Current Expected Loss Model: A Practical Implementation Approach for Community Banks
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1 Current Expected Loss Model: A Practical Implementation Approach for Community Banks David Heneke, CPA, CISA, Principal Liz Rider, CPA, Principal Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC registered investment advisor.
2 What We Hope You Take Away High level understanding of the standard s requirements Implementation timelines Possible model options Most importantly, less confusion and fear about the implementation of this standard than when you walked in this room 2
3 The Standard ASC 326 Financial Instruments Credit Losses: Measurement of Credit Losses on Financial Instruments 3
4 CECL Overview Issued June 16, 2016 Measure expected losses over life of loan _C&pagename=FASB%2FDocument_C%2FDocument Page&cid=
5 ALLL Amount Unadjusted historical lifetime loss experience Plus or minus: Q Factor adjustments Plus or minus: adjustment for reasonable and supportable forecasts Equals: ALLL 5
6 Implementation Timeline How Far Along Do I Need to Be and Who Needs to Be Involved? 6
7 Effective Dates for Banks with Calendar Yearends Entities Document(s) Effective date SEC filers 10 Q and Call Report March 2020 Non SEC public business entities All other entities Call Report March 2021 Financial statements and Call Report December
8 Public Business Entity Public Business Entity Conclusion Current evaluation Re evaluation Need procedures to support initial conclusion and update annually, or more frequently if circumstances require 8
9 Public Business Entity Entities not meeting the definition of a Public Business Entity Almost all credit unions Mutuals S Corporations with contractual agreements restricting sale or transfer to preserve the S Corp election Most banks with assets under $500 million 9
10 CECL Implementation Approach PHASE 1 CREATE ROADMAP Review CECL Standard (ASU ) in Detail Board and Management Education Establish a Multi discipline CECL Implementation Committee Determine PBE Status/Effective Date for Institution Establish a Project Plan Examine Data Resources and Challenges and Processes 10
11 CECL Implementation Approach PHASE 2 MODELING AND SCENARIOS Identify Scenarios and Modeling Options Develop Data from Internal and External Sources Validate Data Parallel Models 11
12 CECL Implementation Approach PHASE 3 FINAL MODEL AND VALIDATION Identify Relevant Data Narrow Model Selection Identify Final CECL Model Approach Validate Model Results PHASE 4 POST IMPLEMENTATION (CONTINUOUS) Monitor Model Performance Backtest Model Results Refine Model Input and Calculations 12
13 Bank Personnel to Include Chief Financial Officer Chief Risk Officer/Chief Audit Executive Chief Lending Officer Chief Information Officer 13
14 Example Timeline Establish an implementation timeline June 2016 to June 2017 Develop Implementation Plan June 2016 to June 2018 Model Evaluation and Data Retention June 2018 to June 2020 Model Selection and Application June 2020 to January 2021 Finalization and Validation Note: Example dates are for non PBE 14
15 Should the Bank Increase its ALLL in Anticipation of CECL? 15
16 Model Selection How Do I Decide What Model to Use? 16
17 Available Methods Very flexible Choice of methods include: Loss rate methods Probability of default and loss given default Migration analysis Vintage analysis Any reasonable approach or approaches may be used guidance is not prescriptive. 17
18 Let s Look at Live Data We are going to look at three example models based on a real bank s loan data: Static Pool/Migration Analysis Vintage Analysis Discounted Cash Flow/Probability/Loss Given Default Analysis The following slides are screen shots of similar examples for your reference. 18
19 Simple Migration Analysis Example Historical Risk Rating to Current Risk Rating Historical Risk Rating Rating Description Loan Balances Loan Percentage 1 No Risk 1,628, % 2 Minimal Risk 2,852, % 3 Better Than Average Risk 1,316, % 4 Average Risk 508,719, % 5 Special Mention Watch Risk 38,551, % 6 Substandard Well Secured 30,900, % 7 Substandard Marginally Secured 10,329, % 8 Substandard Unsecured 5,195, % 9 Substandard Special Reserve 2,031, % 10 Doubtful 336, % 11 Loss 0.00% Totals 601,861, % 601,861,334 19
20 Simple Migration Analysis Risk Ratings and Loan Balances at Migration End Date Risk Rating at 12/31/ or Worse Paid Off or Renewed Charged Off Foreclosures Total % 19.79% 0.00% 3.29% 0.00% 0.00% 0.00% 55.55% 0.00% 0.00% % % 23.26% 0.00% 2.98% 0.00% 0.00% 0.00% 73.76% 0.00% 0.00% % % 0.00% 26.59% 54.82% 0.00% 0.00% 0.00% 18.59% 0.00% 0.00% % % 0.00% 0.00% 45.71% 0.56% 0.24% 0.00% 52.66% 0.57% 0.27% % % 0.00% 0.00% 18.98% 9.29% 1.64% 0.00% 52.43% 14.04% 3.62% % % 0.00% 0.00% 2.23% 4.44% 23.31% 0.00% 60.53% 6.36% 3.12% % % 0.00% 0.00% 0.00% 10.45% 37.13% 0.00% 27.99% 10.59% 13.84% % % 0.00% 0.00% 0.00% 13.47% 0.00% 0.00% 44.71% 44.60% 2.78% % % 0.00% 0.00% 0.00% 4.22% 63.37% 0.00% 18.14% 12.27% 1.99% % % 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 98.32% 1.68% % % 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% % 0.00% % 20
21 Simple Migration Analysis Example Current Risk Ratings Rating Description Current Loan Balances Loss % Q Factors Total Expected Loss 1 No Risk 1,750, % 0.00% 2 Minimal Risk 5,824, % 0.00% 3 Better Than Average Risk 604, % 0.00% 4 Average Risk 792,780, % 0.00% 4,493,035 5 Special Mention Watch R 16,631, % 0.00% 2,335,260 6 Substandard Well Secured 19,516, % 0.00% 1,242,132 7 Substandard Marginally S 10.59% 0.00% 8 Substandard Unsecured 44.60% 0.00% 9 Substandard Special Rese 12.27% 0.00% 10 Doubtful 98.32% 0.00% 11 Loss 548, % 0.00% 548,876 Totals 837,656, % 8,619,302 ALLL as % of Total Loans 1.03% 21
22 Static Pool Analysis Average Loss Rates for HELOC and 2 nd REM Loan Lifetime Loss Rate Loan Lifetime Loss Rate Loan Lifetime Loss Rate Loan Lifetime Loss Rate Average Lifetime Loss Rate Expected Lifetime Losses Current Loan Type Balance 1 4 Family Junior Lien Closed 1 PASS 0.00% 0.00% 0.49% 0.00% 0.12% 8,369,403 10, Family Junior Lien Closed 2 WATCH 0.00% 0.00% 0.00% 0.00% 0.00% 26, Family Junior Lien Closed 4 SUBSTANDARD 6.87% 36.08% 3.36% 38.22% 21.13% 86,658 18, Family Revolving 1 PASS 0.00% 0.00% 0.00% 0.00% 0.00% 22,017, Family Revolving 4 SUBSTANDARD 0.00% 0.00% 0.00% 77.72% 19.43% 158,760 30,845 Totals 30,658,167 59,325 ALLL Percentage 0.19% 22
23 Static Pool Analysis Average Loss Rates for C&I and CRE Loan Lifetime Loss Rate Loan Lifetime Loss Rate Loan Lifetime Loss Rate Loan Lifetime Loss Rate Average Lifetime Loss Rate Expected Lifetime Losses Current Loan Type Balance Commercial & Industrial 1 PASS 0.32% 0.06% 2.31% 0.14% 0.71% 144,638,430 1,021,963 Commercial & Industrial 2 WATCH 7.20% 5.01% 4.75% 0.67% 4.41% 8,222, ,567 Commercial & Industrial 3 SPECIAL MENTION 38.17% 0.00% 0.00% 0.00% 9.54% 5, Commercial & Industrial 4 SUBSTANDARD 15.78% 36.24% % 63.23% 53.81% 12,567,544 6,762,613 Commercial & Industrial 5 DOUBTFUL 90.85% 0.00% 0.00% 0.00% 22.71% Commercial & Industrial 6 LOSS 0.00% 0.00% 0.00% 0.00% 0.00% Commercial Real Estate 1 PASS 1.15% 0.28% 1.33% 1.64% 1.10% 245,021,089 2,698,152 Commercial Real Estate 2 WATCH 6.77% 0.00% 0.00% 0.00% 1.69% 10,674, ,739 Commercial Real Estate 3 SPECIAL MENTION 1.49% 12.33% 14.80% 0.00% 7.15% 524,392 37,515 Commercial Real Estate 4 SUBSTANDARD 17.94% 8.19% 8.62% 9.78% 11.13% 27,099,768 3,017,394 Commercial Real Estate 5 DOUBTFUL 4.11% 0.00% 34.87% % 34.75% Totals 448,754,319 14,081,477 ALLL Percentage 3.14% 23
24 Static Pool Analysis Weighted Average Losses for HELOC and 2 nd REM (1) (2) (3) = (1)/(2) (4) (5) = (3)x(4) Three Year Weighted Current Total Charge Total Loans In Average Loss Principal ALLL Without Loan Type Offs Pools Rate Balance Q Factors 1 4 Family Junior Lien Closed 1 PASS 82,327 44,644, % 8,369,403 15, Family Junior Lien Closed 2 WATCH 275, % 26, Family Junior Lien Closed 4 SUBSTANDARD 95, , % 86,658 19, Family Revolving 1 PASS 139,152, % 22,017, Family Revolving 2 WATCH 584, % 1 4 Family Revolving 3 SPECIAL MENTION 188, % 1 4 Family Revolving 4 SUBSTANDARD 24, , % 158,760 29,435 Totals 30,658,167 64,231 ALLL Percentage 0.21% 24
25 Static Pool Analysis Weighted Average Losses for C&I and CRE (1) (2) (3) = (1)/(2) (4) (5) = (3)x(4) Three Year Weighted Average Loss Rate Current Principal Balance Total Charge Total Loans In ALLL Without Loan Type Offs Pools Q Factors Commercial & Industrial 1 PASS 3,882, ,450, % 144,638,430 1,304,592 Commercial & Industrial 2 WATCH 626,243 13,209, % 8,222, ,816 Commercial & Industrial 3 SPECIAL MENTION 4,773,482 18,144, % 5,605 1,475 Commercial & Industrial 4 SUBSTANDARD 20,196,893 38,383, % 12,567,544 6,612,860 Commercial & Industrial 5 DOUBTFUL 97, , % Commercial Real Estate 1 PASS 10,825, ,768, % 245,021,089 2,721,133 Commercial Real Estate 2 WATCH 1,354,714 72,567, % 10,674, ,278 Commercial Real Estate 3 SPECIAL MENTION 3,175,845 61,663, % 524,392 27,008 Commercial Real Estate 4 SUBSTANDARD 18,635, ,882, % 27,099,768 2,955,321 Commercial Real Estate 5 DOUBTFUL 648,772 2,951, % Totals 448,754,319 14,211,484 ALLL Percentage 3.17% 25
26 Other Methods Vintage Analysis Works well for large groups of homogenous loans Predictable losses Auto loans Present Value of Cash Flows Great in theory Hard to implement for community banks 26
27 A Look at Other Methods PD/LGD Probability of Default and Loss Given Default PD times LGD time Exposure at Default Define what constitutes a default Predict likelihood of default Predict loss given default Predict the loan balance at default 27
28 Impaired Loans Various models do not treat impaired loans differently than performing loans. This is permitted under CECL However, we do not believe that the regulatory agencies will accept this. Initial reaction is that regulators still want impaired loans evaluated separately using PV of cash flows or FV of collateral, less cost to sell. 28
29 Q Factors Do analysis for a number of years Choose the time period(s) that best represent today s environment Adjust for reasonable and supportable forecasts Other Q Factors remain the same Thought process is a little different Compared to the historical lifetime loss rates that the bank has chosen most representative of today s environment, does the bank expect that losses will be higher or lower 29
30 Parting Thoughts The flexibility of the standard allows this to be a management process. Start thinking about models and which one will best fit your bank. Once you have an idea of what models you will use, start thinking about the data you will need, it may not be as bad as you think. Make sure you include accounting, operations, lending, and IT personnel in your discussions. Each provide valuable perspective in your model decision. 30
31 Our interactions with you will be designed to support your goals and dreams and help impact your success. 31
32 2014 CliftonLarsonAllen LLP David Heneke, Principal CliftonLarsonAllen LLP Liz Rider, Principal CLAconnect.com twitter.com/ CLAconnect facebook.com/ cliftonlarsonallen linkedin.com/company/ cliftonlarsonallen 32 32
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