CECL & ALLL THAT JAZZ CONFERENCE DIGEST

Transcription

1 CECL & ALLL THAT JAZZ CONFERENCE DIGEST

2 The MST 2017 National ALLL Conference, the only national conference dedicated to the ALLL, hosted more than 300 financial professionals from banks and credit unions, auditors, and regulators looking for guidance from more than thirty of the industry s leading experts on the allowance to guide them as they begin their transition to the new allowance accounting standard. The resulting deep-dive into rules and regulations, policies and best practices, left them with the information, ideas and insights that will allow them to lead their institutions to and through CECL. From hard and fast rules to anecdotal commentary, the experts and attendees shared knowledge and observations through three days of intense education. The MST 2017 National ALLL Conference Digest intends to share the highlights of each of those general sessions and workshops. 2

3 General Session: CECL: Fact or Fiction? Presenters: Mike Lundberg Partner National Director of Financial Institutions Services RSM US LLP Graham Dyer Partner Accounting Principles Consulting Group Grant Thornton LLP KEY TAKEAWAYS CECL is designed to be scalable, but it is a significant undertaking for all institutions. CECL will require more data. The impact of CECL will be enterprise wide. CECL requires pooling loans with similar characteristics. Through a series of statements presented as fact or fiction, Lundberg and Dyer explored several of the basic tenets of the new ASU accounting standard. Among the key issues addressed and points made: CECL is designed to be scalable to smaller institutions and less complex portfolios, but is a significant undertaking for all institutions, and it will impact the institution enterprise wide. So, preparing for CECL should involve all stakeholders and perspectives, including accounting, credit, IT, internal audit and top executives. CECL is fundamentally different than what estimating the ALLL has involved under the incurred loss model. You ll need the accounting expertise, but also credit and economic data, and lots of involvement from IT. There are many different models, methodologies or techniques available to address CECL. The FASB has intentionally left that decision up to each institution, and each institution must be guided in its choices by its own portfolio and policies. Each entity will likely employ different approaches across different portfolios or portfolio segments. CECL requires the pooling of assets with similar risk characteristics. Lenders will likely employ different approaches across different portfolios or even portfolio segments. 3

4 SPEAKERS Mike Lundberg Partner, National Director of Financial Institution Services RSM US LLP Mike has responsibility for audit, accounting and risk containment matters across the firm s financial institution practice, which includes community banks, credit unions, finance and leasing companies, and other specialty lenders. CECL is absolutely NOT the same as fair value. You will require more data to comply with CECL, in particular life of loan data, the amount and type of which will depend on the methodology you select and the methodology you select will be dependent on the amount and quality of data you can access. The question is, Do you pick a methodology first, then find the data, or see what data you have, then choose the suitable methodology? If you don t know where to start, you can pick a methodology and see how it works, and if it doesn t then you can try another methodology. The forecast must be as extended as is reasonable and supportable, up to the contractual term of the loans reduced by expected prepayments. Graham Dyer Partner, Accounting Principles Group Grant Thornton LLP Graham currently consults with financial institution clients of all sizes and audit teams regarding technical accounting and auditing matters, with a focus on regulatory capital and compliance impact. Some specific areas of expertise include accounting for the allowance for loan losses, accounting for business combinations, accounting for purchased credit-impaired debt, fair value, modeling impact on regulatory capital, and accounting for mortgage banking and servicing activities. A compliant CECL methodology will generally require a larger reserve than a compliant incurred loss model. Due to the subjective nature of the estimate, your auditors will ask not only about the resulting allowance amount but how you got there. What are the controls? CECL requires you to extend internal controls beyond the credit functions, which is new and maybe disruptive to how your institution operates. CECL requires you to pool loans with similar characteristics. The only loans evaluated independently are those that do not fit in a pool. Please visit the National ALLL Conference website for full speaker bios. Watch the entire presentation on the MST YouTube Channel. Click here for CECL: Fact or Fiction. Read the MST blog 10 Crucial Truths About CECL. 4

5 General Session: Current GAAP: ALLL We Need to Know Presenters: Will Neeriemer Partner DHG Financial Services Garry Rank Senior Advisor MST Advisory Services KEY TAKEAWAYS A lender cannot increase reserves in anticipation of CECL. Internal controls are important now and will continue to be under CECL. As you prepare for CECL, remember you are still estimating under incurred loss until your implementation date. Even after 40 years of estimating the reserve under incurred loss, the ALLL continues to be a source of both material and immaterial misstatements. The confusion is generally due to heavy spreadsheet use, multiple input sources, and insufficient reconciliation and review processes. This session addressed some of the challenges lenders face today in estimating their allowances under the current GAAP standard. Troubled Debt Restructures: A TDR that has been performing and is refinanced to market terms may be a candidate for removal from TDR status. There are different assessments as to what constitutes a TDR, but the status is generally assigned when the borrower is clearly in trouble and the loan is renewed without compensation for the additional risk or other modification. Call report guidance defines TDR and offers an example of when a TDR can be assigned non-tdr status. Rules for unallocated loans: Need to provide supporting rationale for categorizing them as unallocated Need explicit approval Need limitations and guidelines stated in a policy; more than 10 unallocated loans is pushing the envelope. A lender cannot increase reserves in anticipation of CECL. Some institutions have been using Q-factors to total 50 percent or more of their allowance to make their board comfortable as well as to prepare for a higher reserve under CECL. You can t include future considerations in 5

6 SPEAKERS Will Neeriemer Partner, DHG Financial Services Will has more than 15 years of experience in providing attest and advisory services to financial institutions. His experience includes clients ranging in size from one branch local banks to multi-state regional banks. Will has extensive experience with the accounting and auditing issues related to mergers and acquisitions, mortgage banking and complex valuations. He has a deep appreciation for the challenges that face community banks in complying with regulator and industry expectations. Garry Rank current GAAP, for example, due to impending changes in Dodd-Frank. However, if there was an amendment in bankruptcy laws, you could make adjustments relative to that change already in effect. An emerging trend is an increase in illiquid assets in borrower s statements. Auditors continue to find errors and lapses related to internal controls. Some best practices to improve internal controls: Thoroughly document your process Consider all sources of inputs into your model Review design and documentation of controls Consider timing of performance of controls Avoid over-reliance on high-level reviews by C-level or board committees Secure third-party model validation Senior Advisor MST Advisory Services During Garry s career with a top 30 regional accounting firm, he specialized in corporate financial auditing, accounting and financial reporting as well as consultation regarding governance, financial systems and internal controls. With more than 36 years of experience, his industry concentration in financial services included Securities and Exchange Commission (SEC) reporting and regulatory compliance. Additional professional experience included the management of complex engagements, mergers and acquisitions, and projects involving subsidiary companies. Garry brings these skills to MST Advisory Services as a Senior Advisor to assist financial institutions in making the transition to CECL. Watch the entire presentation on the MST YouTube Channel. Click here for GAAP: ALLL We Need to Know Now. 6

7 General Session: Building Your Blueprint for Expected Credit Loss Presenters: Pam Molvar SVP Credit Risk Analytics and Policy Manager HomeStreet Bank Dorsey Baskin Consultant to MST Advisory Services and retired partner Grant Thornton LLP Shane Williams Senior Advisor MST Advisory Services Chris Emery Senior Advisor - Engineering Director of Special Projects MST KEY TAKEAWAYS Start your CECL project now in order to assess the impact to your reserve requirements. Educate yourself on CECL as fully as possible. Validate your implementation plan with your auditors and regulators. HomeStreet Bank is a $6.5 billion financial institution with a $4 billion complex loan portfolio that includes a large number of acquired loans. HomeStreet is working with MST Advisory Services, a team of industry-leading allowance experts assisting financial institutions in their transition to CECL. The conference session provided an overview of the transition process underway at HomeStreet as described by HomeStreet s Senior Vice President of Credit Analytics, Pam Molvar, and three members of the MST Advisory team assisting Molvar and HomeStreet. Questions and input from conference attendees rounded-out the hour. Among the highlights of the discussion: The Bank s initial activity associated with MST s Blueprint for CECL was to form a steering committee of internal stakeholders. HSB s steering committee includes the CEO, CFO, chief risk and credit officer, treasurer, and Molvar. The goals of the committee and advisory team in terms of CECL compliance were described as: Develop an understanding of the new standard and what needs to be changed from HSB current practices. Determine the impact to the reserve level of the CECL implementation as soon as possible to allow time to make adjustments. 7

8 SPEAKERS Pam Molvar Senior Vice President, Credit Risk Analytics and Policy Manager HomeStreet Bank In her current role, Pam is responsible for overseeing the Allowance for Loan and Lease Losses (ALLL), loan and ALLL related external financial and regulatory reporting, internal credit reporting to the Board of Directors, loss forecasting, and loan and credit related policies. Dorsey Baskin Consultant to MST Advisory Services and retired partner Grant Thornton LLP Dorsey recently retired from the national professional standards group of Grant Thornton LLP. Dorsey s roles at Grant Thornton included national leadership of the firm s innovation function, technical accounting and audit advisor for the banking industry audit and consulting practice, and national professional practice director. Prior to joining Grant Thornton in 2002 Dorsey spent more than 25 years with Arthur Andersen in a variety of positions, most recently in Chicago as the Managing Director of their Worldwide Assurance Professional Standards Group. Before that Dorsey spent a decade in Washington DC as the firm s Technical Director for Banking and regulatory liaison. As a Senior Advisor with MST Advisory, Dorsey is consulting with financial institutions in understanding the transition to CECL. Leverage HSB s existing methodology and platform to the extent possible. Determine the appropriate methodology to calculate life-of-loan loss. Determine if the current pools and data capture are adequate. Develop processes for reasonable and supportable forecasts. The project structure involved examining and addressing key areas, including: Data and pooling analysis Methodology for life-of-loan calculation Qualitative and quantitative adjustments Reasonable and supportable forecasts Individually measured loans Purchased loans Unfunded loan commitments Policy and disclosure Methodologies analyzed for applicability: Probability of Default/Loss Given Default (PD/LGD) Migration Vintage (HSB found it currently lacks sufficient loss data) Discounted Cash Flow (DCF) (HSB lacked complete cash-flow data) Open Pool (addresses needs and is viable) The process also involved an extensive pooling analysis, a review of applicable Q-factors, drafting guidelines for policies and disclosures, and setting and achieving other milestones. Watch the entire presentation on the MST YouTube Channel. Click here for Building Your Blueprint to Expected Credit Loss. 8

9 SPEAKERS Other observations: Molvar: We wanted to start early to run parallel as early as possible. This gives us time to run some risk impact tests to allow for possible changes to our methodology. Molvar: We are currently analyzing a restructuring of our pools. We are consolidating some of our smaller commercial pools and segregating some of our larger consumer loans into more risk level pools, anticipating higher reserves due to the long duration of those loans. CECL is an opportunity to reanalyze loan pools based on your current product mix and risk levels that might not have been addressed in some time. You will have to justify your loan pools for CECL. Shane Williams Senior Advisor- Modeling MST Advisory Services As a senior consultant for MST Advisory, Shane works with banks and credit unions to set priorities, identify data needs, implement allowance technology, run shadow analyses and identify appropriate methodologies in preparation for accounting for loan losses under CECL. Following two decades as a treasurer with a national bank, he worked with Fiserv helping lenders implement financial services technologies, then as a consultant to bankers with Price Waterhouse Cooper. The FASB decided that disclosures around vintage were necessary. So, even if you don t adopt vintage as a methodology, you still have to disclose information by year of origination. Loans that need to be individually measured, that is, not pooled as generally required by CECL, include: loans defined by qualifying descriptors, TDRs, loans for which the principal has been charged off, and collateral dependent loans. Overall advice is to move toward testing methodologies in shadow analyses (running CECL parallel) with your current ALLL estimate to identify strengths and weaknesses of each. Do not select a methodology solely based on the lowest estimate result. Chris Emery Senior Advisor Engineering Director of Special Projects MST Chris has helped hundreds of financial institutions of varying asset sizes and employing all major core systems implement allowance technology that supports their efforts to comply with regulatory and accounting standards, including in their current transition to estimating the allowance under CECL. In addition to his client engagements, Chris advises the technology group at MST which is charged with developing, implementing and supporting software solutions that assist financial institutions with calculating the Allowance for Loan and Lease Losses (ALLL) and now making preparations for CECL. 9

10 General Session: Compliant Methodologies Under CECL Presenters: Mike Gullette Vice President Accounting and Financial Management American Bankers Association Vince Milano Director Accounting & Assurance Services Postlethwaite & Netterville Chris Emery Senior Advisor - Engineering Director of Special Projects MST KEY TAKEAWAYS Start preparing now by (via a steering committee) to assess existing technology, sources of portfolio data and determine whether to use vendor-supplied technology. There are a variety of methodologies from which to choose, including loss-rate, vintage and discounted cash flow. Different methodologies may be applied to different groups of financial assets based on similarity of risk characteristics. The session focused on CECL methodologies and covered what institutions should be doing now en route to identifying appropriate methodologies, rules applicable to methodologies and a look into the various methodologies themselves. Highlights of the discussion include: As is broadly recommended, the institution should have in place a cross-functional steering committee including, at a minimum, representatives from credit, accounting, IT, financial analysis and someone to serve as liaison with the board of directors. Selecting a methodology is a collaborative effort, but it is important that the process is driven through Credit as it is a measurement of credit risk. Types of portfolio data for CECL include: Basic, such as loan number, origination balance, maturity, interest rate, payment terms, lien position, etc. Risk indicators, such as risk rating, credit scores, industry, property type, debt service coverage, etc. Others, such as charge-off and recovery amounts and dates, default reason, amount outstanding at default, etc. 10

11 SPEAKERS The look-back period should encompass a timeframe that best matches the life-of-loan concept, and, if possible, should include the Great Recession years. Some specifics on various methodologies: Loss rate: cumulative credit losses Pooling method currently used by most institutions in determining the ASC 450 component of the allowance Regulators indicate that small, less complex institutions may continue to use this method with segregation by call report code Based on the open pool concept which is simpler than other methods and fewer data needs Qualitative factors are a challenge and more difficult to quantify Mike Gullette Vice President, Accounting & Financial Management American Bankers Association Arriving to the American Bankers Association in February 2009, Mike works with the FASB, the IASB, and the U.S. banking regulators in helping bankers understand and implement policies and regulations related to accounting, financial reporting, internal controls, and capital management. Mike was very active in both the CECL and IFRS 9 standardsetting processes, leading the industry s evaluation of each of the several different impairment models considered by FASB. Vintage An example of a closed pool Impairment based on origination date Loss factor based on the financial asset s age Example is provided in the implementation section of the Standard Aligns with the required credit quality vintage disclosures required by ASC Isolates the impact of the economic environment and changes in underwriting standards over time Improves forecasting ability but requires extensive data Vince Milano Quality Control Director (CPA) Postlethwaite & Netterville Vince has more than 35 years of public accounting experience. Throughout his public accounting career, Vince has focused on depository institutions and mortgage banking. He has extensive experience with generally accepted accounting principles, SEC reporting and PCAOB standards, risk assessments, audits of internal controls, generally accepted auditing standards and litigation support. PD/LGD is getting a lot of attention as a prospective methodology, as it measures frequency and severity of losses. Combining the two is the simplest way to estimate. Watch the entire presentation on the MST YouTube Channel. Click here for Compliant Methodologies Under CECL. 11

12 SPEAKERS Chris Emery Senior Advisor Engineering Director of Special Projects MST Chris has helped hundreds of financial institutions of varying asset sizes and employing all major core systems implement allowance technology that supports their efforts to comply with regulatory and accounting standards, including in their current transition to estimating the allowance under CECL. In addition to his client engagements, Chris advises the technology group at MST which is charged with developing, implementing and supporting software solutions that assist financial institutions with calculating the Allowance for Loan and Lease Losses (ALLL) and now making preparations for CECL. 12

13 General Session: The Board, Investors and Expected Credit Loss Panel: Garry Rank Senior Advisor MST Advisory Services Walter McNairy Managing Partner DHG Financial Services Mike Gullette VP Accounting and Financial Management American Bankers Association Chad Kellar Partner Advisory Services Crowe Horwath Ben Hoffman Managing Director KPMG KEY TAKEAWAYS Decide on your methodologies at least one year before implementation. Understand that by year three, following implementation, many of the assumptions from your initial CECL estimates will have changed as you have learned more about the impact of your methodology. The definition of a Public Business Entity (PBE) has changed. You need to know if your institution is considered a PBE. The CECL implementation date for PBEs is a full year earlier than privately held institutions. To govern effectively, your board needs to understand the CECL standard. And an effective CECL implementation process involves educating the board and investors on the nuances and system-wide impact of CECL. This session addressed the challenges involved in education, reporting and ongoing governance. A good practice is to present your board with some crude numbers, some CECL-based calculations rooted in your history that will make them aware of how it might affect capital, how meaningful an impact it will have. You should have decided on your methodologies at least one year before implementation and understand that by year three, following implementation, many of the assumptions from your initial CECL estimates will have changed as you have learned more about the impact of your methodology. 13

14 SPEAKERS Garry Rank Senior Advisor MST Advisory Services During Garry s career with a top 30 regional accounting firm, he specialized in corporate financial auditing, accounting and financial reporting as well as consultation regarding governance, financial systems and internal controls. With more than 36 years of experience, his industry concentration in financial services included Securities and Exchange Commission (SEC) reporting and regulatory compliance. Additional professional experience included the management of complex engagements, mergers and acquisitions, and projects involving subsidiary companies. Garry brings these skills to MST Advisory Services as a Senior Advisor to assist financial institutions in making the transition to CECL. Chad Kellar Partner Advisory Services Crowe Horwath Chad s business unit focuses on transaction, valuation, accounting consultation, and model validation services in the financial services industry. Chad is one of the firm s subject matter expert on the valuation and accounting for financial instruments and is in-charge of Crowe s CECL Implementation Services. The provision is going to evolve over the years and it is important that your board understands that. Also you will need to explain to your board why your expectations are different from your peer institutions. CECL will mimic SOP 03-3 in terms of misunderstanding, even by the analysts. CECL will be like that on steroids. The definition of a Public Business Entity (PBE) has changed. It is critical to know if it applies to your institution for several reasons, including that the CECL implementation date for PBEs is a full year earlier than privately held institutions. Due diligence for an acquisition requires you to understand the history and trends of that institution over time to calculate an appropriate CECL reserve. If you buy a smaller institution, it is likely the quality of its data will not be as good as yours. It is important to have day-one data on acquired loans as that will be needed for a compliant CECL estimate. If you re a seller you might want to adopt early, or at least be well down the road toward transition so you can share the expected impact on your portfolio with your acquirer. One of the challenges to assembling the data needed for CECL is the low number of charge-offs and lack of losses in recent years. It will be challenging to understand how your provision will evolve over the year based on growth, acquisition, changes in economic factors, etc. Explaining the volatility 14

15 Ben Hoffman of your provision to board members, investors, and all stakeholders will be difficult. Managing Director KPMG Retaining comparability of financial statements will be a significant challenge. Examine how a recession will impact your reserves. Your numbers won t be precise, but they will give the board a good idea of how a recession will impact your provision. It will help them understand how the new model affects your bottom line during a downturn. For the additional data you need, look to peer groups as your guardrails for investors. But also look to public companies because by the third quarter of 2019 they will have done a lot of that work. Regulators are also likely to have data on potential trends. Ben leads the firm s ALLL specialist group in support of KPMG s external audit clients and is a co-chair of KPMG s CECL steering committee. Ben supports a range of advisory and audit clients on complex ALLL issues as well as assisting clients as they develop their CECL implementation plans, enhance their credit risk models, and improve their data analytics to support loss forecasting processes across the Bank. Walter McNairy Managing Partner DHG Financial Services Walter leads a team of 35+ partners and more than 300 audit, tax and consulting professionals. As the Managing Partner, Walter oversees the work done for clients throughout DHG s footprint and serves as Engagement Quality Review Partner for many of DHG s largest banking clients. He is considered a thought leader in the industry and helps develop DHG s strategic approach to knowledge share within DHG Financial Services. Mike Gullette Vice President, Accounting & Financial Management American Bankers Association Watch the entire presentation on the MST YouTube Channel. Click here for The Board, Investors and Expected Credit Loss. Arriving to the American Bankers Association in February 2009, Mike works with the FASB, the IASB, and the U.S. banking regulators in helping bankers understand and implement policies and regulations related to accounting, financial reporting, internal controls, and capital management. Mike was very active not only in both the CECL and IFRS 9 standardsetting processes, leading the industry s evaluation of each of the several different impairment models considered by FASB. 15

16 General Session: Bankers Share CECL Transition Experiences Panelist: Muneera Carr EVP Chief Accounting Officer and Controller Comerica Bank Hans Pettit Partner Horne LLP Dave Cogswell SVP Credit Administration Director Chemical Bank Mark Williams Chief Executive Operations and Credit Renasant Bank KEY TAKEAWAYS It is not too early to start 2020 will be here before you know it! Be sure to include cross-functional players on your team this is not just a credit or accounting thing. You can t have too much data. Don t be afraid to ask for outside help this is a big deal! What are your peers doing in their transition to CECL? Three larger institutions, ranging in size from $72 billion in assets to $8 billion, were joined by an auditor who served as the voice of smaller lenders, to discuss the processes they use to estimate their allowances and the progress they are making toward CECL implementation. Chemical Bank estimates a CECL implementation timeline of between 14 and 20 months. Phase one will involve creating the roadmap, including educating stakeholders, identifying requirements and determining the resources they will need. The timeline proceeds to developing and refining multiple approaches to CECL and running methodologies parallel to current estimates. The second phase will involve validating the selected methodologies, designing internal controls over the provision estimating process, getting their model approved by their directors and auditors, then implementing, testing and fine-tuning their process. Comerica s timeline has involved external and internal meetings to understand and interpret the standard, evaluate its platform and assess its data. By the end of 2017 they will 16

17 SPEAKERS have a CECL platform in place and have built working models. The process will be completed in 2018 with sensitivity testing, documentation and model validation, parallel testing over four quarterly runs, determining procedures and controls, reporting, disclosures and analytics. Renasant Bank has also developed and is pursuing a detailed plan for CECL implementation that includes cross-section involvement, data mining, segmenting for loan pools, identifying prospective models, determining credit quality indicators that will impact the portfolio, and performing model simulations. The bank s plan calls for completing the process, including training, at least six months in advance of the CECL deadline. Hans Pettit explained the position of smaller community banks, where fatigue exists, and there is real trouble in getting buy-in. Many have the attitude Isn t Trump going to take care of this for me? He says while the industry continues to pound the message of compliance, there is a tremendous opportunity by simply changing the nomenclature. Hans suggests fostering a climate of collaboration not cooperation. Differences between accounting and credit concerns are often vast. Collaboration allows everyone to come together to discuss their differences where expected credit loss is concerned and that s what it s going to take. Other observations: Regulators want us to walk them through our implementation process and want to know how we re going to get there. Long-term loans will be considered differently under CECL. People in the financial institution understand that, though not why or how. Muneera Carr EVP, Controller & Chief Accounting Officer Comerica Bank In her current role, Muneera is responsible for overseeing external financial and regulatory reporting, planning & forecasting, tax, accounting operations, and accounting policy and research. Prior to joining Comerica, Muneera was a Professional Accounting Fellow in the Office of the Chief Accountant at the U.S. Securities and Exchange Commission from 2007 through She has performed the accounting policy function at major banks such as SunTrust and Bank of America. Dave Cogswell Senior Vice President, Credit Administration Director Chemical Bank In his current position, Dave is responsible for the Allowance for Loan and Lease Losses, Credit Policy, and Credit Risk Modeling and Reporting. He serves on the Bank s CECL Implementation Committee, SOX Committee, Credit Policy Committee, Bank Loan Administration Committee, Senior Loan Committee, and Directors Loan Committee. Having worked in the financial services industry for 30 years, Dave has held positions including Chief Credit Officer, internal audit, commercial lending, regional management, and credit administration. Prior to his current role, he was a consultant to a variety of Banks assisting them with credit policy, Allowance for Loan and Lease Loss set-up and validation, and loan review. Have to document thoroughly the testing you do through all the scenarios documentation that clearly outlines 17

18 SPEAKERS Mark Williams Chief Executive Operations and Credit Renasant Bank Currently, Mark is responsible bank wide for Information Technology, Deposit Operations, Loan Operations, Call Center, Credit Administration, M&A, Due Diligence, CECL, Stress Test, Loan Review, Special Assets, Appraisal Department, FDIC Loss Share and Small Business Lending. Additionally, he is/has been instrumental in taking the lead and setting strategy to prepare for CECL, DFAST serving as Committee Chair, Enterprise Data Warehouse strategies, Credit Policy, Digital Banking, and process and efficiency management. Mark serves as one of three Corporate Credit Officers for Renasant. the processes you ve gone through, controls you ve put into place, and results, then why you think it is not an appropriate methodology. Loss emergence period is converging with life of loan. Best advice is to give yourself the time you need to ensure you are producing the best results for your institution. Data needs will result in creating information not looked at in the past that will help better understanding of an institution. The lesson is to find ways of leveraging the information you are compiling. Lessons learned include that there is a large volume of work to be done, that data is king, and that they will have to test multiple models before determining those that best suit their institution. Hans Pettit Partner, Financial Institutions HORNE LLP Hans challenges his clients to evaluate perspectives and find opportunities unique to their organizations. His focused experience with highly regulated entities means specific assessment of a client s situation is only the beginning of the relationship. Hans specialty is guiding clients through the complexities of risk and regulatory issues, while identifying strategic opportunities for outcomes that position a client s leadership team to succeed. Watch the entire presentation on the MST YouTube Channel. Click here for Bankers Share CECL Transition Experiences. 18

19 General Session: Signal or Noise? An Economic Forecast Presenters: Tom Cunningham Economist and Senior Advisor MST Advisory Services Retired Senior Economist Federal Reserve Bank of Atlanta Max Oberkofler Subject Matter Expert MST KEY TAKEAWAYS Understanding the relationship between an Institution s Loan Losses and the Economy historically is the first step to forecasting Expected Losses based on Economic Conditions. Considering economic conditions is not necessarily a new concept to the Allowance calculation. The 2006 Interagency Policy Statement suggested that economic conditions be considered when making qualitative adjustments to the Allowance Qualitative Adjustments are an acceptable part of an Allowance calculation because even the best Quantitative Measurement has its shortcomings. Common shortcomings include different economic environments, changes in lending policies, insufficient historical data Using economic data to help forecast loan losses is a reasonable idea, and CECL makes that explicit. Right now, that economic outlook suggests that there is nothing on the immediate national horizon that would change existing loss estimates. Wage increases have been quite moderate in light of what seems like a very low unemployment rate. The answer may be slack in the labor market that is captured by the gap between U3, the headline unemployment rate, and U6, a broad measure of labor underutilization. Although these numbers are published each month, U3 typically gets all the attention Labor shortages generally are going to become a larger constrain on businesses. Baby boomers aging out of the workforce is decreasing the rate of labor force growth. This is great for existing workers who will find it easier in the future to get jobs and/or raises, but it will be increasingly challenging for employers. 19

20 SPEAKERS Tom Cunningham Economist and Senior Advisor MST Advisory Services Retired Senior Economist Federal Reserve Bank of Atlanta Tom joined the Federal Reserve Bank of Atlanta as an economist with the macropolicy group in He was promoted to senior economist in 1989 and to research officer and senior economist with responsibility for the regional group in Cunningham retired in 2015 after a 30 year career. He has recently joined the Metro Atlanta Chamber s leadership team as chief economist. Cunningham s deep experience covers all aspects of applied economics and real estate trends, and he is a specialist in macroeconomic policy and regional analysis. Throughout his career, he has interacted with multiple business leaders and companies in the Southeast, and has deep knowledge and expertise in areas such as real estate mortgage, mortgage finance, insurance, capital markets, transportation and government. This wide range of economic specialties is now being leveraged with the MST Advisory team. Why consider economic data in your CECL forecast? The short answer is because the FASB says to. Moreover, forecasting future loan performance requires you to consider the economic climates, from local to global. Under the incurred loss model, economic considerations were included as a qualitative adjustment. But economic conditions will play a much larger role under CECL: The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. (ASU ). Adjustments for economic data: have to understand how economic data and your loss experience correlate. Have to ensure there is actual causation between economic data and your loss experience. Today, consumers are in a relatively robust position, because the recession was not followed by a spending spree. Government spending is a major part of the economy and one of the reasons the recovery was slow is that state and local governments were suffering and laying people off. Because of aging baby boomers, economic growth has slowed. Considering current productivity growth of 1% to 1.5%, the new normal annual increase in GDP is about 2%. Trade deficit: what matters is the change in the trade deficit not the deficit itself. Labor market: averaging a little over 200,000 new jobs per month with 120,000 people coming into the work force. But in an average month in the U.S., about five million people get a job and about five million lose a job, the 200,000 in growth represents the difference. 20

21 SPEAKERS Beyond the statistics: two factors driving labor underutilization are those who haven t looked for work but would take a job if one was offered, and part timers. Part time work is driven by software that can predict when a firm needs employees; in particular, service industry jobs are going more to part time, and there is a trend among millennials toward preferring part-time work. The Federal Reserve Economic Data (FRED) database can be extremely helpful to financial institutions looking at ecomomic data. It offers approximately 280,000 data series (economic indicators) compiled by the St. Louis Fed, including state and city measures. Max Oberkofler Subject Matter Expert MST Max has assisted many financial institutions with ALLL automation implementing MST s Loan Loss Analyzer (LLA) and is a member of the MST team assisting institutions in their transition to CECL. Besides his experience with a variety of banks, methodologies and models, Max is instrumental in the development of the MST Virtual Economist, a powerful tool that simplifies correlation analysis and forecasting utilizing a lender s internal data and Federal Reserve Economic Data (FRED). Watch the entire presentation on the MST YouTube Channel. Click here for Signals or Noise? An Economic Forecast. 21

22 General Session: Governance Best Practices Presenters: Graham Dyer Partner Accounting Principles Consulting Group Grant Thornton LLP Walter McNairy Managing Partner DHG Financial Services Dorsey Baskin Consultant to MST Advisory Services and retired partner Grant Thornton LLP KEY TAKEAWAYS The more informed the audit committee is, the better job they can do in helping steer management down the right path. CECL will bring some M&A challenges, many of which have not yet been well thought out. Those that are ahead of the curve will have the advantage. Disclosure and communication to stakeholders will be key as the model introduces significant volatility and will be difficult for many folks to truly understand The session opened with an overview message from each of the prestigious presenters: Graham Dyer: The governance over the process is as important as the quality of the process itself, because in the year of adoption the bank will spend as much time defending the process, with internal and external auditors and regulators, as it did developing it. The one thing the institution can rely on is the quality of your governance. Ultimately, it s not what you do but why you did it. Dorsey Baskin: After implementation and over time your expectations of credit losses will change and you will be asked why your expectations changed. You are entering a whole new era of second-guessing. If you don t have good processes, the right people involved, and good documentation, your changing credit loss expectations and the resulting impacts on earnings will be difficult to explain. Walter McNairy: By educating the audit committee on CECL, management can help the audit committee do its job better, which is to protect the interests of the bank and its shareholders. In doing so, the audit committee is also indirectly helping management do their job. Think of your role as being a good parent. 22

23 SPEAKERS The three continued to provide insights and address attendee questions with observations including: Most ALLL errors go back to a lack of controls. Use CECL to improve your controls. Most common question from bankers today about CECL is, Where do we start? The best answer might be, With the development of a steering committee. CECL allowances and provisions will be more volatile. There will be greater procyclicality: in comparison to the incurred loss approach, loss provisions will be bigger as the economy gets worse and smaller (or negative) as it gets better. Graham Dyer Partner, Accounting Principles Group Grant Thornton LLP Graham currently consults with financial institutions clients of all sizes and audit teams regarding technical accounting and auditing matters, with a focus on regulatory capital and compliance impact. Some specific areas of expertise include accounting for the allowance for loan losses, accounting for business combinations, accounting for purchased credit-impaired debt, fair value, modeling impact on regulatory capital, and accounting for mortgage banking and servicing activities. Have policies and procedures reflect that CECL is a journey over time each quarter is a new estimate and a refinement of prior estimates. Before implementing CECL it is important to run parallel and document what didn t work and why. We tell people to take their best stab at it, to try a well thought-out process that fits your bank. Then improve it and be ready to explain why you took the approach you settled on. Don t expect auditors or regulators to tell you exactly what your model should look like. Instead you should consult during the process but make a good faith effort to implement a model that reflects your particular bank s situation. Back-testing is of questionable help because usually too much has changed in the years since the original estimation. 23

24 SPEAKERS Walter McNairy Managing Partner DHG Financial Services Walter leads a team of 35+ partners and more than 300 audit, tax and consulting professionals. As the Managing Partner, Walter oversees the work done for clients throughout DHG s footprint and serves as Engagement Quality Review Partner for many of DHG s largest banking clients. He is considered a thought leader in the industry and helps develop DHG s strategic approach to knowledge share within DHG Financial Services. In other words, if you don t separate charge offs due to unexpected and unknown events from the charge offs due to the expected and known events, your comparison of subsequent charge offs to the loss estimate is flawed; but separating charge offs is very difficult and time consuming. It may be possible to back-test some components of the process. Dorsey Baskin Consultant to MST Advisory Services and retired partner Grant Thornton LLP Dorsey recently retired from the national professional standards group of Grant Thornton LLP. Dorsey s roles at Grant Thornton included national leadership of the firm s innovation function, technical accounting and audit advisor for the banking industry audit and consulting practice, and national professional practice director. Prior to joining Grant Thornton in 2002 Dorsey spent more than 25 years with Arthur Andersen in a variety of positions, most recently in Chicago as the Managing Director of their Worldwide Assurance Professional Standards Group. Before that Dorsey spent a decade in Washington DC as the firm s Technical Director for Banking and regulatory liaison. As a Senior Advisor to MST Advisory, Dorsey is consulting with financial institutions in understanding the transition to CECL. Watch the entire presentation on the MST YouTube Channel. Click here for Governance Best Practices. 24

25 General Session: Beyond Compliance Presenters: Chad Kellar Partner Advisory Services Crowe Horwath Vince Milano Quality Control Director Postlethwaite & Netterville Ben Hoffman Managing Director KPMG KEY TAKEAWAYS CECL will cause you to look in-depth at your portfolio. The in-depth look could lead to unexpected benefits. The data warehouse built as a result of CECL will provide a great source of actionable information. There are so many things to consider as you work toward a CECL-compliant methodology, but some of the most beneficial might not have to do with compliance at all. CECL will cause you to look in-depth at your loan losses and doing so could lead to benefits, including refinements in lending policies, retraining people, and changing direction in terms of lines of business. Maybe, these experts proposed, you will eventually appreciate CECL for its benefits. Generally recommending that methodologies be tested four to six quarters before you go live. CECL will mean a fundamental change in how the institution is valued. To position yourself in the CECL world, you have to understand your portfolio better to determine what products you want to offer. A short duration portfolio might seem attractive, but the rollover is quicker and that translates to additional risk. Top down DFAST models have led lenders to segment loans better, which leads to collecting more segmentation data. If you re selling your financial institution, CECL might make you more attractive by giving the acquirer a better view of your portfolio. Institutions should have a data warehouse a golden source of information. Board reporting and call reporting are all built off those data sets; leverage that infrastructure. 25

26 SPEAKERS Chad Kellar Partner Advisory Services Crowe Horwath Chad s unit focuses on transaction advisory, valuation, accounting consultation, and model validation services in the financial services industry. Chad is one of the firm s subject matter expert on the valuation and accounting for financial instruments and is in-charge of Crowe s CECL Implementation Services. Chad has authored many articles articulating the complexities with CECL accounting, and how financial institutions can efficiently transition from an incurred loss to expected loss methodology. Your auditor will be more interested in the directional consistency of your projections than exact amount; both should be going in same direction and using the same metrics. We got a lot of good information from this conference that will help us guide our clients. There are a lot of nuances about CECL that are not in the Guidance, more than are in it. Timing is critical in terms of earlier rather than later; educating the board and making sure everyone understands what all this means should be done earlier rather than later. Ben Hoffman Managing Director KPMG Ben leads the firm s ALLL specialist group in support of KPMG s external audit clients and is a co-chair of KPMG s CECL steering committee. Ben supports a range of advisory and audit clients on complex ALLL issues as well as assisting clients as they develop their CECL implementation plans, enhance their credit risk models, and improve their data analytics to support loss forecasting processes across the Bank. Watch the entire presentation on the MST YouTube Channel. Click here for Beyond Compliance. 26

27 SPEAKERS Vince Milano Quality Control Director (CPA) Postlethwaite & Netterville Vince has more than 35 years of public accounting experience. Throughout his public accounting career, Vince has focused on depository institutions and mortgage banking. He has extensive experience with generally accepted accounting principles, SEC reporting and PCAOB standards, risk assessments, audits of internal controls, generally accepted auditing standards and litigation support. 27

28 General Session: The Expanding Role of Disclosures Presenters: Rahul Gupta Partner National Professional Standards Group Grant Thornton LLP Dorsey Baskin Consultant to MST Advisory Services and retired partner Grant Thornton LLP KEY TAKEAWAYS Concept of impaired loans will no longer exist in GAAP. The incurred loss breakdown of loans into three buckets (impaired, general allowance and purchased deteriorated loans) is replaced by: - pooled loans based on similar risk characteristics - individual loans that do not share risk characteristics with a pool CECL should be explained to investors how it works and why the allowance will change over time. The definition of a purchased credit deteriorated (PCD) asset and how it is treated in the allowance is different than that of purchase credit impaired (PCI) loans under ASC (which has been deleted). PCD designation will only affect the accounting for loans and debt securities at the time they are purchased and initially recognized (i.e. booked) into the portfolio subsequent to initial recognition and measurement they are accounted for the same as for originated or non PCD loans and debt securities. The new vintage disclosures are required for public business entities and optional for private companies. 28

29 SPEAKERS The overall purpose of CECL is to help institutions better understand the risk in their portfolios. Rahul Gupta Partner, National Professional Standards Group Grant Thornton According to Rahul Gupta, who served as the FASB s CECL project manager, the Board wasn t focused on changing disclosures, but with a new standard there had to be tweaks. Since the overall purpose of CECL is to help institutions better understand the risk in their portfolios, the disclosures follow suit in supporting the new standard in that initiative. So while the changes to disclosure requirements are not significant, they are substantial and this session provided the details. Changes in disclosures address the following areas: Rahul assists engagement teams and clients with technical accounting issues and monitors current accounting developments, under both U.S. GAAP and IFRS. Rahul is also involved in developing firm s thought leadership on accounting issues, including liaising with Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB), AICPA and Securities and Exchange Commission (SEC). Rahul was a staff member at FASB from 2011 through 2015, first as a practice fellow and then as a senior project manager, where he provided technical depth and practical insight to assist the FASB in improving U.S. generally accepted accounting principles. Policies Credit quality information by class and major security type Allowance for credit losses by portfolio segment and major security type Past due and nonaccrual status by class of financing receivable and major security type PCD assets in terms of reconciliation between purchase price and par value Collateral-dependent financial assets by class of financing receivable and major security type Off-balance sheet credit exposures as to the accounting policy and methodology used to determine liability for credit losses 29

30 SPEAKERS Dorsey Baskin Consultant to MST Advisory Services and retired partner Grant Thornton LLP Dorsey recently retired from the national professional standards group of Grant Thornton LLP. Dorsey s roles at Grant Thornton included national leadership of the firm s innovation function, technical accounting and audit advisor for the banking industry audit and consulting practice, and national professional practice director. Prior to joining Grant Thornton in 2002 Dorsey spent more than 25 years with Arthur Andersen in a variety of positions, most recently in Chicago as the Managing Director of their Worldwide Assurance Professional Standards Group. Before that Dorsey spent a decade in Washington DC as the firm s Technical Director for Banking and regulatory liaison. As a Senior Advisor to MST Advisory, Dorsey is consulting with financial institutions in understanding the transition to CECL. Presenters drew attention to two particular details: the requirement to describe your charge-off policy and the new credit quality disclosures. A summary of changes: Vintages required by public business entities on amortized cost basis (everything in CECL works off amortized costs basis) Disclosure of how the institution developed its reasonable and supportable forecast Discussion of reversion methods The rollforward for purchased credit loans Allowance has to be shown on balance sheet Disclsosure of amortized costs for nonaccrual loans For off-balance credit sheet where there is a liability estimate: allowance must be shown separately as a liability on your books Presenters left attendees with five primary points: 1. The concept of impaired loans will no longer exist in GAAP. Therefore, all disclosures about impaired loans are removed from GAAP. Watch the entire presentation on the MST YouTube Channel. Click here for The Expanding Role of Disclosures. ADDITIONAL RESOURCES CECL Modifications of Typical ALLL Disclosures Whitepaper 30

31 2. The incurred loss breakdown of loans into three buckets (impaired, general allowance and purchased deteriorated loans) is replaced by: pooled loans based on similar risk characteristics individual loans that do not share risk characteristics with a pool 3. CECL should be explained to investors how it works and why it will change over time. 4. The definition of a purchased credit deteriorated (PCD) asset and how it is treated in the allowance is different than that of purchase credit impaired (PCI) loans under ASC (which has been deleted). 5. The new vintage disclosures are required for public business entities and optional for private companies. Other observations included: For purchased loans, reporting must be on the basis of the loans years of origination, not dates of acquisition. As changes in your portfolio are reflected in a change in the amount of your allowance, you will need to explain why you needed to make such a provision. Vintage disclosure is required for public business entities even if vintage is not their chosen CECL estimation methodology. Entitles are required to disclose material changes in internal controls. 31

32 General Session: The Divided States of America Presenters: Mike Gullette VP Accounting and Financial Management American Bankers Association Bart Smith Managing Director Performance Trust Capital Partners Tom Cunningham Economist and Senior Advisor MST Advisory Services Retired Senior Economist Federal Reserve Bank of Atlanta KEY TAKEAWAYS The continued urbanization of economic growth and, more importantly, economic opportunity, will only exacerbate the existing divide for the foreseeable future. The number of community banks continues to decline. Community banks need to have a long-term strategy for their existence. The session addressed two questions: Are we a divided nation? And if so, how does that impact banking and credit? The answers as to whether we are divided were both yes and no. When it comes to what we want, what we vote for, the answer can be no, because we all want the same things: good jobs, a better world for our children. But from an economic perspective, the answer was a sound and well-documented yes. We are in the middle of very serious economic bifurcation. Two-thirds of the GDP comes from just a few states and nearly half of the new firms being created are concentrated in just five cities. Economic recovery since the early century recession has been limited mostly to the college educated. It is a systemic problem that can t easily or quickly be resolved. The number of community banks continues to decline. The big financial institutions have enjoyed thirty years of favorable legislation. Now comes the Financial Choice Act, a horrible rule with a horrible impact on the industry. It s like giving a tax loophole to a billionaire. The Act exempts institutions that maintain a capital position from any law that would: 1 further address liquidity or capital standards, 2 - prevent capital distribution, 3 - prevent mergers and acquisitions because of systemic-risk determination, 4 - require stress testing for banks under $50b, 5 prevent mergers and acquisitions because they exceed the 10% domestic deposit limitations. 32

33 SPEAKERS It takes 212 $10 billion banks or credit unions to equal one Chase. Are you operating long term or looking to sell out at some growth factor? Starting a bank to sell it has undermined what community banks represent and robs community banking of political capital. Community banks will go away if they don t have a long-term strategy for their existence. Mike Gullette Vice President, Accounting & Financial Management American Bankers Association Arriving to the American Bankers Association in February 2009, Mike works with the FASB, the IASB, and the U.S. banking regulators in helping bankers understand and implement policies and regulations related to accounting, financial reporting, internal controls, and capital management. Mike was very active not only in both the CECL and IFRS 9 standardsetting processes, leading the industry s evaluation of each of the several different impairment models considered by FASB. Bart Smith Managing Director Performance Trust Capital Partners Drawing on his 25 years of experience with the Federal Deposit Insurance Corporation (FDIC), Bart serves as an expert resource in bank policy and regulatory matters. Bart joined Performance Trust Capital Partners as Managing Director in

34 SPEAKERS Tom Cunningham Economist and Senior Advisor MST Advisory Services Retired Senior Economist Federal Reserve Bank of Atlanta Tom joined the Federal Reserve Bank of Atlanta as an economist with the macropolicy group in He was promoted to senior economist in 1989 and to research officer and senior economist with responsibility for the regional group in Cunningham retired in 2015 after a 30 year career. He has recently joined the Metro Atlanta Chamber s leadership team as chief economist. Cunningham s deep experience covers all aspects of applied economics and real estate trends, and he is a specialist in macroeconomic policy and regional analysis. Throughout his career, he has interacted with multiple business leaders and companies in the Southeast, and has deep knowledge and expertise in areas such as real estate mortgage, mortgage finance, insurance, capital markets, transportation and government. This wide range of economic specialties is now being leveraged with the MST Advisory team. 34

35 General Session: What Are We Waiting For? Presenters: Graham Dyer Partner Accounting Principles Consulting Group Grant Thornton LLP Rahul Gupta Partner National Professional Standards Group Grant Thornton LLP KEY TAKEAWAYS Determining whether an entity is a PBE is critical. The CECL standard is flexible and over the next year we expect more clarity. There is no off-the-shelf solution that can solve all of your CECL problems. A solution that allows the institution to define a methodology suited to its unique circumstances is better. The final general session of the MST 2017 National ALLL Conference took a deeper look into four areas where the application of ASU is unclear: financial assets secured by collateral maintenance provisions, transition to the purchased credit deteriorated (PCD) guidance of financial assets accounted for under Topic today, application of the PCD guidance to beneficial interest in securitized financial assets, and the definition of a public business entity (PBE). Financial Assets Secured by Collateral Maintenance Provisions: : for financial instruments for which... the borrower may be required to continually adjust the amount of the collateral securing the financial assets as a result of fair value changes in the collateral, entities may measure expected credit losses (ECL) by comparing the amortized cost basis of the financial asset with the fair value of collateral. However, if situations arise where the lender expects that the borrower is unable to continuously replenish collateral, can the lender continue to use this expedient? Yes, if a future decrease in fair value of the posted collateral is considered in calculating the allowance. Transition of Financial Assets Accounted for Under Topic (SOP 03-3): (d)... An entity may elect to maintain pools of loans accounted for under Subtopic at adoption. The question is whether entities may elect to maintain their pools in the periods after initial adoption, or whether the allowance for credit losses and any unamortized discount must be pushed down to the individual assets within the pool. The FASB s Transition Resource Group for Impairment (the TRG) clarified that entities may elect to maintain their current pools in periods after initial adoption. 35

36 SPEAKERS Rahul Gupta Partner, National Professional Standards Group Grant Thornton Rahul assists engagement teams and clients with technical accounting issues and monitors current accounting developments, under both U.S. GAAP and IFRS. Rahul is also involved in developing firm s thought leadership on accounting issues, including liaising with Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB), AICPA and Securities and Exchange Commission (SEC). Rahul was a staff member at FASB from 2011 through 2015, first as a practice fellow and then as a senior project manager, where he provided technical depth and practical insight to assist the FASB in improving U.S. generally accepted accounting principles. Beneficial Interests in Securitized Financial Assets: A(a) states that beneficial interests (BIs) in securitized financial assets are considered PCD assets if... There is a significant difference between contractual cash flows and expected cash flows at the date of recognition. The question is what if the difference is due to prepayments and not credit losses? The TRG concluded that entities should not consider differences between expected and contractual cash flows due to expected prepayments. Definition of a PBE: Determining whether an entity is a PBE critical, as PBE s must implement CECL a year earlier than private companies. Also, many of the disclosure requirements depend on whether or not the entity is a PBE. Applying the PBE definition is complex and requires judgment. Entities should evaluate the definition and consult timely with their auditors. Additionally, the AICPA has taken up a project to explore the issue further, and entities may want to track progress on that project. Graham Dyer Partner, Accounting Principles Group Grant Thornton Graham currently consults with financial institutions clients of all sizes and audit teams regarding technical accounting and auditing matters, with a focus on regulatory capital and compliance impact. Some specific areas of expertise include accounting for the allowance for loan losses, accounting for business combinations, accounting for purchased credit-impaired debt, fair value, modeling impact on regulatory capital, and accounting for mortgage banking and servicing activities. Other wrap-up observations: If your loan emergence period (LEP) is longer than your contractual loan period, your allowance might actually go down under CECL. The standard is flexible and over the next year we expect more clarity. There is no off-the-shelf solution that can solve all of your CECL problems. A solution that allows the the financial institution to define a methodology suited to its unique circumstances is better. Lenders must use their institutional knowledge to create a model that works with their portfolio. Watch the entire presentation on the MST YouTube Channel. Click here for What Are We Waiting For? Watch the discussion on Public Business Entities from the session. Click here. 36

37 WORKSHOPS The workshops of the MST 2017 National ALLL Conference promised a deeper dive into specific issues related to CECL. Moreover, they were opportunities for individuals in these small gatherings to ask questions of the experts and discuss with their peers the issues they are encountering as they progress toward CECL adoption. Workshops were designed with financial institutions of all sizes and types of portfolios in mind. The results were opportunities to learn from a variety of practitioner perspectives as well as from the industry experts. 37

38 Workshop: Models and Strategies I and II Moderators: Chris Emery Senior Advisor - Engineering Director of Special Projects MST Mike Thornson Partner Moss Adams Shane Williams Senior Advisor - Modeling MST Advisory Services Gabe Nachand Partner Moss Adams KEY TAKEAWAYS Questions to ask yourself as you consider methodologies 1. What does your data allow as an option? 2. If you can estimate losses in more than one way, which methods are the best fit for your institution? 3. Can you try numerous methodologies over time and draw conclusions by actual performing the analysis? 4. There is a cost benefit analysis for more complex modeling approaches (i.e. DCF). Is the value gained worth the expense of developing the model? 5. How much historical data do you have available to perform the analytics required? Do you have loss data that goes through an entire economic loss cycle? 6. Do you need to alter your current pooling structure to meet the needs that arise from the different methodologies? The two workshops addressed various methodologies for estimating CECL, including cohort, transitional matrix, vintage and discounted cash flow methodologies: Clearly, by now, the public companies should be building and testing CECL-compliant methodologies. Dorsey Baskin, MST Senior Advisor 38

39 SPEAKERS Transitional Matrix Where an institution has applied a consistent risk rating system to its loans for at least one full economic cycle, it might want to use a transitional matrix to track loan performance and estimate future losses. A transitional matrix can provide a measure of probability of default by tracking, over quarter-end or year-end periods, how loans move, or transition, from one risk metric to another. The matrix can be used to follow credit scores or delinquencies, but risk ratings are most commonly used. Key considerations for using a transitional matrix include: Consistency - A transitional matrix is appropriate for any type of loan as long as the lender has consistently applied its risk metrics over several years. If ratings haven t been applied consistently, or definitions for ratings or other rating criteria have changed over time, the matrix won t produce reliable results. Sufficient rating data Matrix calculations should cover a complete economic cycle, worse case scenarios as well as best, so that it can be a reliable forecast as economic conditions change. Establishing a transition matrix takes several years as the lender must follow the loans in the determined period and pool to their termination, default or pay off. Loss Given Default denominator The matrix provides the probability of default part of the PD/LGD calculation. The loss given default must be calculated separately there are several ways to determine the loss given default that is, add the losses for the loans that have defaulted. The loss given default becomes the denominator; probability of default the numerator. Chris Emery Senior Advisor- Engineering MST Advisor Services Director of Special Projects MST Chris has helped hundreds of financial institutions of varying asset sizes and employing all major core systems implement allowance technology that supports their efforts to comply with regulatory and accounting standards, including in their current transition to estimating the allowance under CECL. In addition to his client engagements, Chris advises the technology group at MST which is charged with developing, implementing and supporting software solutions that assist financial institutions with calculating the Allowance for Loan and Lease Losses (ALLL) and now making preparations for CECL. Shane Williams Senior Advisor- Modeling MST Advisory Services As a senior consultant for MST Advisory Services, Shane works with banks and credit unions to set priorities, identify data needs, implement allowance technology, run shadow analyses and identify appropriate methodologies in preparation for accounting for loan losses under CECL. Following two decades as a treasurer with a national bank, he worked with Fiserv helping lenders implement financial services technologies, then as a consultant to bankers with Price Waterhouse Cooper. Vintage Modeling In Vintage (Closed Pool) Modeling, impairment is based on the age (origination date) of the accounts and the historical 39

40 SPEAKERS Mike Thronson Partner Moss Adams Mike has worked in public accounting for over 24 years. He works exclusively in the Financial Services Industry Group and the firm s SEC practice. His clients range from credit unions and de novo community banks to larger regional banks and credit unions with multi-state branch networks. Gabe Nachand Partner Moss Adams Gabe joined Moss Adams in 1995 and has been partner in the Financial Services Practice since Gabe s client base consists exclusively of financial services companies, many with complex accounting and auditing issues. In 2016, Gabe was appointed to a CECL Modeling Subgroup of the AICPA s Depository Institution s Expert Panel. Gabe also serves as the Quality Control Coordinator for one of the firm s largest practice offices, routinely dealing with professional standards and independence matters. performance of assets with similar risk characteristics. Those who adopt this methodology typically have financial assets that follow patterns or loss curves comparable and predictive for subsequent generations of financial assets (indirect auto loans, for example). Static Pool Modeling Static Pool Modeling is based on grouping by similar risk characteristics, which may or may not be vintage-based. Because the entire life of the loan pool is included in the analysis, stratifying loan pools with origination periods is considered to provide a more accurate estimate of historical lifetime loss experience. While vintage modeling can help isolate changes in a loan pool that are helpful for forecasting (i.e., losses due to underwriting, collateral values, economy, etc.), if loans are not truly homogeneous, the number of pools necessary can become significant and the necessity to reconcile expected to actual activity may be extensive. Discounted Cash Flow Discounted Cash Flow (DCF) is calculated using the present value of expected future cash flows (principal & interest) discounted at the loan s effective interest rate. This type of analysis is one of the currently prescribed methods for measuring impairment on an individual impaired loan. A CECL DCF allowance is defined as the difference between the amortized cost basis and the present value of the expected cash flows. FASB has made it clear that DCF is neither required, nor is reconciling your chosen methodology to DCF expected. DCF is intended as a life-of-loan methodology, so many of the challenges with other methodologies do not exist (accretion of discounts, reversion period, prepayments, etc.). 40

41 Implementation Planning: Manage Cost and Enhance Value Presenters: Hans Pettit Partner Financial Institutions HORNE LLP Ashley McAdams Partner Financial Institutions HORNE LLP The purpose of the workshop was to encourage discussion that would result in providing attendees with a better perspective of how embracing the data analytical requirements of CECL will create opportunities for making better loan product pricing, and credit quality decisions. Among the issues discussed: Every group of loans has different factors that drive them to perform well or poorly. The data gathered for CECL is an opportunity to improve your understanding of the risk in your portfolio and to identify opportunities in your marketplace. Data analytics can help the institution make better business decisions. You don t need a quant on staff for data analytics. Benefits reported by analytics users were the ability to: Target market products Price products better Better understand institutions being acquired Identify potential for fraud Understand client behavior related to low or no FICO scores Identify problem loan trends Identify the effects of credit concentrations. 41

42 SPEAKERS Ashley McAdams Partner, Financial Institutions HORNE LLP Ashley works with community bankers to develop strategic plans and streamline processes, while building operational capacity to complement the future plans of the institution. She focuses her expertise on identifying the right balance between policies and procedures with growth and innovation. Ashley shares her 13 years of specialized expertise with community banks through analyzing and advising on strategic goals and assisting in all phases of mergers and acquisitions. Additionally, Ashley guides clients through the complex accounting issues while building processes that will grow with the bank well into the future. Hans Pettit Partner, Financial Institutions HORNE LLP Hans challenges his clients to evaluate perspectives and find opportunities unique to their organizations. His focused experience with highly regulated entities means specific assessment of a client s situation is only the beginning of the relationship. Hans specialty is guiding clients through the complexities of risk and regulatory issues, while identifying strategic opportunities for outcomes that position a client s leadership team to succeed. 42

43 Workshop: Early Days Transition Experiences Presenter: Francisca Ventriglia Senior Associate FRM Credit Risk KPMG KEY TAKEAWAYS CECL adoption will have a significant impact on the way in which institutions estimate their allowance reserve and as such the process through which an institution transitions into the new standard requires a structured program that can be adequately managed and understood by stakeholders. One size does not fit all and thus the extent to which detail and complexity is incorporated into a CECL program should be commensurate with the institution s size and capabilities. Time and resources are competing components of developing an implementation plan all else equal a shorter timeline leads to a higher resource requirement and vice versa. As such, a key decision impacting the time and resources available is whether to exercise the option to early adopt in Due to the significance of changes required to adopt CECL, many institutions are reconsidering the feasibility and/or benefits of early adoption. Not only can early adoption significantly shorten the implementation timeline, but it very likely results in a sizable requirement for additional resources. More importantly, as the industry continues to develop best practices those institutions that choose to not early adopt may benefit from additional knowledge gained from future industry views or best practices. The interactive discussion offered atteendees with real-life examples of key challenges observed at various financial institutions as they work through their transition to CECL. In general, key challenges that institutions may encounter in their CECL conversion projects may be better identified and addressed if the context around the phase of the project in which they occur is understood. As such, a CECL conversion program, and more broadly any conversion project, can be described by a five-phase process including: Planning, Assessing, Designing, Implementing and Sustaining. Any conversion project should begin with a Planning phase this is the project mobilization phase where the institution determines the scope of the project, identifies stakeholders 43

44 SPEAKERS Francisca Ventriglia Senior Associate, FRM Credit Risk KPMG Francisca specializes in the assessment, enhancement and development of credit risk measurement methodologies with a focus on Allowance for Loan and Lease Losses (ALLL) and Current Expected Credit Losses (CECL) for both retail and commercial portfolios. Francisca has experience working with a range of clients in the financial services industry in both an advisory role and in support of KPMG s external audits. In these roles, Francisca has gained an understanding of the key challenges experienced at financial institutions of varying size and complexity and leverages this experience to help clients build robust credit risk processes aligned with their needs and capabilities. who will be impacted by the project, establishes a governance framework over the project execution and establishes a common understanding of the task at hand. Once the structure of the project has been established, the Assessment phase is primarily made up of a gap assessment through which the institution (1) defines a target state, (2) understands existing capabilities and (3) identifies gaps that represent the distance between existing capabilities and the defined target state. During the Design phase an institution develops its implementation plan, including a project timeline, work breakdown structure, and a resource and cost plan. Lastly, execution of the implementation plan occurs during the Implementation phase which culminates with the adoption date (i.e. Go-live ) and is followed by a Sustain phase where the new standard becomes part of the business as usual. Much like the impact of CECL varies across institutions based on their specific situation, the components of their CECL conversion project will also vary. However, CECL adoption is a complex process and as such navigating through that process will inevitably require a thoughtful, structured and integrated framework. A few of the observed challenges discussed in this session include: Lack of governance structure in CECL program and insufficient representation of resources across the institutions hierarchy. Lack of cross communications across CECL program workstreams. Inconsistent understanding or interpretation of CECL accounting standard, its requirements and optionality in application. Insufficient consideration of alternative and their trade-off for time and resources. 44

45 Workshop: Long-Term Project Management for CECL Presenters: John Hurlock President SMARTER Risk Management A successful project has a need for good communication, minimization of surprises and effective reactions when surprises occur. The seven steps below provide a guideline for success. KEY TAKEAWAYS Develop and document your goal. CECL presents a very clear and specific goal of establishing an expected loss value for earning assets. Take this and establish dates, milestones and other key success factors. Identify resources required to be successful. This is a shared project between lending, accounting and IT over a significant time period. Others in your institution will need to be involved as well. Plan for outside assistance also. Enlist help and support make this a team project. If you are doing this alone you are doing it wrong, is a quote from many years ago that can be a key to success. Build your team and make sure the tactical and strategic members are identified and treated as such. Take a bite size chunks approach on a quarter-by-quarter basis. Go pool by pool in establishing the expected loss methodology. Trying to do everything up front, such as identifying and cleaning data, can lead to rework later on. Data doesn t stay clean unless it is used from the onset. Identify problems/ issues as early as possible. Keep a parking lot document for any emerging or unaddressed problems or issues. One area to keep an eye on is when activities cross departmental/ organizational lines. Get executive support and keep things transparent when dealing with these types of issues. 45

46 SPEAKERS John Hurlock President SMARTER Risk Management John has 30 years of experience in the financial institution arena. His first fifteen years were spent working for financial institutions of various size and complexity, and has spent the last eleven plus years in the business consulting field. Prior to starting SMARTER Risk Management (SRM), John was the National Director for Enterprise Risk Management and Compliance for Sheshunoff Consulting + Solutions. Prior to Sheshunoff, John was the Director of Integrated Risk Management Consulting Services for Metavante, a $2 billion technology firm focused on financial institutions. KEY TAKEAWAYS Be prepared for the unexpected. Slippage in project dates is bound to occur. Allow one quarter of slippage but no more. Even if you don t engage outside support, have a line of communication open in case you need it. Communicate and document progress. Questions about progress will most likely arise quarterly. This will be when a formal update will be most effective. But don t wait until the end of the quarter to put this together. Remember that surprises are not good things to executive management and the Board of Directors (and the regulators, auditors.) 46

47 How CECL Will Be Impacted by Acquisitions Presenters: Mike Lundberg Partner National Director of Financial Institutions Services RSM US LLP Suzanne Marra Director, Financial Advisory Services Group RSM US LLP CECL will change the accounting for acquired loans. The workshop exposed the changes and helped attendees understand how they might impact their acquisition plans. With acquisition activity gaining traction in the banking industry, it is important for institutions that plan to grow via acquisition to consider how adoption of the current expected credit loss (CECL) model, or Accounting Standards Codification (ASC) 326, will affect accounting for loans, securities and other affected instruments at the target institution. Acquirers will need a solid understanding of the target s CECL modeling decisions (which may be different from your own), as well as an understanding of the impact on the provision for loan losses resulting from the acquisition of performing loans required under CECL, which will likely affect capital requirements following the acquisition and the internal rate of return from the deal. Keep in mind that deals often take several months to complete, so information gathered at the start of the process will likely change before closing. Additionally, the new CECL accounting guidance changes purchase accounting in a business combination for financial assets with credit deterioration. Other purchase accounting rules are still applicable. CECL basics First, here are a few reminders regarding timing and the basic concepts of CECL. The following are the effective dates for CECL: For Securities and Exchange Commission (SEC) filers, fiscal years beginning after Dec. 15, 2019, including interim periods (2020 for calendar year-end) For public business entities that are not SEC filers, fiscal years beginning after Dec. 15, 2020, including interim periods (2021 for calendar year-end) For all others, fiscal periods beginning after Dec. 15, 2020, interim periods beginning after Dec. 15, 2021 (2022 for calendar year-end) Early adoption is permitted for fiscal years beginning after Dec. 15, 2018 (2019 for calendar year-end) CECL requires financial institutions to recognize expected credit losses over the life of an asset on day one through an allowance for recognized financial assets, which has been expanded to include held-to-maturity (HTM) debt securities or through a liability for any off balance sheet exposure. This is in contrast to the current incurred loss requirement applied to the loan portfolio. Allowance disclosures and roll forwards as well as disclosure of past-due and nonaccrual assets will continue to be required and now also apply to HTM securities. 47

48 Treatment of acquired loans under purchase accounting Currently, under purchase accounting rules, the acquired loans are marked to fair value by the acquiring institution. The fair value marks consist of yield and credit components. As these loans are marked to fair value there is no allowance for loan and lease losses (ALLL) carried over on day one for the acquired loans. The majority of acquisitions in recent years have involved primarily non-impaired loans. For these loans, the acquiring bank accretes the total fair value discount from day one into earnings over the life of the acquired loans, and an increase in the ALLL needs to be considered. (The accounting is different for purchased credit impaired loans as essentially only the yield mark can be accreted). Under CECL, for loans considered non-purchase credit deteriorated (non-pcd), the acquiring bank will still mark the loans to fair value, taking into consideration both credit and yield at acquisition. However, the acquiring bank will also have to include in the combined banks ALLL the expected credit loss on the acquired loans, affecting the income statement in the quarter of acquisition. The acquiring bank will still accrete the fair value mark discount, both credit and yield, into earnings. Due to these changes, a buyer needs to take into consideration capital on day one and the return on an acquiring institution s investment as they will both likely be negatively affected. Which loans of the target should be classified as PCDs? A loan that is delinquent as of the acquisition date A loan that has experienced downgrades to the risk rating since origination A loan that is in nonaccrual status or that has been identified as a criticized or classified loan for regulatory purposes The key change with the implementation of the concept of PCD loans is that when they are acquired in a transaction the only fair value mark component considered is related to yield, not credit. This differs from non-pcd loans, the fair value mark for which, as stated above, has both a credit and yield component. Similar to non-pcd loans, an adjustment is made to the ALLL for the expected loss, however in the case of PCD loans, the acquisition date allowance does not impact the income statement. The following examples illustrate the differences in pre-tax treatment between PCD and non-pcd loans at acquisition. Purchase credit deteriorated (PCD) assets is a new concept introduced with CECL. PCD refers to financial assets with credit deterioration at purchase. During the transaction, the acquirer is likely to acquire loans or other assets that have suffered credit deterioration since their origination; therefore, it is imperative for financial institutions to understand how to account for PCDs. 48

49 Assume a financial institution acquires a loan that is a non-pcd loan with a current outstanding amount of $1 million, for which the acquirer pays $950,000. At the date of acquisition, the allowance for credit losses on the unpaid principal balance is estimated at $40,000. The acquisition date journal entry would be as follows: EXPENSE IS $40,000 Loan current balance $1,000,000 Provision for loan loss $40,000 Loan discount (credit and yield) $50,000 Alowance for credit losses $40,000 Purchase Considetaion $950,000 Now assume a PCD loan, also with an outstanding amount of $1 million, was acquired for $750,000 with an expected allowance for credit loss of $175,000, the acquisition date journal entry would appear as follows: EXPENSE IS ZERO Loan current balance $1,000,000 Loan yield discount $75,000 Alowance for credit losses $175,000 Purchase Considetaion $750,000 CECL Differences between acquirer and target As an acquirer, there are additional matters to keep in mind during due diligence, including how the acquirer is modeling the combined institution on a pro forma basis: Which loans of the target will be treated as PCD and non-pcd? What is the corresponding impact on capital and projected earnings? What methods has the target used to account for their loans under CECL? If those methods differ from the method used by the acquirer, what impact will this have on the ALLL and what issues could this cause from an implementation standpoint? What assumptions are being used by the target, and are they reasonable and supportable? Will adjustments be made to these assumptions post-acquisition? How adequate and accurate is the historical performance information compiled by the target? What impact will the above matters have on the combined institution? Will additional capital be needed? How are the expected return on investment and payback periods affected? As institutions complete acquisitions, what impact will the acquired loans versus legacy loans have on the ALLL post-cecl? Is adequate information available to meet full disclosure requirements following the acquisition? 49

50 SPEAKERS Mike Lundberg Partner, National Director of Financial Institution Services RSM US LLP In this role, Mike has responsibility for audit, accounting and risk containment matters across the firm s financial institution practice, which includes community banks, credit unions, finance and leasing companies, and other specialty lenders. Suzanne Marra While an institution still has time before the implementation of CECL, as you plan your acquisition strategy it is important to keep these questions in mind. Also, in the near term it is key for acquisition institutions to be aware of how targets have started preparing for CECL and what information they have started to gather. If an institution is planning to sell, taking a proactive approach in CECL readiness and information gathering can lead to a more efficient and beneficial sales process. CECL will be a significant accounting change for financial institutions. Understanding the new CECL purchase accounting changes and their impact on any transaction, from both a seller and buyer standpoint, is important for effective implementation. Director, Financial Advisor Services Group RSM US LLP Suzanne joined RSM in 1993 and leads the Firm s financial institution valuation group. She is a member of the firm s CECL (Current Expected Credit Loss model) taskforce. Her experience includes valuation of financial institutions equity, loan portfolios, intangible assets, deposits and borrowings, and trust preferred securities. The valuation of loan portfolios includes developing expected credit losses, including default and recovery, and yield premiums/discounts. She is experienced in validation assessment of ASC (Accounting for acquired impaired loans) and valuation models. 50

51 Workshop: Adjustment Factors Under CECL Presenters: Dorsey Baskin Consultant to MST Advisory Services and retired partner Grant Thornton LLP Garry Rank Senior Advisor MST Advisory Services KEY TAKEAWAYS Adjustment factors are here to stay. Using some adjustment factors based on quantitative analysis of past losses is increasingly expected. But analysis of charge offs over life-of-loan periods may introduce greater uncertainty in the magnitude of adjustment factors. Qualitative and quantitative adjustment factors will remain part of estimating the allowance under CECL and, in fact, will include some additional considerations. The Interagency Policy Statement on the ALLL declares that management should consider qualitative or environmental factors that could call for adjustments to historical loss experience and that changes resulting from adjustments should be directionally consistent with trends in historical loss experience, changes in qualitative factors and loan portfolio composition. The purpose of adjustment factors is to adjust the average charge-off rates calculated over a historical charge-off accumulation period for the differences between: The conditions that existed when the loss-causing events were occurring that resulted in the charge offs captured in the accumulation period; and The conditions that existed during the incurred loss measurement period leading up to the date of the financial statements. Or under CECL, the conditions expected or forecasted during the expected life of a pool of loans. CECL changes how adjustment factors will be used in that the loss, or charge-off, accumulation period changes from an arbitrary number of periods, years or quarters, to a period that covers the lives of historical pools of loans. 51

52 SPEAKERS 52 Dorsey Baskin Consultant to MST Advisory Services and retired partner Grant Thornton LLP Dorsey recently retired from the national professional standards group of Grant Thornton LLP. Dorsey s roles at Grant Thornton included national leadership of the firm s innovation function, technical accounting and audit advisor for the banking industry audit and consulting practice, and national professional practice director. Prior to joining Grant Thornton in 2002 Dorsey spent more than 25 years with Arthur Andersen in a variety of positions, most recently in Chicago as the Managing Director of their Worldwide Assurance Professional Standards Group. Before that Dorsey spent a decade in Washington DC as the firm s Technical Director for Banking and regulatory liaison. As a Senior Advisor to MST Advisory, Dorsey is consulting with financial institutions in understanding the transition to CECL. Garry Rank Senior Advisor MST Advisory Services During Garry s career with a top 30 regional accounting firm, he specialized in corporate financial auditing, accounting and financial reporting as well as consultation regarding governance, financial systems and internal controls. With more than 36 years of experience, his industry concentration in financial services included Securities and Exchange Commission (SEC) reporting and regulatory compliance. Additional professional experience included the management of complex engagements, mergers and acquisitions, and projects involving subsidiary companies. As an MST Advisor, Garry works with financial institutions to ensure a smooth transition to CECL. Depending on the lives of the pools, loss accumulation periods could be longer than in the past, capturing more different and changing conditions. Adjustment factors will need to be adjusted for this change. As a consequence of the longer time periods and more variations in loss-causing conditions during those time periods, correlations between past conditions and observed losses may or may not be as strong. Applying adjustment factors under CECL requires understanding: What were the conditions during the loss-causing period leading to the loss-accumulation period and how did they change, if any, during the loss-causing period? How did those conditions affect losses observed during the loss accumulation period? How will the conditions be different over the forecasted future period of collection of the existing loan portfolio (vs. the historical loss accumulation period)? How should the differences, when applied to the historical average loss rate, affect the forecast losses? Measurement uncertainty will increase under CECL because: The forecast of economic and other conditions over the future lives of different portfolios will involve much greater uncertainty than does the observation of the actual conditions over the historical period leading up to the balance sheet date. There will be uncertainty of varying degrees in the expected lives of different loan portfolios, which will be affected by the future economic conditions and other circumstance under which the borrowers will be repaying and the lenders collecting the loans. Thus, the lender s confidence with respect to magnitude (and, perhaps, direction) of adjustment factors will be less. More use of quantitatively determined adjustment factors may provide greater confidence in forecasting losses and using some quantitatively determined adjustment factors seem to be a growing expectation of auditors and regulators.

53 Workshop: Applying an Economic Outlook to Your Allowance Presenters: Tom Cunningham Economist and Senior Advisor MST Advisory Services Retired Senior Economist Federal Reserve Bank of Atlanta Max Oberkofler Subject Matter Expert MST KEY TAKEAWAYS Correlation Analysis is a useful tool in identifying relationships between loan losses and internal/ external factors. However, it is important to utilize an Institution s expertise to recognize the possible shortcomings of a Correlation Analysis. Since many factors could be affecting historical loss experience, it may not be possible to pinpoint the exact impact of a given factor. Judgement and experience will matter a lot in terms of applying forecasts to losses. Major (and minor) data series are readily available, and seeing if they actually matter to your portfolio is a critical first step, particularly in identifying things that simply don t matter to your own portfolio/ economy. Recognize the limitations of statistical analysis. If your lending procedures have changed, or loans have been acquired from differing sources, statistical history will need to be judgmentally adjusted to reflect the different circumstances. The workshop discussion revolved around how information on the economy should be applied to the current allowance estimate and the forthcoming expected credit loss estimate. In a perfect world scenario, the lender will have a full economic cycle of high quality data on which to base an estimate. It will be able to identify internal and external qualitative factors that correlate strongly to its loss experience. And it will have a sufficient amount and quality of data to allow it to confidently use regression analysis to adjust current, or under CECL, expected loss rates. Most institutions do not operate in a perfect world. Data quality is typically an issue as are the consistency of 53

54 SPEAKERS Tom Cunningham Economist and Senior Advisor MST Advisory Services Retired Senior Economist Federal Reserve Bank of Atlanta Tom joined the Federal Reserve Bank of Atlanta as an economist with the macropolicy group in He was promoted to senior economist in 1989 and to research officer and senior economist with responsibility for the regional group in Cunningham retired in 2015 after a 30 year career. He has recently joined the Metro Atlanta Chamber s leadership team as chief economist. Cunningham s deep experience covers all aspects of applied economics and real estate trends, and he is a specialist in macroeconomic policy and regional analysis. Throughout his career, he has interacted with multiple business leaders and companies in the Southeast, and has deep knowledge and expertise in areas such as real estate mortgage, mortgage finance, insurance, capital markets, transportation and government. This wide range of economic specialties is now being leveraged with the MST Advisory team. Max Oberkofler Subject Matter Expert MST methodology and loan segmentation between current and expected loss scenarios and the availability of information on which to base forecasts. In an imperfect world, it might be necessary to make assumptions that peer data, grouped segmentations, or loan risk indicators interact with the economy similar to an Institution s segmentation loss experience to provide a large enough sample size for an analysis. Considerations in making economic adjustments to an allowance include: Do not adjust the allowance twice for two variables that are intertwined. Economic adjustments might not always increase the allowance. Internal changes could be related more to changes in losses than economic factors. Idiosyncratic portfolios require judgment and economic correlations can inform that judgment. First, identify economic variables that correlate well with the institution s loan loss history. Then, look at forecasts that suggest what is ahead for the economic data selected. It is then a matter of adjusting the loan loss estimate based on the forwardlooking forecast. Max has assisted many financial institutions with ALLL automation implementing MST s Loan Loss Analyzer (LLA) and is a member of the MST team assisting institutions in their transition to CECL. Besides his experience with a variety of banks, methodologies and models, Max is instrumental in the development of the MST Virtual Economist, a powerful tool that simplifies correlation analysis and forecasting utilizing a lender s internal data and Federal Reserve Economic Data (FRED). Max holds a Bachelor of Science in Mathematics from Piedmont College. His speaking engagements include RMA s Estimating the Allowance workshop. 54

55 SPEAKERS Workshop: Connecting Stress Testing to CECL Presenters: Robin Sawyer Partner DHG Financial Services The workshop examined parallels between the data used for stress testing and estimating the allowance under expected credit loss. Among the points of discussion and attendee comments during the interactive session: It is possible to work scenario testing for variables like GDP growth, inflation and the home price index into CECL models. Under CECL, stress testing will be more granular than under the current incurred loss model. Robin Sawyer Partner DHG Financial Services Robin has been with DHG Financial Services since 2003 serving both private and publicly traded financial service companies. Prior to joining DHG, Robin served as an audit manager with a Big Four accounting firm, serving primarily financial services companies in the areas of external audit and advisory services. Robin also spent part of his career in industry where he served as the U.S. controller for a large, international investment management company headquartered in Sydney, Australia. With more than 30 years of total business experience in both industry and public accounting roles, Robin brings a unique depth of experience in serving his clients. Risk pools: Pooling structures are likely to be different under CECL. But with few or no losses in recent years, it is difficult to construct pools based on risk. At most institutions stress testing is conducted by different groups than allowance estimation. However, while stress testing is a capital exercise, the driver is the allowance. The two initiatives should come together, perhaps under a committee chair that oversees the combined activities. Smaller lenders might not have the complexity in their portfolios to effectively conduct stress tests. On a reasonable and supportable forecast: If the Fed couldn t forecast the great recession, how can a bank forecast a future recession? Data is a major risk concern: how it is being used and stored. There is substantial support for a centralized data warehouse. Beyond having the data, a key to CECL will be how to store data and maintain data integrity. 55

56 Workshop: Defending Your CECL Implementation Presenters: John Hurlock President SMARTER Risk Management Institutions will be challenged to prove their planning, transition, implementation and results all meet the ECL requirement. What should a lender do now to build this defense? Attendees were advised to follow a process rooted in seven steps: 1. Have a good set of updated documentation (and maybe a PowerPoint). 2. Understand who your audience is (everyone has different goals). 3. Be prepared to discuss intent as well as results. 4. Don t dwell on problems, and potentially failures, along the way. Be ready to discuss what happened and the actions taken. 5. Discuss facts and tell a story. 6. Prepare people (especially insiders) for pending bad news. 7. Talk it over with someone (in the know) before you have to defend. Managing the institution s CECL model will involve: Implementing robust governance processes Limiting the model to its intended purpose Monitoring model performance Calibrating the model Using appropriate independent resources for assistance and validation Managing the risk event reaction loop Checklists of issues involved in defending the institution s CECL process: To external auditors: Alignment with accounting standards Fair and accurate public information Controls regarding the creation of the information Assurance to shareholders Internal Control over Financial Reporting (ICFR) 56

57 SPEAKERS To internal auditors: Safety and soundness of the organization Assurance to the Board of Directors Internal Controls Risk to the Organization To regulators: Safety and soundness of the financial system Compliance with laws and regulations Proper management Model risk management To shareholders: Expected return on investment No surprises John Hurlock President SMARTER Risk Management John has 30 years of experience in the financial institution arena. His first fifteen years were spent working for financial institutions of various size and complexity, and has spent the last eleven plus years in the business consulting field. Prior to starting SMARTER Risk Management (SRM), John was the National Director for Enterprise Risk Management and Compliance for Sheshunoff Consulting + Solutions. Prior to Sheshunoff, John was the Director of Integrated Risk Management Consulting Services for Metavante, a $2 billion technology firm focused on financial institutions. To the board of directors: Business and strategic decisions No surprises Accurate reporting Shareholder representation Regulatory interaction To CEO & other C-suite officers: Business and strategic decisions No surprises Affect on profitability Regulatory compliance Audit compliance 57