The Presenter. Charles N. McQueen. Founded McQueen Financial in 1999 SEC Registered Investment Advisor Asset Liability Management.

Transcription

1 CECL

2 The Presenter Charles N. McQueen Founded McQueen Financial in 1999 SEC Registered Investment Advisor Asset Liability Management Page 2

3 McQueen Financial Advisors SEC Registered Investment Advisor Asset Liability Management Merger Valuations Mortgage Servicing Rights Valuations Municipal and Corporate Credit Reviews Core Deposit Studies Assumption Sensitivity Analysis Prepayment Speed Analysis

4 McQueen Financial Advisors Outline 9:30 to 10:30 am Background discussion & MFA s view What is CECL and why the change and the policy behind it? The adoption process 10:30 to 10:45 AM Break 10:45 to Noon How to group loans What can we use to forecast Noon - Lunch Page 4

5 McQueen Financial Advisors Outline 1:00 to 2:00 PM What data do I want? Data, Data, Data Who should be on the CECL bus? 2:00 to 2:15 PM Break 2:15 to 3:00 PM Board of Directors and CECL Examining CECL Closing Thoughts Q & A Page 5

6 McQueen Financial Advisors Outline 9:30 to 10:30 AM Background discussion & MFA s view What is CECL and why the change and the policy behind it? The adoption process Page 6

7 McQueen Financial Advisors Who is in the Room? Your back grounds Any special requests? Other topics? Confidentiality Page 7

8 From Crowe Horwath

9 McQueen Financial Advisors CECL From MFA s Perspective Purchase Accounting Loan Contra Account Projecting losses for a portfolio for its remining life Portfolio declines to zero over time Short Cut: Provision over the last 5 years added together Data that is easy: Provision Delinquency Credit Scores Page 9

10 CECL & HTM Example of CECL and HTM debt Securities

11 CECL & HTM How does CECL affect the HTM debt Securities portfolio? Financial assets carried at amortized cost (i.e. HTM debt Securities) CECL Applies to HTM as they are carried at amortized cost Establish an allowance for credit losses Pooled be risk characteristics AFS and HTM debt securities with OTTI Rate will stay the same (as determined in OTTI Subsequent changes will flow through the income statement

12 Regulatory guidance Key takeaways Smaller and less complex institutions will be able to adjust their existing allowance methods to meet the requirements of the new accounting standard without the use of costly and complex modeling techniques. Does not require institutions to engage thirdparty vendors to assist in calculating a CECL allowance. Standard will be scalable to all institutions. Inputs to calculation will change to properly implement CECL. Different pools can have different estimation methods. Aggregation and retention of data will be critical. Current credit risk practices can continue to be utilized.

13 CECL When does the new accounting standard take effect? For a PBE that is a SEC filer 1/1/20 Credit Union 1/1/21

14 McQueen Financial Advisors Outline 9:30 to 10:30 AM Background discussion & MFA s view What is CECL and why the change and the policy behind it? The adoption process Page 14

15 What is CECL? What is CECL? CECL stands for Current Expected Credit Loss Methodology What do we expect the credit losses to be going forward Forward looking versus backwards looking

16 Who Does CECL Apply to? Where do the new accounting standards apply? All banks, savings associations, credit unions, and financial institution holding companies, regardless of size, that file regulatory reports for which the reporting requirements conform to U.S. GAAP All financial instruments carried at amortized cost (including HFI, net investment in leases HTM debt securities Trade and reinsurance receivables

17 Who Does CECL Apply to? Where do the new accounting standards apply? Receivables that relate to repurchase agreements and securities lending agreements Off-balance-sheet credit exposures not accounted for as insurance, including loan commitments, standby letters of credit, and financial guarantees The agencies expect the new accounting standard will be scalable to institutions of all sizes Inputs to allowance estimation methods will need to change to properly implement CECL

18 CECL Where do the new accounting standards NOT apply? Trading assets Loans held for sale Financial assets for which the fair value option has been elected Loans or receivables between entities under common control

19 CECL What must be done prior to the new standard becoming effective? Institutions must continue to follow current U.S. GAAP on impairment and the allowance for loan and lease losses (ALLL) along with related supervisory guidance on the ALLL

20 CECL Why is the FASB changing the existing incurred loss methodology? The existing approach for determining the impairment of financial assets, based on a probable threshold and an incurred notion, delayed the recognition of credit losses on loans and resulted in loan allowances that were too little, too late.

21 CECL What are some of the concerns the FASB is addressing with CECL? Removing the probable threshold and the incurred notion as triggers for credit loss recognition, instead adopting a standard that states that financial instruments carried at amortized cost should reflect the net amount expected to be collected Broadened the range of data that is incorporated into the measurement of credit losses to include forward-looking information Introduced a single measurement objective for all financial assets carried at amortized cost

22 CECL What does the new accounting standard change in existing U.S. GAAP? Introduction of a new credit loss methodology Under CECL, an allowance will be created upon the origination or acquisition of a financial asset measured at amortized cost The allowance will then be updated at subsequent reporting dates The allowance for credit losses under the CECL is a valuation account, measured as the difference between the financial assets amortized cost basis and the amount expected to be collected on the financial assets )i.e. lifetime credit losses).

23 CECL What does the new accounting standard change in existing U.S. GAAP? Earlier recognition of credit losses Leveraging of existing credit risk management practices Forward looking information Reduction in the number of credit impairment models Purchased credit-deteriorated (PCD) financial assets AFS debt securities Vintage disclosures by PBE

24 McQueen Financial Advisors Outline 9:30 to 10:30 AM Background discussion & MFA s view What is CECL and why the change and the policy behind it? The adoption process Page 24

25 From Crowe Horwath

26 Suggested timeline for adoption SEC NOW Education re: new standard Begin dialogue with regulators and auditors As soon as possible but before YE 2017 Select methodology Pools identified Verify current data accuracy Evaluate resources Gather data Understand various methodologies allowed Establish processes Develop a timeline for implementation and controls By YE 2018 Verify new activity Ready to perform shadow calculation Testing of controls Training/corrections Q Measure impact as of first day of year of adoption (Jan. 1 for calendar year-end companies) PBE NOW Education re: new standard Begin dialogue with regulators and auditors As soon as possible but before YE 2018 Select methodology Pools identified Verify current data accuracy Evaluate resources Understand various methodologies allowed Gather data Develop a timeline for implementation Establish processes and controls By YE 2019 Verify new activity Ready to perform shadow calculation Testing of controls Training/corrections Q Measure impact as of first day of year of adoption (Jan. 1 for calendar year-end companies) NON-PBE NOW Education re: new standard Begin dialogue with regulators and auditors As soon as possible but before YE 2018 Select methodology Pools identified Evaluate resources Verify current data accuracy Understand various methodologies allowed Gather data Develop a timeline for implementation Establish processes and controls By YE 2019 Verify new activity Ready to perform shadow calculation Testing of controls Training/corrections Q Measure impact as of first day of year of adoption (Jan. 1 for calendar year-end companies)

27 Initial Adoption of CECL How should an institution apply the new accounting standard upon initial adoption? Financial assets carried at amortized cost (i.e. loans HFI and HTM debt Sec) A cumulative effect adjustment for the changes in the allowances for credit loss will be recognized in retained earnings on the balance sheet.

28 Initial Adoption of CECL How should an institution apply the new accounting standard upon initial adoption? Purchased credit-deteriorated assets Purchase Credit Impaired (PCI) will be classified as PCD PCD assets will be grossed up and the credit impairment will be in the loan valuation (CECL or loan contra for example) Subsequent changes to PCD will be charges or credits to earnings

29 Initial Adoption of CECL How should an institution apply the new accounting standard upon initial adoption? AFS and HTM debt securities with OTTI Rate will stay the same (as determined in OTTI Subsequent changes will flow through the income statement

30 McQueen Financial Advisors What is really the adoption process? How to group loans How we use the lifetime historical loss ratio How we determine the credit adjustments based on environmental factors Determining what data I want Using the data I have Page 30

31 McQueen Financial Advisors Outline 10:30 to 10:45 AM - Break Page 31

32 McQueen Financial Advisors Outline 10:45 to Noon How to group loans How we use the lifetime historical loss ratio How we determine the credit adjustments based on environmental factors Page 32

33 The Methodologies More Simple, Data Intensive & Sensitive Standard will be scalable to all institutions. Inputs to calculation will change to properly implement CECL. Different pools can have different estimation methods. Aggregation and retainment of data will be critical. Current credit risk practices can continue to be utilized. More Complex, Computational Intensive & Sensitive

34 Develop methodology to identify pools Terminology to clarify Segment Class Pools Current accounting standards require disclosures of loan segments (ASC ). The new standard requires any time a different methodology is applied to a pool of loans, that pool is a loan segment. Classes are sub components of segments and generally represent different loan types which are beneficial to the reader and are required certain disclosures. A class can be the lowest level of disaggregation. Pools are the lowest level of disaggregation to which the loss methodology will be applied. Loans should be aggregated at levels with similar risk characteristics.

35 Develop methodology to identify pools Example - Financial institution For loans collectively evaluated for credit losses: Five overall segments: Commercial real estate Residential real estate Commercial & industrial Loans to individuals and other Lease financing receivables Disaggregate segments as determined necessary into classes with similar risk characteristics for calculation and disclosure purposes Further disaggregate classes into pools of loans where appropriate (ASC )

36 Develop methodology to identify pools Segment Class Assess for further disaggregation & pool conclusion Commercial Real Estate Construction 1-4 Family Farmland Farmland Nonfarm Pass (1-2) Pass (3-4) Watch Substandard Multifamily Vintage Period 1 Vintage Period 2 Vintage Period 3

37 Develop methodology to identify pools Segment Class Assess for further disaggregation & pool conclusion Unsecured Credit Card Credit Card Lines of credit Lines of credit Auto New vehicle Original FICO > 750 Original FICO < 750 Used vehicle Original FICO > 750 Original FICO < 750 Real Estate: 1-4 Family First lien Original contractual term of 15 years Original contractual term of 30 years Second lien Original combined LTV > 90% Original combined LTV < 90%

38 Loans to be individually evaluated (and excluded from the collective pools) Impaired definition removed in ASC 326 replaced with the concept of individual asset method. If a loan doesn t fit into a pool, it should be individually evaluated. Just because a loan has deteriorated credit, there is no requirement to individually evaluate. ( ) Troubled Debt Restructures (TDRs): These loans have different risk characteristics than other loans within the segment and could be either individually evaluated or pooled. TDRs are identified when they are reasonably expected DCF is required to capture economic loss of a TDR

39 Changes to a loan s risk characteristics A loan can move from one pool to another if risk characteristics change. Loan refinancing or restructuring (ASC ) provides guidance as to what qualifies as a new loan for vintage. If the terms of the new loan resulting from a loan refinancing or restructuring, in which the refinancing or restructuring is not itself a troubled debt restructuring, are at least as favorable to the lender as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the lender, the refinanced loan shall be accounted for as a new loan. This condition would be met if the new loans effective yield is at least equal to the effective yield for such loans and modifications of the original debt instrument are more than minor.

40 A loss rate CECL calculation Key concept = Record losses to the contractual maturity while considering the effect of prepayments. Calculation = Lifetime historical loss rate (vs. annual loss rate today) +/- Qualitative factors for current conditions +/- Reasonable and supportable forecasts = Current Expected Credit Loss Factor Current Expected Credit Loss Factor x Amortized Cost = CECL Allowance

41 Allowance calculation summary Segment Pool Balance Lifetime Historical Loss Rate Collectively Evaluated Current Condition Adjustments Forecast Adjustments Individually Evaluated CECL Rate CECL Reserve Balance CECL Reserve Balance CECL Reserve 1 Construction, 1-4 Family $ 10,000, % 0.01% 0.01% 1.02% $ 102,000 $ 1,000,000 $ 25,000 $ 11,000,000 $ 127,000 2 Construction, Other $ 8,000, % 0.01% 0.01% 1.02% $ 81,600 $ 1,000,000 $ 25,000 $ 9,000,000 $ 106,600 3 Farmland $ 5,000, % 0.01% 0.01% 1.02% $ 51,000 $ 1,000,000 $ 25,000 $ 6,000,000 $ 76,000 4 Nonfarm, Pass (1-2 Rated) $ 12,000, % -0.75% -0.25% 0.81% $ 97,500 $ 1,000,000 $ 25,000 $ 13,000,000 $ 122,500 Commercial 5 Nonfarm, Pass (3-4 Rated) $ 76,000, % -0.25% -0.25% 1.31% $ 997,500 $ 1,000,000 $ 25,000 $ 77,000,000 $ 1,022,500 Real Estate 6 Nonfarm, Watch $ 12,000, % 0.00% -0.25% 1.56% $ 187,500 $ 1,000,000 $ 25,000 $ 13,000,000 $ 212,500 7 Nonfarm, Substandard $ 2,000, % 0.25% -0.25% 1.81% $ 36,250 $ 1,000,000 $ 25,000 $ 3,000,000 $ 61,250 8 Multifamily, Vintage Period 1 $ 12,000, % 0.00% 0.10% 1.03% $ 123,928 $ 1,000,000 $ 25,000 $ 13,000,000 $ 148,928 9 Multifamily, Vintage Period 2 $ 76,000, % 0.10% 0.10% 1.13% $ 860,876 $ 1,000,000 $ 25,000 $ 77,000,000 $ 885, Multifamily, Vintage Period 3 $ 2,000, % 0.25% 0.50% 1.68% $ 33,655 $ 1,000,000 $ 25,000 $ 3,000,000 $ 58,655 Residential Real 11 First Lien $ 35,000, % -0.04% -0.11% 0.61% $ 214,355 $ 1,000,000 $ 25,000 $ 36,000,000 $ 239,355 Estate 12 Junior Lien $ 5,000, % 0.01% 0.01% 1.02% $ 51,000 $ 1,000,000 $ 25,000 $ 6,000,000 $ 76, Pass (1-2 Rated) $ 7,000, % 0.00% 0.10% 0.82% $ 57,234 $ 1,000,000 $ 25,000 $ 8,000,000 $ 82,234 Commercial & 14 Pass (3-4 Rated) $ 45,600, % 0.10% 0.10% 0.92% $ 418,440 $ 1,000,000 $ 25,000 $ 46,600,000 $ 443,440 Industrial 15 Watch Rated $ 4,200, % 0.25% 0.50% 1.47% $ 61,641 $ 1,000,000 $ 25,000 $ 5,200,000 $ 86, Substandard Rated $ 1,200, % 0.50% 0.50% 1.72% $ 20,612 $ 1,000,000 $ 25,000 $ 2,200,000 $ 45,612 Loans to Ind. 17 Auto $ 14,000, % -0.14% 0.29% 2.88% $ 403,745 $ 1,000,000 $ 25,000 $ 15,000,000 $ 428,745 and Other 18 Other $ 5,000, % 0.01% 0.01% 1.02% $ 51,000 $ 1,000,000 $ 25,000 $ 6,000,000 $ 76,000 Leases 19 Leases $ 5,000, % 0.01% 0.01% 1.02% $ 51,000 $ 1,000,000 $ 25,000 $ 6,000,000 $ 76,000 $ 337,000, % $ 3,900,835 $ 19,000,000 $ 475,000 $ 356,000,000 $ 4,375, % Total

42 Example 1: Open pool method Commercial real estate, nonfarm CECL Example December 31, Nonfarm Amortized Cost Nonfarm Annual Losses Losses during year on loans that existed at Dec. 31, 2012 Nonfarm Loans ,000,000 1,000, ,000,000 1,000, , ,000,000 1,000, , ,000,000 1,000, , ,000,000 1,000,000 75, ,000,000 1,000,000 25,000 Average/ annual loss 2012 Cumulative Losses 1,450,000 rate = 2012 Amortized Cost 80,000,000 Lifetime Historical Loss Rate 1.81% Incurred Loss Rate Annual Losses 1.25% 1.19% 1.14% 1.09% 1.03% 0.98% 1.09% Pools - By Risk Rating Nonfarm Amortized Cost at YE 2017 Historical Lifetime Loss Rate Current Condition Adjustments Forecast Adjustments CECL Factor CECL Reserve Pass (1-2) 12,000, % -0.75% -0.25% 0.81% 97,500 Pass (3-4) 76,000, % -0.25% -0.25% 1.31% 997,500 Watch 12,000, % 0.00% -0.25% 1.56% 187,500 Substandard 2,000, % 0.25% -0.25% 1.81% 36, ,000, ,318,750

43 Example 2: Closed pool method Commercial real estate, nonfarm Commercial & Industrial CECL Example December 31, Nonfarm Annual Losses Losses during year on loans with INITIAL outstanding balance at Dec. 31, 2010 Nonfarm Loans Losses during year on loans with INITIAL outstanding balance at Dec. 31, 2011 Nonfarm Loans Losses during year on loans with INITIAL outstanding balance at Dec. 31, 2012 Nonfarm Loans Losses during year on loans with INITIAL outstanding balance at Dec. 31, 2013 Nonfarm Loans Losses during year on loans with INITIAL outstanding balance at Dec. 31, 2014 Nonfarm Loans Nonfarm Amortized Cost - YTD originations ,000, , ,000, , , ,000, , , , ,000, , , , , ,000, , , , , , ,000, ,000 50,000 50,000 75, , ,000 = 500, ,000, ,000-12,500 75, , , ,000, , , , , ,000, , ,000 75, ,000, , ,000 Lifetime Losses 725, , , , ,000 Amortized Cost 40,000,000 42,000,000 44,000,000 46,000,000 48,000,000 Lifetime Historical Loss Rate 1.81% 1.40% 1.22% 1.30% 1.41% 1.43% = Average Historical Pools - By Risk Rating Nonfarm Amortized Cost at YE 2019 Lifetime Loss Rate Current Condition Adjustments Forecast Adjustments CECL Factor CECL Reserve Pass (1-2) 36,000, % -0.75% -0.25% 0.43% 154,332 Pass (3-4) 150,000, % -0.25% -0.25% 0.93% 1,393,049 Watch 7,000, % 0.00% -0.25% 1.18% 82,509 Substandard 2,000, % 0.25% -0.25% 1.43% 28, ,000, ,658,464

44 Example 3: Static pool method; single year Commercial & Industrial Year of Origination (fully settled vintages) Origination Amount Charge-Off Amount Lifetime Loss Rate ,050, , % ,153, , % ,311, , % ,527, , % ,803, , % Multifamily Amortized Cost at YE 2020 Historical Lifetime Loss Rate Current Condition Adjustments Forecast Adjustments CECL Factor CECL Reserve Pools - By Vintage 2017 Vintage 12,000, % 0.00% 0.10% 1.03% 123, Vintage 76,000, % 0.10% 0.10% 1.13% 860, Vintage 2,000, % 0.25% 0.50% 1.68% 33,655 90,000,000 1,018,458

45 Example 4: Static pool method; average Commercial & Industrial Origination Amount Charge-Off Amount Historical Lifetime Loss Rate ,311, , % ,527, , % ,803, , % Totals 76,641, ,000 Weighted average lifetime loss rate = 0.72% Historical Lifetime Loss Rate Current Condition Adjustments Pools - By Risk Rating C&I Amortized Cost at YE 2020 Forecast Adjustments CECL Factor CECL Reserve Pass (1-2 Rated) 7,000, % 0.00% 0.10% 0.82% 57,234 Pass (3-4 Rated) 45,600, % 0.10% 0.10% 0.92% 418,440 Watch Rated 4,200, % 0.25% 0.50% 1.47% 61,641 Substandard Rated 1,200, % 0.50% 0.50% 1.72% 20,612 58,000, ,926

46 Example 5: Vintage Individuals & other, auto Originated Balance Year 1 Year 2 Year 3 Year 4 Year 5 Cumulative losses Historical Lifetime Loss Rate ,000,000 5,000 25, ,000 25,000 10, , % ,300,000 10,000 32,000 75,000 50, , ,600,000-22,000 75,000 97, ,900,000 5,000 5,000 10, ,200,000 2,500 2, ,500,000 - CECL Expected Origination Year Year 1 Year 2 Year 3 Year 4 Year 5 Remaining Losses % 0.50% 2.00% 0.50% 0.20% 3.30% % 0.20% % 0.20% 0.70% % 0.50% 0.20% 2.70% % 2.00% 0.50% 0.20% 3.20% % 0.50% 2.00% 0.50% 0.20% 3.30% Pools - By Vintage Year Remaining Balance at Y/ E 2016 Historical Lifetime Loss Rate Current Condition Adjustments Forecast Adjustments CECL Factor CECL Reserve , % 0.00% 0.00% 0.20% 1, ,680, % -0.05% 0.10% 0.75% 12, ,360, % -0.10% 0.20% 2.80% 66, ,030, % -0.15% 0.30% 3.35% 135, ,400, % -0.20% 0.40% 3.50% 189, ,745

47 Example 6: Weighted Average Remaining Maturity ( WARM ) Residential 1-4 Family; First lien, 15 years Average ANNUAL Period Ending Average Loan Balance Charge-offs Annual Loss Rate Historical Loss Rate ,000, , % ,320, , % ,643,200 75, % ,969,632 50, % ,299,328 25, % ,632,322 20, % ,000,000 15, % 0.18% Average ANNUAL Historical Loss Rate Current Condition Adjustments Year Amortized Cost at YE 2016 Assumed Amortization Forecast Adjustments CECL Factor CECL Reserve 0 35,000, % -0.01% -0.03% 0.14% 50, ,800,000 4,200, % -0.01% -0.03% 0.14% 44, ,400,000 4,400, % -0.01% -0.03% 0.14% 38, ,700,000 4,700, % -0.01% -0.03% 0.14% 31, ,800,000 4,900, % -0.01% -0.03% 0.14% 24, ,500,000 5,300, % -0.01% -0.03% 0.14% 16, ,800,000 5,700, % -0.01% -0.03% 0.14% 8, ,800, % -0.01% -0.03% 0.14% - 214,355

48 Forecasting Losses Lifetime historical loss rate (vs. annual loss rate today) Qualitative factors for current conditions

49 A loss rate CECL Calculation Key concept = Select a lifetime historical loss rate from a period most like today s portfolio and forecast. Calculation = Lifetime historical loss rate (vs. annual loss rate today) +/- Qualitative factors for current conditions +/- Reasonable and supportable forecasts = Current Expected Credit Loss Factor Current Expected Credit Loss Factor x Amortized Cost = CECL Allowance

50 Selection of Lifetime Historical Loss Rate Goal is to select a period most like today s environment and forecast. Selection of Lifetime Historical Loss Rate December 31, 20X0 20X1 20X2 20X3 20X4 20X5 20X6 20X7 20X8 20X9 20X10 TODAY FORECAST Losses: 1,000, , , , ,000 50,000 50, , , ,000 1,000,000 N/A Amortized Cost at YE: 76,832,000 78,400,000 80,000,000 81,600,000 83,232,000 84,896,640 81,500,774 78,240,743 75,111,114 72,106,669 69,222,402 70,606,850 Lifetime Historical Loss Rate: 1.30% 0.96% 0.63% 0.37% 0.12% 0.06% 0.06% 0.38% 0.67% 0.97% 1.44% % of loans past due over 60 days 8.0% 5.0% 4.0% 2.0% 1.0% 2.0% 1.0% 2.00% 4.00% 6.20% 7.50% 7.25% % of loans classified 6.0% 4.0% 3.0% 2.0% 1.0% 1.0% 1.0% 2.00% 4.00% 5.00% 6.50% 6.25% % of loans with LTV policy exceptions at origination 5.0% 3.7% 2.4% 1.4% 0.5% 0.2% 0.2% 1.00% 2.00% 1.00% 3.00% 4.00% % of loans with remaining amortization less than 15 years 30.0% 25.0% 22.0% 22.0% 30.0% 35.0% 30.0% 25.00% 25.00% 22.00% 20.00% 27.00% Unemployment - National Unemployment - Regional Real GDP Growth - National (1.50) (1.00) (0.05) 0.25 CPI - National

51 Current Conditions/ Forecast Adjustment ASC : Because historical experience may not fully reflect an entity s expectations about the future, management should adjust historical loss information, as necessary, to reflect the current conditions and reasonable and supportable forecasts not already reflected in the historical loss information. In making this determination, management should consider characteristics of the financial assets that are relevant in the circumstances. To adjust historical credit loss information for current conditions and reasonable and supportable forecasts, an entity should consider significant factors that are relevant to determining the expected collectability. Examples of factors an entity are included in ASC We recommend a one page document identifying these criteria, a brief narrative, and selection of adjustment factor. A sample analysis for one of the criteria in ASC follows:

52 Current Conditions/ Forecast Adjustment (cont.) Sample section of narrative k. The environmental factors of a borrower and the areas in which the entity s credit is concentrated, such as: 1. Regulatory, legal, or technological environment to which the entity has exposure 2. Changes and expected changes in the general market condition of either the geographical area or the industry to which the entity has exposure 3. Changes and expected changes in international, national, regional, and local economic and business conditions and developments in which the entity operates, including the condition and expected condition of various market segments. Baseline Reporting 3 Year Date Forcast Unemployment - National* Real GDP Growth - National* CPI - National* Unemployment - Chicagoland MSA** n/a Chicago Manufacturers Index n/a Current factor adjustment based on noted changes to macro econcomic data including improvements to GDP growth and unemployment declines. Inflation has remained modest at or around the Federal Reserve's target number. Unemployment in our MSA has had improved tremendously, however, further improvements not considered reasonable as the current unemployment rate is considered below "full employment." Local economic conditions - During the summer of 2017, the IL legislature passed an income tax increase which will increase corporate and individual tax rates on residents. Most economists agree that the tax increases will have an impact on state production and, therefore, management has allocated 0.25% to forecasted adjustments based on the unknown impact of these tax increases. Pool Current Factor Adjustment Forecast Adjustment Pass (1-2) -0.50% 0.25% Pass (3-4) -0.50% 0.25% Watch -0.50% 0.25% Substandard -0.50% 0.25% *Federal Reserve's 2017 Supervisory Scenarios for Annual Stress Tests Required under the Dodd-Frank Act Stress Testing Rules and the Capital Plan Rule. ** Bureau of Labor Statistics - Reporting date - 6/30/17 -

53 McQueen Financial Advisors Best way to forecast the future: Flux capacitor and a DeLorean Yield Curve Page 53

54 Interest Rates Why the EESA was Created Source: Bloomberg Page 54

55 Yield Curve Today and 12/2012 Why the EESA was Created Page 55 Source: Bloomberg

56 Yield Curve Cycle Why the EESA was Created Page 56

57 Yield Curve Slow Changes Why the EESA was Created Thoughts: - Low inflation remains - Rates higher though - Just in case? FOMC in Action: - Fed Funds up from 0.25% to 1.25% to Not what we call fast - DMV fast Flash. Page 57

58 Yield Curve and Forecasting Page 58

59 McQueen Financial Advisors Outline Noon - Lunch Page 59

60 McQueen Financial Advisors Outline 1:00 to 2:00 PM Determining what data I want Using the data I have Who is on the bus Page 60

61 What data do I want? How do I predict losses? What data do I really want?

62 What I Want: Perfect data When are loans going bad How much will I loose

63 What I Want: Probability of Default Forward looking Compare to historical data

64 What I Want: Severity of losses Forward looking Compare to historical data

65 Example: Car Loan Example 2008 average loss per loan was $3, average loss per loan is $10,000

66 Car Loan Example:

67 Car Loan Example:

68 Example: Mortgage Example Loan to Value Credit Scores Delinquency Amortization schedule

69 Mortgage Loan Example:

70 Mortgage Loan Example:

71 Data This is what is making people nervous The quantity of data seems overwhelming What data to store? What data am I missing? Should I go back and re-populate data that is missing????? DATA?????

72 Risk Identification Five categories of data to analyze Attributes and Characteristics: Create a current data cut of the portfolio with relevant product codes, term structure, etc. Basic financial types Collateral Loan purpose Size Geography Age Effective interest rate Borrower s industry Vintage (economic condition and underwriting standards at the time of origination)

73 Data inventory Results of risk identification: Based on the preliminary risk assessment and analysis of the portfolio, what data is collected today and what are the goals for long-term data capture? How can current systems and processes be utilized? What is the desired end-state and what are the priorities to get there? How frequently are credit quality indicators updated and how are theses archived (if at all)? Delinquency statistics and counters FICO Risk rating Property values Collateral coded

74 Data inventory Assess current state of data inventory capabilities and consider ancillary sources of loan data (cont.): What information may be available to build historic life of loan datasets? Does treasury management or lines of business maintain archives accounting and risk management aren t aware of? How will those data points be validated and auditable? Are there previous mergers and/or portfolio acquisitions to consider? Is prepayment data important for consideration and is this tracked at a disaggregated basis? Is original balance, date of origination, and charge-off/recovery information available for loss rate methods and vintage analysis? Is draw activity on lines of credit or other non-cancellable commitments available?

75 Data inventory Assess current state of data inventory capabilities and consider ancillary sources of loan data (cont.): What forecast data is available? Is there data utilized for stress testing purposes that may be leveraged? Is there data that is periodically updated and overwritten? Is there origination data that is rarely refreshed? Key Point Data availability may drive the models used upon implementation, but data can be captured over time to enhance or improve the model. Have an end goal in mind throughout the process.

76 Data inventory Consider common data issues observed: Amortization structures are often not easily displayed in data cuts. Data purges occur upon loan charge-off in some systems, especially those without shadow ledgers. Transition details on defaults and risk ratings are often not archived in the system. Community banks do not regularly update consumer credit scores and/or data fields are over-written. Collateral information is often in separate systems and appraisal dates may be missing or non-existent. Product specific characteristics and manual overrides example 5/1 ARM products manually maintained.

77 Data inventory Assess quality of the data inventoried to date: Scrub portfolio for anomalies and data quality issues for example: Missing fields Unusual rates, balances, and terms at the cohort level Undefined collateral and loan type codes

78 Data inventory Potential critical data elements Structural elements and identifiers: Account or loan number Loan type or purpose Borrower/guarantor identities Current balance Commitment amount at origination Original balance Origination date Renewal date (if origination date not reset) Maturity date Interest rate and type (fixed, variable including frequency) Payment type (P&I, balloon, I/O, etc.) Lien position and additional debt secured by property Prepayment activity or support for life of loan assumptions

79 Data inventory Common risk identifiers Risk rating Date of risk rating change(s) NAICS or SIC code Location of borrower (city/state/zip) Location of collateral Property type or other collateral type Appraised values and dates for collateral Collateral coverage (LTV) at origination Current LTV DSCR/Debt to income ratios Net operating income ratio on commercial Capitalization rate on income producing real estate Occupancy rates Delinquency counts Current days delinquent

80 Data inventory Common methodology data elements Charge-off and recovery amounts by date and instrument Periodic segment balances (if using a loss rate method) Default and cure date (must define these triggers) Default reason Amount outstanding at default Macroeconomic data: Baseline domestic macroeconomic variables provided for CCAR and DFAST purposes Augmented by local indices FDIC and FRED data

81 Who is on the Bus CECL Who is on the bus to implementation?

82 Implementation thoughts Have the right individuals involved in the implementation process is paramount to success. Included should be: Accounting Audit Credit IT Loan operations Credit risk

83 Implementation thoughts Lots of decisions will be made along the CECL bus ride: Document the rationale for those decisions along the way Incorporate the decisions into an accounting policy.

84 Implementation thoughts What changes should be made to processes and internal controls? Data retention Date review Data recording Testing of accuracy

85 Implementation thoughts Identify key controls over financial reporting with CECL Who can change data Who is collecting the data Who is processing data How is the data processed

86 McQueen Financial Advisors Outline 2:00 to 2:15 PM - Break Page 86

87 McQueen Financial Advisors Outline 2:15 to 3:00 PM Board of Directors How to Examine Closing Thoughts Page 87

88 McQueen Financial Advisors Board of Directors Page 88

89 Who s watching the map? BOARD Monitor Roles & Responsibilities Track key Milestones Consider audit implications Directors cannot avoid responsibility for ensuring that management implements CECL in a sound and reasonable manner.

90 Who s watching the map? BOARD Monitor Roles & Responsibilities Directors should be monitoring the rolls that employees are taking and who is responsible for the successful implementation of CECL.

91 Who s watching the map? BOARD Track key Milestones Directors should be tracking the implementation process of CECL and know if they are on track or off track.

92 Who s watching the map? BOARD Consider audit implications Directors should be considering the audits necessary to ensure proper testing and compliance with CECL.

93 McQueen Financial Advisors Examination of CECL Page 93

94 McQueen Financial Advisors Reasonableness Overall Credit Adjustment Risk Pooling Data People and Board How using forward forecasts Page 94

95 McQueen Financial Advisors Reasonableness Overall Historical Balance Sheet Historical Income statement Page 95

96 McQueen Financial Advisors Page 96

97 McQueen Financial Advisors Credit Adjustment Historical Actual Forward adjustment Page 97

98 McQueen Financial Advisors Forward Credit Adjustment Spread should a negative adjustment be greater than 50% Should a positive adjustment be greater than 2 times? What has changed to allow for the adjustment? Are the reasons documented? Page 98

99 McQueen Financial Advisors Risk Pooling Is the pooling reasonable? Mortgages and vintage Car loans by amortization Are they homogeneous enough? Page 99

100 McQueen Financial Advisors Data Is it accurate Data Process Data procedure Data control Tested? Page 100

101 McQueen Financial Advisors People and Board Is the Board engaged? Are the correct people on the bus? Page 101

102 McQueen Financial Advisors How using forward forecasts Reasonable data? Relatable events / data Reasonable? Page 102

103 McQueen Financial Advisors Overall Reasonableness testing 3 rd party review Not the CU s CPA Should be look at standard deviations? Page 103

104 Early Adoption Why would I early adopt? Eager Prove the methodology No good reason???

105 Parallel Run What is a parallel run? For a period of time, you run your incurred loss allowance process for financial reporting and also run your CECL process to test that your CECL process is functioning as intended. During the parallel run, you may identify that adjustments to data, systems or methods are needed in your CECL process.

106 Closing thoughts Measure twice and cut once. Decisions made will have long term impacts. Adoption will be fluid. Setbacks and hurdles will need to be overcome. Fine tuning of your calculation will take place no matter what methodology you use (same as today under our current guidance)

107 Closing thoughts Now is the time to start. Expect operational issues and questions to arise and allow time to appropriately assess, analyze, remediate, and verify. Each methodology above have certain tweaks to meet your institutions needs.

108 Questions

109 CONTACT US McQueen Financial Advisors, Inc. Charley McQueen President 1239 Anderson Road Clawson, MI