CECL: Current Expected Credit Loss

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1 CECL: Current Expected Credit Loss Business Issues Forum May 1, 2018 Counselors of Real Estate Mid-Year Meeting Copyright 2017, Trepp LLC

2 CECL What is it? Accounting Standard Update , issued by FASB in June 2016 Replaces three separate accounting standards: FAS 5 (ASC ) general reserve for performing loans. An incurred loss model. Issued in 1975 FAS 114 (ASC ) specific reserve for originated, non-performing assets (or TDRs). ECF or collateral value model. SOP 03-3 (ASC310-30) for purchase credit impaired assets. Incorporates a credit mark and ECF. 2 Copyright 2017, Trepp LLC

3 CECL Why the change? Outgrowth of experience from the 2007/ 2008 financial crisis Experience showed that the incurred loss model was slow to change in rapidly changing markets Existing accounting standard explicitly prohibited firms from increasing reserve levels based on expectations, but the market was valuing companies based on those expectations. If lenders could have been more proactive in raising their reserves, there would have been fewer bank failures and the banks that did survive would have been healthier. 3 Copyright 2017, Trepp LLC

4 CECL What has changed? Accounting standard for reserving against credit losses from incurred to expected For commercial real estate, it applies to loans Lender must estimate credit losses on each asset Credit losses should reflect the expected life of the loans Reserve is the present value of the expected losses 4 Copyright 2017, Trepp LLC

5 CECL The Challenges Forecasting loan performance is data intensive and computationally complex. Historical loan performance data is needed and a lenders own history may not be enough. Forward looking models for stress testing are carried out over many weeks. Many firms close their books shortly after quarter end, and updating loss estimates will be an operational challenge. Credit loss reserves impact financial statements, which means publicly traded companies must consider Sarbanes/Oxley. 5 Copyright 2017, Trepp LLC

6 CECL How do I prepare CECL does not explicitly require use of complex, econometric models to forecast losses CECL does require that forecasts be done in a repeatable and defensible way. Smaller lenders that are accustomed to having a simple Excel spreadsheet for estimating their reserves will face a significant increase in complexity. Every lender must get its loan data organized. 6 Copyright 2017, Trepp LLC

7 CECL Three approaches to estimating losses Three key segments with different approaches for calculation Very Large Lenders: Seek to leverage internal team to build proprietary models Mid-sized lenders: Leverage third-party credit loss model Small lenders: Scorecards and other analytics tools Delineation between segments more about sophistication than total assets Less sophisticated models and analysis Vendor Supplied Models Custom Models Internally or Consultant Built 5,000+ Banks, Small Funds, Family Offices, Pension Funds Banks, Mid-sized Funds and Mortgage REITS, Pension Funds Banks and Very large Fund < $1B Total Loan Portfolio > $1T 7 Copyright 2017, Trepp LLC

8 CECL Trepp s Approach 8 Copyright 2017, Trepp LLC

9 More Complex Less Complex Trepp CECL Solutions Complexity Trepp Solutions CECL Benefits DM Score Cards DF Benchmarks Generate model-based forward looking CECL ALLL Use historical actual loss rates to drive CECL ALLL calculations Trepp DM - For CECL CRE loan level PD/LGD forecasting tool with built in discounted cash flow CECL ALLL calculator. Trepp Datafeed 20 year CRE loan and property performance data. Institutional, modeling quality historical default and loss data. Generate loan-level, customized, CECL loss forecasts Build custom CECL loss models 9 Copyright 2017, Trepp LLC

10 Less Complex Trepp-DM Scorecards Some banks may wish to use econometric forward looking models at a risk cohort level instead of on a loan-by-loan basis. Trepp-DM Scorecards provide CECL loss rates generated by the Trepp-DM for different classes of loans stratified by vintage, property type, region, loan type, LTV, and DSCR cohorts. Vintage 2015 Rate 3.00 IO No Region South Atlantic CECL ALLL % by Property Type, DSCR, LTV, and Original Term (Select Vintage, Rate, IO, Region) Industrial Lodging Multifamily Office Retail Orig Term DSCR -> Years 5 Years 7 Years 10 Years LTV % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % LTV % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % LTV % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % LTV % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % Total % % % % % % % % % % % % % % % % % % % % % Total 10 Copyright 2017, Trepp LLC

11 Trepp-DM Scorecards CECL loss rates provided in scorecard format and in lookup table format for easy application to loans or loan groups. Scorecard Use the scorecards to find model generated losses for different risk cohorts. Good for reporting and loan scoring at origination. Lookup Table Download the look up table to easily apply CECL loss rates to loans or loan groups based on the risk cohort attributes (LTV, DSCR, Region, Vintage, Term etc.) Use the loss rates to apply CECL reserves to loans at origination and during quarterly financial reporting. Vintage 2015 Rate 6.00 IO No Region Mid Atlantic Industrial Orig Term DSCR -> LTV % % % % 3 Years % % % % % % % % % % % % LTV % % % % 5 Years % % % % % % % % % % % % LTV % % % % 7 Years % % % % % % % % % % % % LTV % % % % 10 Years % % % % % % % % % % % % Total % % % % 11 Copyright 2017, Trepp LLC Vintage Property Type Rate IO Region DSCR LTV Rem Term ALLL% 2015 Industrial 4.00 Yes Mid Atlantic y 2.50% 2014 Industrial 5.00 No East South Central y 1.50% 2015 Retail 4.00 No New England y 1.25% 2013 Multifamily 3.50 Yes East North Central y 2.75% 2015 Industrial 4.00 Yes Mid Atlantic y 2.50% 2014 Industrial 5.00 No East South Central y 1.50% 2015 Retail 4.00 No New England y 1.25% 2013 Multifamily 3.50 Yes East North Central y 2.75% 2015 Industrial 4.00 Yes Mid Atlantic y 2.50% 2014 Industrial 5.00 No East South Central y 1.50% 2015 Retail 4.00 No New England y 1.25% 2013 Multifamily 3.50 Yes East North Central y 2.75% 2015 Retail 4.00 No New England y 1.25% 2013 Multifamily 3.50 Yes East North Central y 2.75%

12 Trepp-DM Scorecards Banks can use the scorecards to apply CECL loss rates to loan groups in the CRE portfolio. Gather Portfolio Loan Data Group Loans Based on DSCR, LTV, Vintage etc. Apply Scorecard CECL Loss % to Balance Loan 1 $100 Loan 2 $150 Group 1: $350 Scorecard Loss: 1.5% $5.25 Loan 3 $200 Loan 4 $150 Group 2: $375 Scorecard Loss: 1.0% $3.75 Loan 5 $125 Loan 6 $300 Loan 7 $575 Group 3: $1,675 Scorecard Loss: 2.5% $33.50 Loan 8 $800 Total CECL ALLL = $ Copyright 2017, Trepp LLC

13 DSCR Trepp-DF Benchmarks Some banks may wish to use historic loss rates to generate, inform, or benchmark their CECL loss projections. Trepp-DF Benchmarks provide actual historical CRE loss rates observed in the Trepp- Data Feed for different classes of loans stratified by vintage, property type, region, loan type, LTV, and DSCR cohorts. Vintage: All Property Type: All State: All Loan Term: All LTV % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % 13 Copyright 2017, Trepp LLC

14 Trepp-DF Benchmarks Banks can use the scorecards to apply CECL loss rates to loan groups in the CRE portfolio. Gather Portfolio Loan Data Group Loans Based on DSCR, LTV, Vintage etc. Apply Benchmark Loss % to Balance or Use to Benchmark Bank Loss Forecasts Loan 1 $100 Loan 2 $150 Loan 3 $200 Group 1: $350 Bank Loss: 1.5% Benchmark Loss: 4.0% w: 0.5 w: 0.5 $9.63 Loan 4 $150 Group 2: $375 Bank Loss: 1.0% Benchmark Loss: 3.5% $8.44 Loan 5 $125 w: 0.5 w: 0.5 Loan 6 $300 Loan 7 $575 Group 3: $1,675 Bank Loss: 2.5% Benchmark Loss: 5.0% w: 0.5 w: 0.5 $62.82 Loan 8 $800 Total CECL ALLL = $ Copyright 2017, Trepp LLC

15 Trepp CRE Default Model (DM) Platform based model for forecasting CRE PD, LGD, EL and CECL with an intuitive user interface for run configuration, execution, and results analysis. Loan level, bottom up model using loan and macroeconomic variables to forecast default and loss performance through DFAST, CCAR and custom macro scenarios. Capabilities include: custom treatment of maturity risk, group NOI/Value overrides, and new origination engine to forecast the effect of loan growth for stress testing. 15 Copyright 2017, Trepp LLC

16 DM - Risk & CECL: Key Attributes Built using the industry standard Trepp historical CRE loan performance data set used by CCAR and DFAST banks for risk management and stress testing model development Includes thorough, comprehensive, and transparent model documentation with independent validation allowing banks to fully understand and justify their results Provides results designed to facilitate flexibility in performing loan and portfolio level analytics with built in logs of all inputs that go into each calculation including portfolio, scenario, and override information 16 Copyright 2017, Trepp LLC

17 Optional Customizable Required Trepp DM - Risk & CECL: Logical Process Flow Input Forecast/Calculations Output Loan Level Information Macroeconomic Scenario Geographic/Group NOI & Value Vectors Loan Level Cash flows Property Values NOI DSCR Refinance Analysis New Loan Origination Loan Level Probability of Default Loss Given Default Expected Loss CECL ALLL Maturity/Refinance Gap Assumptions Loan Growth Assumptions Portfolio Level Probability of Default Loss Given Default Expected Loss CECL ALLL 17 Copyright 2017, Trepp LLC

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