Financial Instruments Credit Losses How to Calculate CECL in Excel Monday, June 11, 2018

Transcription

1 Financial Instruments Credit Losses How to Calculate CECL in Excel Monday, June 11, 2018 Presented by: Ryan Abdoo, CPA, CGMA Industry Technical Leader Plante Moran Chris Ritter, CPA Partner Plante Moran

2 Plante Moran Introduction 2

3 Plante Moran Introduction 65 BANKS HAVE GREATER THAN $1B IN ASSETS 28 OF THOSE BANKS HAVE GREATER THAN $2B IN ASSETS OF THOSE BANKS HAVE GREATER THAN $5B IN 15 ASSETS 3

4 CECL Introduction The accounting standard was issued in June 2016 and creates a new section within the Codification ASC 326. ASC 326 is broken up into three sections Overall guidance Amortized cost (e.g. loans and held-to-maturity investment securities) Available-for-sale investment securities Adjustment to retained earnings at beginning of first period guidance is effective Regulatory proposal for capital implications phase in 4

5 Overview of today s discussion Regulatory guidance The methodologies Examples Minimum data sets New loan qualifications Pooling Loans to be individually evaluated Timeline Implementation and closing thoughts How we can help Questions 5

6 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 third-party 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 retainment of data will be critical. Current credit risk practices can continue to be utilized. See February 27, 2018 Regulator/ SEC/ FASB webinar. If Excel is used today, you can use Excel with CECL. 6

7 Less Complex, Data Intensive & Sensitive The methodologies Loss Rate Weighted average remaining maturity ( WARM ) (balance sheet approach) Snapshot in time (balance sheet approach) Static pool (activity based) Vintage (activity based) Discounted cash flow Migration (roll-rate) Probability of default/ Loss given default (PD/ LGD) Regression More Complex, Computational Intensive & Sensitive Not all are created equal. Recognize the market s perceived precision of the methodologies and auditability. 7

8 A loss rate CECL calculation Calculation Lifetime historical loss rate (vs. annual loss rate today) Qualitative factors for current conditions Reasonable and supportable forecasts Current Expected Credit Loss Factor Key concept = record losses to the contractual maturity while considering the effect of prepayments. Current Expected Credit Loss Factor Amortized Cost (or originated balance) CECL Allowance 8

9 Incurred Loss Methodology Our calculation today December 31, Loan Balance Charge-offs Annual Loss Rate ,000, , % ,000, , % ,000, , % ,200, , % ,000, % ,000,000 8, % ,000, , % Average = 0.10% Loan Balance Historical Loss Factor (Annual) Qualitative Factors ASC 450 (FAS 5) Reserve Factor Allowance $ 267,000, % 0.30% 0.40% $ 1,068,000 9

10 Illustration 1 from Accounting Standard (Snapshot/ open pool) Community Bank A (CBA) provides 10-year amortizing loans to customers. CBA manages those loans on a collective basis based on similar risk characteristics. The loans within the portfolio were originated over the last 10 years, and the portfolio has an amortized cost basis of $3 million. After comparing historical information for similar financial assets with the current and forecasted direction of the economic environment, CBA believes that its most recent 10-year period is a reasonable period on which to base its expected credit-loss-rate calculation after considering the underwriting standards and contractual terms for loans that existed over the historical period in comparison with the current portfolio. CBA s historical lifetime credit loss rate (that is, a rate based on the sum of all credit losses for a similar pool) for the most recent 10-year period is 1.5 percent. 10

11 Example 1: Snapshot/ Open pool method Commercial real estate, nonfarm - OO December 31, Nonfarm Annual Losses Losses during year on loans that existed at Dec. 31, 2010 Nonfarm Amortized Cost ,000, , ,000, , , ,000, , ,000 ($5,000 of losses on loans made in 2011 or 2012) ,000, ,000 50,000 See illustration on next slide ,000, ,000 18, ,000, ,000 8, ,000, , ,000, , Cumulative Losses 407, Amortized Cost 45,000,000 Lifetime Historical Loss Rate 0.91% Current Conditions Adjustment 0.05% Forecast Adjustments 0.05% Total CECL Factor 1.01% Amortized Cost at YE ,000,000 CECL Reserve 787,800 Input tab for charge offs with SUMIF formula to allocate losses to appropriate years. 11

12 Example 1.1: Snapshot / Open pool method - Illustration Commercial real estate, nonfarm - OO December 31, Sum of credit losses from below 550, , , , , ,000 Balance sheet amounts at YE 43,000,000 45,000,000 50,000,000 55,000,000 60,000,000 63,000,000 Lifetime Historical Loss Rate: 1.28% 0.91% 0.87% 0.70% 0.48% 0.21% Year Borrower Charge-offs Most recent year loan qualified as a "new" loan GDE Electric 105, , Open Pool Co. 80, , Uptown Borrower 95, , ABC Borrower 100, , , Jane Doe 25, ,000 25, BBB Company 60, ,000 60, XYZ Corporation 95, ,000 95, John Smith 50, ,000 50,000 50, Road 5, Snapshot Street 15, ,000 15,000 15, Court Street 35, ,000 35,000 35,000 35, Homer's Group 75, ,000 75, Chicago Lane 85, ,000 85,000 85, Court Street 18, ,750 18,750 18,750 18, Blue Billy 46, ,250 46,250 46, Easy Street Cups 100, , , , White Sox Group 8, ,750 8,750 8,750 8,750 8, Joe Schmoe 26, ,250 26,250 12

13 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. Key Point Identify the items that directly relate to collectability. The illustration in the accounting standard only identifies 2 factors (housing prices and unemployment). 13

14 Illustration 1 from Accounting Standard (Snapshot/ open pool) (continued) Community Bank A (CBA) considered significant factors that could affect the expected collectability of the amortized cost basis of the portfolio and determined that the primary factors are real estate values and unemployment rates. As part of this analysis, CBA observed that real estate values in the community have decreased and the unemployment rate in the community has increased as of the current reporting period date. Based on current conditions and reasonable and supportable forecasts, CBA expects that there will be an additional decrease in real estate values over the next one to two years, and unemployment rates are expected to increase further over the next one to two years. To adjust the historical loss rate to reflect the effects of those differences in current conditions and forecasted changes, CBA estimates a 10-basis-point increase in credit losses incremental to the 1.5 percent historical lifetime loss rate due to the expected decrease in real estate values and a 5-basis-point increase in credit losses incremental to the historical lifetime loss rate due to expected deterioration in unemployment rates. Management estimates the incremental 15-basis-point increase based on its knowledge of historical loss information during past years in which there were similar trends in real estate values and unemployment rates. 14

15 Selection of Lifetime Historical Loss Rate Snapshot/ Open Pool Goal is to select a period most like today s environment and forecast OR use current conditions and forecasts to adjust to CECL loss rate. Historical Loss Rates December 31, FORECAST Losses (000's): Amortized Cost at YE (000's): 38,000 40,000 41,000 42,000 43,000 45,000 50,000 55,000 60,000 63,000 66,000 78,000 Lifetime Historical Loss Rate: 0.99% 1.06% 1.10% 1.13% 1.28% 0.91% 0.87% 0.70% 0.48% 0.21% 0.34%? Current Conditions - Credit Risk Criteria Selected % of loans classified 3.0% 4.0% 6.0% 14.0% 12.0% 10.0% 8.0% 6.00% 4.00% 3.00% 2.00% 10.50% % of loans with LTV policy exceptions at origination 2.0% 3.0% 4.0% 8.0% 5.0% 4.0% 3.0% 1.00% 0.50% 0.25% 2.00% 4.00% Economic Forecast - Selected Data Points Unemployment - Regional Real GDP Growth - National (0.30) (2.80) (1.50) 1.00 Allowance is an estimate with a range of reasonableness can consider a goal post approach. 15

16 Current Conditions/ Forecast Adjustment Historical Lifetime Loss Rate Current Conditions * Economic Forecast ** Qualitative Adjustment Deteriorating High Unfavorable Consistent Moderate Increase Loss Rate Improving Low Historical Lifetime Loss Rate Deteriorating Very low - High Consistent Consistent Nominal Improving Very low - High Increase or Decrease Adjustments Deteriorating Low Favorable Consistent Moderate Improving High Decrease Loss Rate * Current conditions adjust for differences in primary credit risk characteristics between loans today and loans during period in which the lifetime historical loss rate was derived. ** Based on short and long term trends of economic factors that best correlate with credit risk of an institution's portfolio and assessment of future periods. NOTE: if an institution's forecast is similar to that experienced during period of lifetime historical loss rate was derived, adjustment may be minimal. 16

17 Example 2: Remaining Maturity Current Conditions Factor Economic Factor December 31, Loan Balance Charge-offs Annual Loss Rate % of loans PD over 30 days at BOY Unemployment - National ,000, , % 5.0% 8.0% ,000, , % 2.7% 7.0% ,000, , % 4.0% 6.0% ,200, , % 3.0% 5.0% ,000, % 1.6% 4.0% ,000,000 8, % 2.6% 5.0% ,000, , % 4.0% 6.0% Forecast 6.5% AVERAGE = 0.10% 3.3% 5.9% Amortized YE Assumed Amortization/ Average ANNUAL Calculated CECL Year 2020 Prepayments Historical Loss Rate Allowance 1 267,000, % 267, ,206,140 45,793, % 221, ,412,280 45,793, % 175, ,618,420 45,793, % 129, ,824,560 45,793, % 83, ,030,700 45,793, % 38, ,030, % % - Blended Lifetime Historical Loss Rate = 0.34% 915,092 Current Conditions Adjustment 0.08% 213,600 Forecast Adjustments 0.04% 106,800 Total CECL Factor 0.46% $ 1,235,492 Amortized Cost at YE ,000,000 CECL Reserve $ 1,235,492 Residential 1-4 family What do you need for this? 1. Loan balances at YE. 2. Losses during year. 3. Current condition data. 4. Economic factor data. 5. Estimated life (interest rate and prepay assumptions). 6. Flex some judgment with current condition adjustment factor (same as today). 7. Flex some judgment with forecast based on trends. The rest is just math! 17

18 Example 3: Vintage Individuals & other, auto Fully amortizing 5 year loans Originations made during year that qualify as "new" Year 1 Year 2 Year 3 Year 4 Year 5 Historical Lifetime Loss Rate Cumulative losses ,000,000 5,000 25,000 30, ,000 5, , % ,000,000 7,500 30,000 32,000 90,000 5, , % ,000,000 6,500 20,000 28,000 95,000 5, , % ,000,000 6,000 25,000 29, ,000 5, , % ,000,000 5,000 30,000 31, ,000 5, , % AVERAGE 5, 000, 000 6, , , , 000 5, , % CECL Expected Remaining Losses Remaining Balance at Y/E 2020 Origination Year Year 1 Year 2 Year 3 Year 4 Year 5 AVERAGE HISTORICAL LOSS 0.12% 0.52% 0.60% 1.96% 0.10% 3.30% % 0.10% 1,191, % 0.10% 2.06% 2,236, % 1.96% 0.10% 2.66% 3,229, % 0.60% 1.96% 0.10% 3.18% 4,174, % 0.52% 0.60% 1.96% 0.10% 3.30% 5,000,000 Pools - By Vintage Year Originated Balance for Years with Loans Outstanding Historical Lifetime Loss Rate Current Condition Adjustments Forecast Adjustments CECL Factor CECL Reserve ,000, % 0.00% 0.00% 0.10% 5, ,000, % 0.00% 0.00% 2.06% 103, ,000, % 0.00% 0.00% 2.66% 133, ,000, % 0.00% 0.00% 3.18% 159, ,000, % 0.00% 0.00% 3.30% 165,000 Allowance for Credit Losses 565,000 Allowance as % of Loans Outstanding 3. 57% $ 15,830,000 18

19 Regulator Polling question During the webinar co-hosted by the Federal Reserve, FDIC, OCC, FASB, and SEC, the following were the results of a polling question to over 600 attendees. Would your institution consider implementing CECL using any of the methods presented today? Results Answer Reference to Plante Moran example 11% Yes Snapshot In Time Method Example 1 3% Yes Remaining Life Method Example 2 9% Yes Vintage Method Example 3 35% Yes I would consider two or all of these methods 28% I don t know I need to think about it more 5% No, I cannot see my institution using any of these without a vendor 9% N/A 19

20 Example 4: Static pool method Commercial real estate, nonfarm - NOO Includes: 1. New loans. 2. Balloon amount of new renewals. 3. Balloon amount of new restructures and refinances. 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, ,000-12,500 75, , , ,000, , , , , ,000, , ,000 75, ,000, , ,000 Lifetime Losses 725, , , , ,000 Nonfarm Amortized Cost - YTD originations 30,000,000 32,000,000 34,000,000 36,000,000 38,000,000 Lifetime Historical Loss Rate 2.42% 1.84% 1.58% 1.67% 1.84% Year Ended Loans originated 42,000,000 44,000,000 46,000,000 48,000,000 50,000,000 Selected Loss Rate 1.87% 1.87% 1.87% 1.87% 1.87% Current Conditions Adjustment -0.05% -0.05% -0.05% -0.05% -0.05% Forecast Adjustments 0.05% 0.05% 0.05% 0.05% 0.05% Total CECL Factor 1.87% 1.87% 1.87% 1.87% 1.87% Original CECL Reserve 784, , , , ,226 Losses Incurred to Date 725, , , , ,000 Remaining CECL Reserve 59, , , , ,226 Total CECL Allowance at YE 2020 = 1,962,439 20

21 Minimum data sets 21

22 New loan qualifications Vintage/ Year of Origination is a required disclosure with CECL (except for non-pbe s) Refinance, restructuring, or modification occurs DURING the contractual maturity = Evaluate as TDR. Renewal takes place AT contractual maturity = Evaluate as TDR. Loan refinancing or restructuring (ASC through 12) provides guidance as to what qualifies as a new loan for vintage (CECL scopes in renewals): If: Renewal, refinance or restructuring more than minor (change in remaining cash flows vs. new cash flows is greater than 10%) And: Not considered a TDR And: Terms at least as favorable to the lender as comparable customers with similar risks* Then: Account for as a new loan *is effective yield at least equal to comparable loans? 22

23 5 Year Fixed; 25 Year Amortization Renewal 23

24 New loan qualifications Example: 5-year contractual term CRE loan with a 25-year amortization made in 2000; bank expects to renew loan 4 times over 25 years. Life of loan = 5 different, 5-year term loans How is this tracked in the loan system? Three possible approaches: 1. Retain loan number for duration and keep original origination date, but overwrite maturity date at each renewal. 2. Assign new loan number at each renewal. 3. Retain loan number for duration, but overwrite origination date and maturity date at each renewal. Recommendation: Establish procedures to create new loan number only when it qualifies as a new loan per accounting guidance % test or significant changes to loan credit characteristics such as significant new collateral 2. Not TDR 3. Interest rate commensurate with risk 24

25 Pooling Terminology = No real changes from today. 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. A segment can be the lowest level of disaggregation. Classes are sub components of segments based on similar risk characteristics 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 next level of disaggregation to which the loss methodology will be applied. Loans should be aggregated at levels with similar risk characteristics. Plante Moran s Rule of Thumb pools between 5% and 20% of the portfolio. 25

26 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 can be individually evaluated. Example: Bank has one loan to a golf course in California. Can evaluate individually from Day 1. 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 26

27 NON-PBE PBE SEC Our suggested timeline for adoption Completed Education re: new standard Begin dialogue with regulators and auditors Evaluate resources Understand methodologies allowed Develop a timeline for implementation In Process Select methodology Pools identified Verify current data accuracy Gather data Establish processes and controls By Jan Verify new activity Ready to perform shadow calculation Testing of controls Training/corrections Have plan for model validation By Q Model validation complete Measure impact as of first day of year of adoption (Jan. 1 for calendar year-end companies) In Process Education re: new standard Begin dialogue with regulators and auditors Evaluate resources Understand methodologies allowed Develop a timeline for implementation Before YE 2018 Select methodology Pools identified Verify current data accuracy Gather data Establish processes and controls By Jan. 1, 2020 Verify new activity Ready to perform shadow calculation Testing of controls Training/corrections Have plan for model validation By Q Model validation complete Measure impact as of first day of year of adoption (Jan. 1 for calendar year-end companies) NOW Education re: new standard Begin dialogue with regulators and auditors Evaluate resources Understand methodologies allowed Develop a timeline for implementation Before July 1, 2019 Select methodology Pools identified Verify current data accuracy Gather data Establish processes and controls By July 1, 2020 Verify new activity Ready to perform shadow calculation Testing of controls Training/corrections Have plan for model validation Q Model validation complete Measure impact as of first day of year of adoption (Jan. 1 for calendar year-end companies) 27

28 Implementation thoughts What information will be needed for each pool to adjust for current adjustments? Have the right individuals involved in the implementation process (accounting, audit, credit, IT, loan operations, and credit risk). Lots of decisions will be made document the rationale for those decisions along the way and incorporate into accounting policy. What changes should be made to processes and internal controls? Identify key controls over financial reporting with CECL. 28

29 Closing thoughts Measure twice and cut once. Decisions made will have long term impacts. Choose your methodology carefully. Increased complexity can come with an increase in risk of error. Now is the time to start. Expect operational issues and questions to arise and allow time to appropriately assess, analyze, remediate, and verify. Fine tuning of your calculation will take place no matter what methodology you use (same as today under our current guidance) Each methodology above have certain tweaks to meet your institutions needs. 29

30 How we can help: Three levels of service Level 1 Educate your institution s CECL team and provide a glimpse of Excel calculations/workaids to aid in understanding of how the full calculation can be done in Excel. Level 2 Level 1, plus providing the Excel templates/workaids to assist management in understanding a calculation of the expected credit losses in Excel. This level also includes assistance with drafting an implementation timeline, complete with tasks and milestones, as well as eight hours of consulting from the completion of Level 2 to adoption to ensure you are not on an island. So far, most community institutions have been selecting this level of service. Level 3 Outsourced turn key solution with project management. This is a fully outsourced service to build full calculations or assist with software evaluation and selection, internal control assessments, assist with the building tailored allowance calculations, internal control assessments, and/or creation of accounting policy memos. Other services Model validation, internal audit testing. 30

31 Contact Information Ryan Abdoo, CPA, CGMA Industry Technical Leader Plante Moran 10 S. Riverside Plaza Chicago, IL P: E: Chris Ritter, CPA Partner Plante Moran 10 S. Riverside Plaza Chicago, IL P: E: 31

32 Q&A 32

33 Disclaimer The examples presented are illustrations based on facts and circumstances at the time created. These facts and circumstances can, and likely will, change as the industry continues to understand and implement this new standard. Additionally, these examples are not intended to be our views on how an institution would disaggregate a loan portfolio and apply a specific methodology. They are for illustration purposes only. The management of each institution is responsible for the adoption of Accounting Standard Update ; Financial Instruments Credit Losses. Thus, the management of each institution should assess their own loan portfolio for disaggregation and select the methodology, or methodologies, that are deemed appropriate for its circumstances. 33