Getting Ready for CECL Why Start Now? ANNA KRAYN, SENIOR DIRECTOR, SME TEAM

Getting Ready for CECL Why Start Now? ANNA KRAYN, SENIOR DIRECTOR, SME TEAM September, 2016

2 Moody s Analytics is an independent entity from Moody s Investor Services Leading global provider of credit rating opinions, insight and tools for credit risk measurement and management Independent provider of credit rating opinions and related information for over 100 years Models, data, software and research for financial risk analysis and related professional services 2

Today s Presenters Presenter Anna Krayn Team Lead, Impairment, Capital Planning and Stress Testing Anna Krayn is a Senior Director and Team Lead, responsible for solution structuring across Moody s Analytics products and services focusing on impairment, stress testing and capital planning solutions. Her clients include a variety of financial services institutions, including those in the banking and insurance sectors across Americas. Prior to her current role, she was with Enterprise Risk Solutions as engagement manager leading projects with financial institutions across Americas in loss estimation, enhancements in internal risk rating capabilities and counterparty credit risk management. Anna holds a B.S. and MBA from Stern School of Business at New York University. Moderator Michael Richitelli Head of Regulatory Compliance and Capital Management Team Michael leads the Regulatory Compliance and Capital Management solutions team for the Americas. He focuses on assisting banks across the United States with various aspects of the CCAR/DFAST and Basel regulations. Michael joined Moody s Analytics in 2002 and spent a number of years managing the firm s relationships with large global financial institutions. Prior to joining Moody s Analytics, Michael worked in Investment Banking at Commonwealth Associates, a boutique firm. He holds a BA from Fordham University along with an MBA in Marketing from the Fordham Graduate School of Business. 3

What is CECL and how did we get here? May 2010 Exposure Draft (ED) December 2012 2 nd Exposure Draft June 2016 Final Standard 2019 Early Adoption 2020 SEC Filer 2021 PBE Non-SEC filers 2022 Non-PBEs Re-deliberations Re-deliberations» This summer, FASB issued a new accounting model for recognition and measurement of credit losses for loans and debt securities.» The standard aims to address delayed recognition of losses inherent in the incurred loss reserving model» Scope: financial instruments measured at amortized cost basis Loans held for investment Debt securities held to maturity» For more information on the new standard and its implications, see The Long Road to CECL webinar (in association with GARP and E&Y) 4

Market participants have started preparations Moody s Analytics is conducting a survey to assess US bank preparation for CECL. Preliminary results indicate that early stage activities are under way. 2016 2017 2018 2019 2020 2021 Early Auditor Engagement Early Vendor Engagement CECL Working Group Formation Timeline Development 58% 27% 65% 50% Budget Approvals 58% Gap Analysis 0% Vendor Decisioning 0% Implementation 0% Parallel Run 0% Anticipated timeline for SEC filers Anticipated extension for non-sec filers Source: Moody s Analytics, as of August 2016 5

Significance of the challenges cannot be underestimated Anticipated Increase in Allowance Anticipated Challenges by Size of Institution <$5b $5b- $10b $10b- $50b (DFAST) $50b+ (CCAR) Data 62% 26% 12% Increase Decrease/Flat Unknown Life-of-Loan Loss Models ~ Automation of Process / Calculations ~ ~ ~ Reporting / Disclosures ~ ~ Challenges anticipated No challenges expected ~ Mixed responses Source: Moody s Analytics, as of August 2016 6

Lessons learned from IFRS 9 Implementation November 2009 IASB Exposure Draft March 2013 Exposure Draft July 2014 Final Standard 2015 TRG Meetings 1/1/2018 Mandatory Effective Date Re-deliberations Re-deliberations Observations on Complexity of Implementation» Broad scope of impact: IFRS 9 impairment affects processes from origination to portfolio monitoring at each reporting period, with a direct impact to capital» Calculation complexity: Credit risk model parameter extrapolation and macro-economic forecasting at exposure and/or portfolio level is a data-dependent exercise with multiple calculation sources, and therefore both a methodology and technology challenge» Data: Gaps are significant as stage allocation logic does not exist in legacy systems (30 days past due marker is insufficient) and best-available as per BCBS 239 is required for staging disclosures» Governance and controls: Since calculation involves a series of judgments, models are complex and impact is significant, internal controls are key to manage inherent conflicts of interest (e.g. firmwide governance of scenarios, enhanced model validation, greater involvement of internal audit)» Most banks are expecting to have an end-to-end process (staging and classification, provision calculation, reporting) implemented by the end of 2016 for first impact analysis and parallel runs (projects were kicked off in 2015) 7

COMPLEXITY AND VOLATILITY Anticipated challenges: Credit Loss Methodologies Strengths Gap to CECL 1 Historical Losses (Loss Rate, Roll Rate)» Easily available data (internal and industry)» Intuitive NCO / NPL / etc. driven approach Incorporates historical experience Incorporates current conditions Incorporate forecasts Forecast life of loan ECL? Segment-appropriate 2 Incorporates historical experience TTC Loss Estimation (PD / LGD / EAD)» Often outputs of scorecards» Relatively stable through time» Useful for capital adequacy assessment Incorporates current conditions Incorporate forecasts Forecast life of loan ECL? Segment-appropriate 3 PIT Loss Estimation (PD / LGD / EAD)» Reflects state of economic cycle» Can be forward-looking» Estimates prob. weighted mean of future paths» Less complex than scenario-conditioned estimates Incorporates historical experience Incorporates current conditions Incorporate forecasts Forecast life of loan ECL? Segment-appropriate 4 Scenario Conditioned Loss Estimation (PD / LGD / EAD)» Explicitly incorporates scenarios forecasts» Uses only a representative sample of future paths» Less complex than simulation-based approaches» Commonly used for stress testing Incorporates historical experience Incorporates current conditions Incorporate forecasts? Forecast life of loan ECL? Segment-appropriate 8

Anticipated challenges: Process and Systems Exposures Collateral Client Scenarios Data Calculation PD/LGD Models Cash flows Lifetime ECL Variance Drill-down Analysis Expert Overlay Management input Extract into GL Regulatory reports Posting Workflow 9

The regulators view CECL as an interdisciplinary exercise From the presentation by Rusty Thompson, Deputy Comptroller and Chief Accountant, OCC September, 2016 10

Planning the CECL Project CECL Implementation Phase Range of Activities EDUCATE» Key Stakeholder Education (Management, Board)» Internal Training» Operational Training ORGANIZE & GOVERN» Gap analysis» Framework design» Project planning» Program management QUANTIFY» Credit risk models» Cash flow generation» Economic forecasts» Benchmark Data» Qualitative Adjustments Framework AUTOMATE & REPORT» Calculation engine / model execution» Workflow administration» Management reporting» G/L Posting» Forecasting and Planning» Disclosures 11

Why start now? Implementation timeline can be tight Project Start Some activities can be run in parallel Go Live Preparation Methodology Design Software Implementation Parallel Run ~12 weeks 4 12 months 6 12 months >6 months» Gap Analysis (review of available data, models, systems)» Initial impact analysis» Requirements gathering» Project plan definition» Methodology framework design (and Segmentation)» Data gathering» Risk modeling (incl. linkage to stress testing, if appropriate)» Provisioning methodology» Overlay approach» Validation» Documentation» Training» Process definition» System requirement gathering» Data mapping» Model deployment» GL reconciliation» Interface configuration» Report / disclosure configuration» UAT» Entire process (models, implementation) should be subject to parallel run» Production support 12

How Moody s Analytics can help Solutions to Support CECL Impairment Calculation Economic Scenarios» Historical economic data» Business intelligence tools» Dashboards for management reporting» GL Posting & Regulatory Reporting Analysis & Reporting Credit Impairment Solution Credit Data» Probability-weighted scenario» Historical credit data across asset classes» EL benchmarking for user defined cohorts and data supplementation» Automation of a repeatable CECL process» Overrides management» Integration with firm s core systems» Aggregated analytics to quickly test sensitivity to changing scenarios Workflow and Overlay Management Sensitivity Analysis Credit Modeling & EL Calculation» Credit models across major asset classes» Cash flow generation» Deployed off-the-shelf or calibrated with firm s internal data 13

Moody s CECL Councils: Collaborating with the Industry Activities» Discuss key implementation challenges» Share best practices regarding implementation timelines, governance structure, and modeling methodologies» Deep dives into current provision calculation practices and gaps relative to CECL requirements Benefits for Participants» Network with leading impairment accounting practitioners» Define specific impairment calculation methods for different asset classes and different-sized institutions» Help shape design of your and our loss estimation tools Three Groups to Right Size CECL Implementation Community Banks Regional Banks Large Banks High-Level Timelines Form Councils Current point Meeting #1 Q4 2016-Q1 2017 Other Meetings TBD If you would like to participate, please email us at Events@moodys.com 14

Moody s Analytics CECL webinar series 2016 Don t miss the next in the series: Leveraging Basel and Stress Testing Models for CECL Tuesday, October 11, 2016 1PM EST 11AM PST The Value of Granular Risk Rating Models for CECL Tuesday, November 15, 2016 1PM EST 11AM PST Register at www.moodysanalytics.com/cecl

Moody s Analytics Risk Practitioner Conference OCTOBER 24-26, 2016 CARLSBAD, CALIFORNIA www.moodysanalytics.com/rpc2016

moodysanalytics.com Anna Krayn Sr. Director, Team Lead Stress Testing & Capital Planning 212.553.3705 tel anna.krayn@moodys.com 7 World Trade Center at 250 Greenwich Street New York, NY 10007 www.moodys.com 18

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