Susan Hannigan noted the revisions are progress toward a workable solution» Allows community financial institutions to evaluate and adjust their loan-loss amounts using qualitative factors, historical losses and current systems Final standard expected by the middle of the year Specifics on the proposal s revised language? 12

13 CECL Implementation Timelines. 13

14 Implementation Planning. Forming an Implementation Committee 14

15 Scope of CECL Implementation. Operational Credit Legal/ Compliance IT Systems Vendor Management Credit Business Lines Mergers & Acquisitions Counterparties Regulatory Reporting Financial Reporting 15

16 Forming An Implementation Committee. Look at how the allowance calculation flows through your credit union and how many areas touch it CFO Strive for senior level representation across all departments CECL will require significant collaboration across functional areas Head of Credit /Lending Workout CECL Committee Risk Officer Audit IT 16

17 Factors to Consider. Methodology Changes Data Requirements Capital Adjustment Historical loss to migration, PD/LGD, vintage analysis Reasonable and supportable forecasts Life of loan expected loss versus one year incurred loss Model validation Internal controls External provider Communication Projected Impact 17

18 Factors to Consider. Methodology Changes Data Requirements Capital Adjustment Building and maintaining a data warehouse Assessing availability and quality of historical data Determining key data needed for calculation Data validation process Report building process Communication Projected Impact 18

19 Factors to Consider. Methodology Changes Data Requirements Capital Adjustment Need to raise additional capital? Timing consideration Member communication Regulatory communication Communication Projected Impact 19

20 Factors to Consider. Methodology Changes Data Requirements Socialization of CECL with board and senior management Periodic meetings Documents read into the minutes Capital Adjustment Communication Projected Impact 20

21 Factors to Consider. Methodology Changes Data Requirements Capital Adjustment Communication Earnings projection due to changes in provision Peer comparisons will change Asset and liability management Stress testing Loan pricing Underwriting guidelines Segment lending limits Projected Impact 21

22 Implementation Planning. Strengthening Risk Rating Procedures 22

23 Risk Rating Systems. Forms the basis for broader risk management practices:» Risk-based loan pricing» Calculating the reserve» Stress testing» Strategic planning for the institution Insight into portfolio risk for:» Management team» Board» Auditors 23

24 Internal System Requirements. 1. Granular Number of ratings will depend on the credit union s portfolio, but should be sufficiently granular that loans do not pool in one or two ratings. 2. Transparent Credit union staff and examiners should be able to review and distinguish between risk ratings. Both parties should be able to risk rate a loan independently and arrive at the same rating. 3. Objective The risk rating matrix will only be valuable if the personnel responsible for risk rating a loan are external to the lending process (someone other than the lender, for example). 24

25 Determining a Risk Rating Scale. Total number of ratings will vary, anywhere from 5 to 10 grades PASS SPECIAL MENTION SUB- STANDARD DOUBTFUL LOSS Largely risk free Low risk Minimal risk Modest risk Additional review Criticized Classified Classified Classified The granularity in pass loan categories is where credit unions typically differ 25

26 Determining a Risk Rating Scale. More commonly, loans are pooled in too few categories PASS SPECIAL MENTION SUB- STANDARD DOUBTFUL LOSS Largely risk free Low risk Minimal risk Modest risk Additional review Criticized Classified Classified Classified 26

27 Establishing Rating Criteria. Capacity Debt Service Coverage (Proposed & Historical) Interest Coverage Sensitivity of the Business to Change in Income Sensitivity to Interest Rate Risk Business Credit Score Lease Terms / Customer Base Capital Current Ratio Debt to Equity Tangible Net Worth Dimensions Collateral Loan to Value Collateral Quality (variability of value, easy to liquidate) Factors Conditions Member s Skills Industry Performance (Current ratio, DSC, NPM) Comparison to Industry (Financial & Product Line) Character Member s Financing Alternatives Management of the Business Guarantor's Credit Score (and others?) Tangible Net Worth of Guarantors 27

28 Building a Matrix. Capacity 35% Capital 15% Collateral 10% Conditions 15% Character 25% Proposed Debt Service Coverage 20% Historical Debt Service Coverage 20% Sensitivity of the Business to Change in Income 10% Sensitivity to Interest Rate Risk 10% Business Credit Score 10% Lease Terms / Customer Base 30% Current Ratio 40% Debt to Equity 40% Tangible Net Worth 20% Loan to Value 25% Collateral Quality 75% Member s Skills 20% Industry Current Ratio 20% Industry DSC 20% Industry NPM 20% Comparison to Industry 20% Member s Financing Alternatives 25% Management of the Business 25% Guarantor's Credit Score 25% Tangible Net Worth of Guarantors 25% 28

29 Calculating Risk Rating Score. RAW SCORE WEIGHT RAW SCORE CAPACITY X 35% = CAPITAL X 15% = COLLATERAL X 10% = CONDITION X 15% = CHARACTER X 25% = Final Raw Score = < >570 29

30 CECL Prep: What to do Now. 30

31 CECL Poll. When will you start CECL preparations? Prior to enforcement date Already planning Don't know 1% 10% When CECL is finalized When examiners require it 12% 45% 32% 31

32 2016: Create Roadmap. Key Action Items Build committee Set project plan Review final CECL language Inform board & management of committee/alll changes Examine data/current processes 32

33 Key Takeaways. Minimize risk in loans you re underwriting today Avoid the temptation of simply adapting your current methodology Reduce dependency on spreadsheets Start cross-department conversation now, including Credit and Finance Review/strengthen risk rating procedures Capture, archive and incorporate loan-level detail into the ALLL 33

34 Contact Information & Questions. Aaron Lenhart Senior Risk Management Consultant Risk Management Summit Sept in Austin, TX ALLL & Stress Testing Conference CECL Prep: Data Guide web.sageworks.com/cecl-prep-guide-data/ 34