How the Proposed Current Expected
Credit Loss (CECL) Rule Will Affect your
Allowance for Loan and Lease Losses
Presented by Wilary Winn
Brenda Lidke, Director
September 22, 2014
1
Topics Covered
• Proposed standard
• Data to start tracking
• Example of current ALLL model vs discounted
cashflow example that meets CECL
• Non loan items affected by CECL
2
FASB Proposed Accounting Standards Update (ASU)
• Issued on December 20, 2012
• Will significantly change the allowance for loan and
lease losses and other approaches to impairment
• Newly created subtopic “Financial Instruments: Credit
Losses (Subtopic 825-15)”
• Not just the ALLL, applies to all financial assets not classified
at fair value
e.g. AFS securities not included in scope
3
Instrument Type
• All financial assets - debt instruments, leases, and loan
commitments
– The term “debt instrument” is defined in the proposal as
“a receivable or payable that represents a contractual
right to receive cash (or other consideration) or a
contractual obligation to pay cash (or other consideration)
on fixed or determinable dates, whether or not there is
any stated provision for interest.”
– Covers loans, debt securities, trade receivables,
reinsurance receivables, lease receivables, and loan
commitments
4
Amortized cost should be based on the present value
of the cash flows an entity expects to collect
• Contractual cash flows are adjusted for expected
prepayments and defaults
– Cash flows should not be adjusted for extensions, renewals, or
modifications unless a TDR is reasonably expected
• Cash flows expected to be collected are discounted at
the effective interest rate
• Cash flows not expected to be collected are also
discounted at the effective interest rate
5
Why the Change?
• GAAP did not properly reflect risk pre-financial crisis
because of the delayed recognition of credit losses –
Financial Crisis Advisory Group
– 362 comment letters – investors generally in favor of
CECL and preparers generally not
• Departs from the incurred loss model which means the
probable threshold is removed
– Removes the prohibition on recording day one losses
6
Not without controversy
FASB FAQ
• Issued on March 25, 2013
Continued re-deliberations
• FASB not expected to re-expose ASU
• FASB states that a final ASU will be issued by the end
of this year – consensus is mid-2015 effective for 2017
or 2018
7
Measuring Expected Credit Losses
• Begin with historical loss rates for similar assets
(grouped approach)
– Static pool for example
• Adjust for current conditions
• Adjust for reasonable and supportable forecasts
• Life of loan estimate - can assume economic conditions
after the end of the reasonable forecast time period
remain the same or can revert to historical loss rates
– Final guidance is expected to state that the entity should revert
to historical loss experience
8
Final Guidance
• Final guidance will include implementation guidance
describing the factors that an entity should consider to
adjust historical loss experience for current conditions
and reasonable and supportable forecasts
9
Technical Considerations
• Permits allowance calculation to be based on methods
which “implicitly” include the time value of money
– DCF explicitly considers time value of money
– Loss-rate, roll-rates, probability of default methods, and
provision matrices implicitly consider discount
• Contemplates use of mean and not mode if using
statistical modeling
10
Economic Conditions to Start Tracking Now
• Unemployment – national and local
• Current and expected interest rates
– Forward curves
– Monetary policy
•
•
•
•
Inflation
GDP (Gross Domestic Product) growth rates
Expected housing appreciation/depreciation
Credit union industry performance as a whole
11
Unemployment Rates 2007-2014
GA 7.9%
MI 7.9%
16%
CA 7.3%
14%
OR 6.7%
12%
FL 6.2%
10%
MD 6.2%
National 6.1%
8%
WI 6.0%
6%
MA 5.6%
4%
MN 4.6%
2%
MT 4.6%
IA 4.5%
0%
2007
2008
2009
2010
2011
12
2012
2013
NE 3.7%
Market Interest Rates - US Treasury Yield Curve at 6/30/14
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
13
Market Interest Rates - US Treasury Rates Forecast at 6/30/14
Rate Forecast
US 10-Year
US 2-Year
Spread 2-10
Q3 14
Q4 14
Q1 15
Q2 15
Q3 15
2.75
0.60
2.15
2.94
0.76
2.18
3.11
0.96
2.15
3.28
1.21
2.07
3.42
1.48
1.94
14
Inflation and GDP Forecast
Economic
Indicator
Fed Funds Target
Unemployment
Real GDP growth
CPI
Q3 14
Q4 14
Q1 15
Q2 15
Q3 15
0.25
6.10
2.95
2.10
0.25
5.90
3.00
2.20
0.25
5.80
2.90
2.20
0.38
5.70
2.95
2.05
0.63
5.60
2.95
2.10
15
FHFA Seasonally Adjusted House Price
Index for USA
Quarterly Appreciation Annualized
Appreciation from Same Quarter 1 Year Earlier
15.00%
10.00%
5.00%
0.00%
‐5.00%
‐10.00%
16
2014 Q2
2013 Q4
2013 Q2
2012 Q4
2012 Q2
2011 Q4
2011 Q2
2010 Q4
2010 Q2
2009 Q4
2009 Q2
2008 Q4
2008 Q2
2007 Q4
2007 Q2
2006 Q4
2006 Q2
2005 Q4
2005 Q2
2004 Q4
2004 Q2
‐15.00%
Expected Home Price Long Term Average
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Data from Pulsenomics quarterly surveys
17
Expected Housing Appreciation by Region
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
Data provided by Case-Shiller / CoreLogic
via CNN Money
2014
2015
18
30+ Day Residential 1st Mortgage Loans By Region 12.0%
10.0%
Northeast 7.10%
8.0%
North Central 6.06%
6.0%
South 6.90%
4.0%
West 4.31%
2.0%
National 6.04%
0.0%
Data from SNL Financial
19
Loan Data to Start Tracking Now
• Loan product type – 30yr Fixed, HELOC, New Vehicles
• Loan Terms – rate, amortization term, original balance
• Delinquency status
• Defaulted loan balance and date at the loan level
• Recovered amounts and date of recovery by loan
• Prepayments at the loan level – date and balance
• Current CLTV (Combined Loan to Value)
• Current FICO
20
How Should the Loan Data be Tracked?
• Easily accessible database of loans
– Depends on loan volume
• Could use Excel or Access
• Alternatively, there are companies that specialize in
data storage
• Save pertinent information each quarter-end
21
What Else Should My Credit Union be Doing Now?
• Use the data to explore forecasting
– Look at using the different economic factors and how these will
adjust prepay and default assumptions
• Run a parallel ALLL model
– Credit unions that create the proposed model now will have a
better chance of a successful implementation later
– To have a better understanding of the magnitude of reserve
change that will be required
22
Discounted Cashflow Analysis
Key Valuation Inputs:
• Conditional Repayment Rate (CRR)
• Conditional Default Rate (CDR)
• Conditional Prepayment Rate (CPR = CRR + CDR)
• Loss Severity
• Discount Rate – depends on accounting context. For CECL it
is original yield
23
Loan Example - 620 FICO group
Sched. P&I payment $ 30,686.07
Loan
Remaining
Repo
Total
Valuation Payment
Loan
Actual
Voluntary
Prin
Prin
Month
Month
Balance
Amort
Prepays Recoveries Collected
0
23 5,000,000
1
24 4,973,028
5,669
21,302
26,972
2
25 4,946,248
5,656
21,124
26,781
3
26 4,919,657
5,644
20,947
26,591
4
27 4,893,255
5,631
20,772
26,402
5
28 4,867,039
5,618
20,598
26,216
6
29 4,841,009
5,605
20,425
26,030
7
30 4,815,164
5,593
20,253
25,846
8
31 4,789,501
5,580
20,083
25,663
9
32 4,764,020
5,567
19,914
25,481
10
33 4,738,719
5,555
19,746
25,301
11
34 4,713,598
5,542
19,580
25,122
12
35 4,688,654
5,529
19,414
24,944
13
36 4,663,887
5,517
19,250
24,767
14
37 4,639,295
5,504
19,088
24,592
15
38 4,614,876
5,492
18,926
24,418
16
39 4,590,631
5,480
18,766
24,245
17
40 4,566,557
5,467
18,607
24,074
18
41 4,542,654
5,455
18,449
23,904
18 - 338 42 - 360
0 1,239,624 1,799,821 1,205,709 4,245,154
Total
1,339,728 2,157,063 1,205,709 4,702,500
Discounted Annual Annual Annual
Losses
CRR% CDR% Severity%
$ 196,507
5.0%
3.5%
20%
Interest
24,926
24,718
24,511
24,306
24,102
23,900
23,699
23,500
23,302
23,106
22,912
22,719
22,527
22,337
22,148
21,960
21,774
21,590
2,109,775
2,527,810
24
Total
P&I
DQ
Repo
Collected Balance Balance Liquidations
51,897 14,823
51,498 29,521
51,102 44,097
50,708 58,551
50,317 72,884
49,930 87,096
49,545 86,366
14,823
49,163 85,642
29,521
48,783 84,924
44,097
48,407 84,211
58,551
48,033 83,503
72,884
47,662 82,800
87,096
47,294 82,103 101,189
46,929 81,411 115,164
46,566 80,725 129,021
46,206 80,043 142,762
45,848 79,367 156,386
45,493 78,696 169,896
6,354,928
1,503,209
7,230,310
1,503,209
Repo
Prin
Losses
297,500
297,500
Monthly Monthly Monthly
CRR% CDR% Severity%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.43%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.30%
0.29%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
20%
Risk Layering
Real Estate Loans – Key Loan Attributes
• Interest rate – fixed or variable
• Contract term – balloons, hybrids, etc.
• Lien position
• Closed or open ended
• Source – retail vs. wholesale
• Loan purpose – primary, second home, investor
• Debt to income ratios
• Credit score
• Combined Loan-to-Value ratio
25
Average 12 month CDR% by LTV% and FICO
15.0%
> 125%
12.5%
105% - 125%
CDR%
10.0%
95% - 105%
7.5%
80% - 95%
5.0%
< 80%
2.5%
0.0%
>775
725 - 774
700 - 724
FICO
26
650 - 699
600 - 649
Example of Current ALLL Calculation
Loan
Ending
Type
Balance
All Mortgages 125,000,000
Historical Historical
TDR
Known
Total
Average
C/O
Loss
Loss
Loss
Q & E
Required
Balance
Ratio Allowance Allowance Allowance Change Allowance
112,500,000
0.50% 562,500 250,000 500,000 200,000 1,512,500
27
Example of Proposed ALLL Calculation - DCF Analysis
Loan
Payment
Type
Status
Fixed ‐ 30 yr Current
Current
Current
Current
Current
Current
Repeat for FICO Buckets
Current
Current
Current
Current
Delinquent
Delinquent
Delinquent
Discounted Discounted
Annual Annual
Gross
Discount Discounted Lifetime
Annual
Prepay % Default %
Loss
Avg Future
Rate
Future
Future
Future
(CRR)
(CDR) Severity % Life
Losses
(WAC)
Losses
Losses %
Losses %
10%
0.0%
0% 6.0 ‐
4.0% ‐
0.0%
0.0%
9%
0.1%
10% 6.5 9,750
4.0% 7,556
0.1%
0.0%
8%
0.1%
15% 7.0 10,500
4.0% 7,979
0.1%
0.0%
7%
0.4%
17% 7.5 24,750
4.0% 18,443
0.4%
0.0%
4%
1.3%
23% 9.0 132,210
4.0% 92,889
1.9%
0.2%
4%
1.8%
42% 9.5 359,955
4.0% 247,988
5.0%
0.5%
Credit
Score
720+
720+
720+
720+
720+
720+
LTV
Status
Under 50%
50% ‐ 75%
75% ‐ 100%
100% ‐ 120%
120% ‐ 150%
Over 150%
Ending
Balance
25,000,000
15,000,000
10,000,000
5,000,000
5,000,000
5,000,000
660‐719
620‐659
500‐619
Under 500
by LTV bucket
by LTV bucket
by LTV bucket
by LTV bucket
5,000,000
5,000,000
5,000,000
5,000,000
6%
5%
4%
4%
0.7%
3.5%
13.0%
20.0%
20%
20%
20%
20%
8.5
8.5
5.5
4.5
500,000
500,000
500,000
4%
2%
2%
30.0%
50.0%
75.0%
20%
20%
20%
38,500,000
125,000,000
8%
8%
2.0%
2.9%
20%
15%
30+ days
60‐89 days
90+ days
ARM ‐ 10/1 repeat all FICO & LTV buckets above
Total Mortgages
28
55,250
297,500
715,000
900,000
4.5%
5.0%
5.5%
5.5%
38,005
196,507
532,620
707,305
0.8%
3.9%
10.7%
14.1%
0.1%
0.5%
1.9%
3.1%
4.5 135,000
3.0 150,000
2.5 187,500
4.0% 113,158
4.0% 133,349
4.0% 169,988
22.6%
26.7%
34.0%
5.0%
8.9%
13.6%
6.0 924,000
6.5 3,901,415
3.5% 751,675
4.0% 3,017,462
2.0%
2.4%
0.3%
0.4%
Difference in Methodology
Much more detail is required – loans are grouped by like
characteristics – LTV, FICO, amortization term, etc.
Prepay (CRR) and default (CDR) assumptions are built
from historical losses by group and adjusted for
economic environment
Loan terms, interest rates, and scheduled amortization are
used in the calculation
Results under new methodology are 2x higher than
current results
29
What is the expected change in your organization’s
provision under the proposed rules?
•
•
•
•
Decrease
Increase by 25%
Increase by 25% to 50%
Increase more than 50%
30
For Purchased Credit-Impaired (PCI) financial assets
•
•
•
•
Amortized cost would be the purchase price plus the associated
expected credit loss at acquisition. The difference between
amortized cost and the par amount (noncredit discount or
premium) is amortized or accreted into income
The credit discount is not accreted - establish a day one
allowance instead
Permits increases in expected cash flows to be recognized
immediately – significant shift from current GAAP
Final rule is expected to state that non-credit related
discount/premium should be allocated to the individual assets
purchased
31
TDR Guidance
• Use the modified contractual cash flows, discounted at the
original effective interest rate
• Initial rule stated that the difference would be recorded by a
basis adjustment rather than an allowance
• However, the final rule will clarify that an entity is required to
increase the cost basis of the restructured asset through a
corresponding increase in the entity’s allowance for
expected credit losses in certain TDRs.
•
The effect is that the write-down is not permanent and the
reserve is recoverable.
32
No more “other than temporary impairment” (OTTI)
model for debt securities
• Change from individual security evaluation to include pool
evaluations
• Record an allowance instead of direct write-off (allows the
opportunity for reversal)
• For assets carried at FV/OCI, there is a practical expedient
available. Credit losses do not have to be recognized if both:
– Fair value equals or exceeds the amortized cost (which is the
first step in the existing OTTI model); and
– Expected credit losses on the asset are insignificant
33
Miscellaneous Items
Redefines collateral-dependent in the glossary
• “A financial asset for which the repayment is expected to be
provided primarily or substantially through the operation (by
the lender) or sale of the collateral, based on an entity’s
assessment as of the reporting date.”
• Clarifies that operation is by the lender and removes the word
“solely”
• Final rule is expected to state that on collateral-dependent
assets, the reserve is measured as the difference between
the collateral’s fair value (less selling costs) and the
amortized cost basis of the asset.
34
Miscellaneous Items - Continued
Defines nonaccrual, cost-recovery and cash-basis
methods, write-off (charge-off)
Final guidance is expected to clarify that an entity is not
required to recognize a loss on a financial asset for
which the risk of nonpayment is greater than zero, yet
the amount of the loss would be zero
- Example – have a CDR, but have a zero loss severity
35
36
Contact Information
Wilary Winn LLC
First National Bank Building
332 Minnesota Street, Suite 1750W
Saint Paul, MN 55101
651-224-1200
www.wilwinn.com
37
Services and Contact Information
Private Label MBS/CMOs and Asset Liability Management:
Frank Wilary
fwilary@wilwinn.com
Mergers and Acquisitions, Fair Value Footnotes, ASC 310-30, and
TDRs:
Brenda Lidke
blidke@wilwinn.com
Mortgage Servicing Rights and Mortgage Banking Derivatives:
Eric Nokken
enokken@wilwinn.com
38