CECL Current Expected Credit Losses

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1 2016 Annual Risk Management Conference CECL Current Expected Credit Losses Matt Esposito, Assistant Director November 14, 2016 The views expressed in this presentation are those of the presenter. Official positions of the FASB are reached only after extensive due process and deliberations. Copyright 2016 by Financial Accounting Foundation, Norwalk CT. For non-commercial, educational/academic purposes only

2 Agenda The need for a new standard CECL Top ten truths Other areas of the new standard 2

3 The need for a new standard 3

4 CECL... Why? Loan $ increased 44%, LLR $ decreased 10% BC 3 & 11 Loan $ increased 70%, LLR $ decreased 8% Tax Reform Act of 1969 & FAS 5 (effective 1975) Concerns about cookie jar reserves & Suntrust hearings 4

creditloss model* Trading FV-NI ** P C D P C D Under the new credit-loss model for AFS, credit losses will be recorded through an allowance.

5 Credit Losses... What s Changing? ASU No Held for Investment Held for Sale Loans CECL P C D Lower of amortized cost basis or market Debt Securities Held to Maturity Available for Sale CECL AFS creditloss model* Trading FV-NI ** P C D P C D Under the new credit-loss model for AFS, credit losses will be recorded through an allowance. The allowance will be limited to the difference between the debt security s amortized cost basis and its fair value. ** P C D No change to current GAAP. Allowance for purchased financial assets with credit deterioration determined in similar manner; however, initial allowance added to purchase price, rather than as provision expense. 5

2Q2021 3Q2021 4Q2021 1Q2022 2Q2022 326-10-65-1 Prep Time 4.

3Q2023 4Q2023 Non-PBEs Prep Time NFPs, Quarter private Annual cos.

6 CECL... Who s Affected? When? Public Business Entities (PBSs) SEC Filers Non- SEC Filers Prep Time Quarter Annual Vintage Disclosures * 3Q2016 4Q2016 1Q2017 2Q2017 3Q2017 4Q2017 1Q2018 2Q years 3Q2018 4Q2018 1Q2019 2Q2019 For Calendar Year Financials 3Q2019 4Q2019 1Q2020 2Q2020 3Q2020 4Q2020 '20,'19,'18,'17,'16 1Q2021 2Q2021 3Q2021 4Q2021 1Q2022 2Q Prep Time 4.5 years Quarter Annual Vintage Disclosures * '19, '18, '17 '21,'20,'19 '22,'21,'20,'19 '23,'22,'21,'20,'19 3Q2022 4Q2022 1Q2023 2Q2023 3Q2023 4Q2023 Non-PBEs Prep Time NFPs, Quarter private Annual cos. Vintage Disclosures * SEC filer is any entity required to file or furnish its financial statements with either: The Securities and Exchange Commission An entity subject to Section 12(i) of the Securities Exchange Act of 1934, as amended, the appropriate agency under that Section. 5.5 years Not required Time available for implemention Earliest date adoption permitted First period adoption required * For interim-periods, current year-to-date considered to be current-period originations. 6

.. Note: PBEs must be a business entity, so a not-for-profit entity and an employee benefit plan are excluded.

7 CECL... What s a PBE? Master Glossary Required to (or voluntarily does) file or furnish its financial statements with Securities and Exchange Commission (SEC) Public Business Entity meets any of these criteria... Note: PBEs must be a business entity, so a not-for-profit entity and an employee benefit plan are excluded. Required to file or furnish its financial statements with a regulatory agency other than the SEC in accordance with: the Securities Exchange Act of 1934 (Act), as amended or rules and regulations promulgated under the Act Required to file or furnish its financial statements with a foreign or domestic regulatory agency with issuance of securities not subject to contractual restrictions on transfer Has issued, or is a conduit bond obligor for, securities that are traded, listed or quoted on an exchange or an OTC market Has securities not subject to contractual restrictions on transfer, and required by law, contract, or regulation to both... prepare U.S. GAAP financial statements (including notes) make them publically available on a periodic basis 7

8 CECL Top ten truths 8

through net income Book the difference as Allowance A B = C Amortized cost.

9 CECL... Top Ten Truths Allowance for Credit Losses... A valuation account Deducted from amortized cost basis of financial assets Used to present net amount expected to be collected Changes flow through net income Book the difference as Allowance A B = C Amortized cost... unpaid principal balance (UPB) lent to a customer adjusted for loan fees and origination expenses, repayments, writeoffs, nonaccrual practices, and certain hedging transactions Amount expected to be collected... remaining amounts expected to be collected on loans

CECL... Top Ten Truths 326-20-30-2 & 326-20-55-5 Expected credit losses shall be measured on... Collective (pool) basis if.

10 CECL... Top Ten Truths & Expected credit losses shall be measured on... Collective (pool) basis if... Asset has similar risk characteristic(s) with other financial assets Risk characteristics may include (not all inclusive): Credit score/rating (internal or external), asset or collateral type, size, effective interest rate, term, geographical location, borrower industry, vintage, historical or expected loss patterns, reasonable and supportable forecast period An individual basis if... Asset does not have similar risk characteristic(s) with other financial assets For example, a loan in default or a receivable past a delinquency period... But not included in both

11 CECL... Top Ten Truths Expected credit losses may be determined using... Various methods For example: discounted cash flow (DCF), loss rate, roll rate, probability of default, provision matrix Not required to... Utilize probability-weighted DCF model Reconcile estimation technique with DCF model Expected credit losses shall be measured over... Contractual term, considering estimated prepayments Contractual term shall not be extended for... Expected extensions and renewals Expected modifications, unless TDR anticipated to 6 11

CECL... Top Ten Truths 326-20-30-7 to 8 Shall consider available information relevant to assessing collectibility.

12 CECL... Top Ten Truths to 8 Shall consider available information relevant to assessing collectibility... information includes internal, external or combination For past events, current conditions, and reasonable and supportable forecasts Not required to search all possible information... not reasonably available May find... internal information is sufficient Historical credit loss information ( past events )... Generally provides a basis for assessing expected credit losses Shall consider adjustments for differences in... Current asset-specific risk characteristics (within a pool) Contractual term (individual or pool) Different economic conditions

13 CECL... Top Ten Truths BC 50 to 51 Any approach to estimating collectibility is subjective... Entities manage credit risk differently Therefore, various methods are permitted Varying methods may result... From differing degrees of portfolio complexity and entity sophistication In range of acceptable outcomes (rare only one acceptable choice) Should not default to using only most observable external data If internal market data is more relevant Most subjective aspect... qualitative adjustments to historical Board expects adjustments for current and future

14 Various methods, with varying results to 22 Example 1 Fact Pattern: Year end 20X5 Amort. Cost Basis = $10M Management expects in 20X6 and 20X7: Fall in real estate values Rise in unemployment Improved underwriting Management cannot reasonably forecast beyond 20X7 Percentage Loss Rates Historical loss rate (cumulative) 1.50% Adjustment for current conditions and reasonable and supportable forecasts 0.15% Expected loss rate 1.65% Loan loss reserves $165K Dollar Loss Rates Historical loan losses (cumulative) $150k Fall in real estate values +15K Rising unemployment + 5K More experienced underwriting - $1K Loan loss reserves $169K 14

Total $ 167 Shading represents realization timing of expected losses: 20X6 20X7 20X8 and thereafter $70 $60 $50 $40 Cumulative Loss Curves by

15 Actual chargeoffs and expected losses by vintage year and year of loan's life (in thousands) Year Originated Year 1 Year 2 Year 3 Year 4 Year 5 Expected Losses 20X0 $1 $20 $14 $8 $2 n/a 20X $ 4 20X X X X Total $ 167 Shading represents realization timing of expected losses: 20X6 20X7 20X8 and thereafter $70 $60 $50 $40 Cumulative Loss Curves by Vintage to 31 Example 3 And, given same facts... Vintage Analysis $30 $20 $10 $0 Year 1 Year 2 Year 3 Year 4 Year 5 20X0 20X1 20X2 20X3 20X4 20X5 15

16 CECL... Top Ten Truths For periods where forecasts are not supportable... Entity shall revert to historical credit loss information... Reflective of the contractual term immediately, on a straight-line basis, or using another rational and systematic basis Shall not adjust for existing and expected future economic conditions Not expected to use reversion technique... if entity is able to forecast over the estimated life Reasoning: Reversion is needed to meet measurement objective: Amount an entity expects to collect Not decision useful to ignore certain time periods Merely because an entity is unable to precisely estimate to 9 16

CECL... Top Ten Truths 326-20-30-10 & Example 8 Expected credit losses shall be measured, even if remote However, not required to measure when expectation that nonpayment is zero Expectation can t be

17 CECL... Top Ten Truths & Example 8 Expected credit losses shall be measured, even if remote However, not required to measure when expectation that nonpayment is zero Expectation can t be solely based on current value of collateral Board did not explicitly state specific financial assets where nonpayment is zero Bright-line approach is not appropriate given nature and characteristics of financial assets change over time However, Board provided Example 8 as one way an entity could evaluate U.S. Treasury securities Not intended to be only applicable to USTs

18 CECL... Top Ten Truths Expected credit losses for off-balance sheet credit exposures shall be measured Over the period entity is exposed to credit risk via a present contractual obligation Unless unconditionally cancellable by issuer, in which case no credit losses are recorded When measuring, consider both the likelihood funding will occur and the amount expected to be funded over estimated life of commitment Collateral-dependent financial assets to 5 Repayment expected substantially through operation or sale of collateral when borrower is experiencing financial difficulty Practical Expedient: Measure expected losses by comparing fair value of collateral to amortized cost

19 Questions or Comments 19

Webinar: Latest Developments on CECL and Upcoming Changes to the Allowance for Credit Losses. September 8, 2016

Webinar: Latest Developments on CECL and Upcoming Changes to the Allowance for Credit Losses September 8, 2016 An Introduction CECL What s Changing? What s not Changing? Acceptable Methods Myths vs Facts