Tips for improving the Allowance for Loan and Lease Loss calculation in 2015. Content and suggestions include: migration analysis, archiving loan-level detail, capital planning, and preparing for regulatory changes, such as FASB's CECL model.
2. Questions
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3. About Sageworks
+ Financial information company that provides credit and risk
management solutions to financial institutions
+ Data and applications used by thousands of financial institutions
and accounting firms across North America
+ Provides resources including: whitepapers, webinars, videos, and
templates for bankers, accessible at www.sageworksanalyst.com
4. Who will be speaking?
Garrett Morris
Managing director of consulting
services at Sageworks
Ed Bayer
Managing director of financial
institutions at Sageworks
5. Objectives
+ What to get out of your strategic plan
+ Concerns, goals & intended results
+ How to make your ALLL more:
+ Comprehensive
+ Defensible
+ Flexible
+ “Audit-able”
+ How to prepare for impending regulatory changes
+ Methodological compliance with new expected loss standard
+ Capital adjustment
6. Concerns, Goals & Results
+ Concerns
+ Regulatory pressure
+ Current methodology – is it future-proofed?
+ Uncertainty in impending changes
+ Data requirements
+ Capital adjustment
+ Goals
+ Solidify ALLL methodology and documentation
+ Make repeatable, defensible, flexible and “audit-able”
+ Ensure present & future compliance
+ Results
+ Confidence in methodology and accuracy of results
+ Decreased regulatory scrutiny
+ ALLL as insight into portfolio performance and risk
7. Building a Better ALLL in 2015
+ Make your ALLL calculation more:
1) Comprehensive
2) Defensible
3) Flexible
4) “Audit”-able
8. Calculation Improvements: Comprehensive
+If you have the ability, move to a more sophisticated
analysis
+De novo institutions changing from peer group loss
rates to true historical loss rates after their de novo
status ends
9. Calculation Improvements: Comprehensive
+Moving from historical loss rates to migration analysis
+Consider an automated software that provides more detailed analysis
10. Calculation Improvements: Defensibility
+Strengthen loss methodology
+Migration analysis, PD/LGD over historical loss/peer analysis
+Extract data to show trends in sub-segmented FAS 5 pools
+Delinquencies, charge-offs monthly/quarterly trends
+Attribute to Q factors
+Migration analysis requires institutions to secure data requirements that
will be required for moving to CECL model (can serve as proxy).
11. Calculation Improvements: Defensibility
+Archive loan-level data
+Aids in pooling analysis
+CECL model’s life-of-loan concept will require more extensive data
aggregation
+Need robust pool of data to draw from for initial expected loss
calculation
12. Calculation Improvements: Defensibility
+Ensure calculation is reliable and consistently applied
+Systems must be in place to ensure calculation is directionally
consistent
+Make sure methodology is established, examiners scrutinize variability
+Establish succession plan – is calculation ‘institutionalized?’
+Backtest to confirm reliability
13. Calculation Improvements: Defensibility
+Questions to ask first:
+Which segments had an increase in the FAS 5 reserve?
+How much of the increase is due to changes in volume of that portfolio?
+How much is due to change in loss rate?
14. Calculation Improvements: Defensibility
Model Validation
+2006 Interagency Guidance: “Policies should require periodic validation of
the methodology”
+Is the methodology appropriate for the portfolio?
+Composition/characteristics
+Historical patterns of loss
+Past and current trends in asset quality
+Granularity and accuracy of grading system
+Does the methodology comply with Interagency Guidance/GAAP
+Is the methodology used as intended?
+Accuracy of calculations, reasonableness
16. Calculation Improvements: Flexibility
+Use scenario planning:
+Displays impact of individual factors on overall analysis
+What if just “X” changed?
+What would it do to my calculation?
+Ex: If I adopted migration analysis, would it change my reserve?
+Ex: If CRE took a hit, how much would I have to provision?
+Ex: If I changed my look-back period, what would it do to my reserve levels?
+Ex: If I began lending in a new segment, what losses would peer groups reflect?
+Helps show range for the reserve
17. Calculation Improvements: Flexibility
+Use scenario planning:
+Consider adjusting look-back period
+2009-2011 had very high periods of loss
+When they migrate out of look-back period, could change
reserve levels
18. Calculation Improvements: “Audit-ability”
+Ensure calculation is transparent
+Document, document, document
+Audit capability for institutions with more complex ALLL calculations
+Workflow process/approval process
+Read-only access for increased transparency
+Examiners should be able to see each and every step in your calculation
+Management reports should demonstrate all high level data and summarize
results
+More ‘digestible’ presentations typically spark less questions
+Momentum in defending
19. Calculation Improvements: “Audit-ability”
+Bolster reporting capabilities:
+Aging analysis
+ALLL roll forward schedule
+Credit risk profile
+Reserve for unfunded commitments
+Impaired loans
+TDR pre & post modification report
+FAS 114 future cash flows
+ FAS 5/ FAS 114 reserves and
balances by loan class
+ Loan exposure report
+ Portfolio concentration by call code,
collateral code, industry, loan officer,
MSA, NAICS, product code
+Watch asset report
20. Regulatory Prep: Compliance w/New Standard
+FASB’s CECL Model:
+Incurred Loss Expected Loss
+Estimated to increase ALLL levels from 30-50%
+NOT a provision expense, but rather a capital adjustment
+Significantly more data required to calculate loss over life of loan
21. Regulatory Prep: Compliance w/New Standard
+What type of models will you use to comply with standards?
What are the data requirements?
+Peer groups
+Historical loss
+PD/LGD
+Migration analysis
22. Regulatory Prep: Compliance w/New Standard
+What data points are required to perform the calculation under the
CECL model?
+Risk rating by individual loan
+Loan duration
+Individual loan balance
+Individual loan charge-offs and recoveries (partial + full)
+Individual loan segmentation
+Look at current system: can I extract data points from my system? Is
this data dynamically available?
23. Migration Analysis – a Proxy?
+Data components required for CECL model also required to perform
migration analysis
+Often considered a more “robust” form of analysis
+Should result in more accurate allowance than historical loss
+More insight into sub-segmented pools (cred quality/deterioration)
+Less prone to examiner criticism if performed correctly
+More effectively justify decrease in provisions, if merited
+Adjusts ALLL provision to reflect the conditions of the current portfolio
+Can drive pro forma projections
24. Regulatory Prep: Capital Adjustment
+Institutions must plan to ensure capital adequacy:
+Ex: If institution’s current ALLL is 2% and CECL merits 50% increase,
reserve becomes 3%, decreasing your capital by a full 1%
+If your institution is managing capital “efficiently,” not planning for the
adjustment can have drastic implications
+Build scenarios/run parallel calculation
+Time between release date and implementation date of new guidance
intended to provide banks with planning period for necessary adjustment
+Capital planning for ALLL will also be impacted by capital planning for
DFAST & BASEL III over same time period
25. Conclusion: Example Strategic Plan
+ Strategic Goals (The end results that will measure the success of the bank’s
efforts)
+ Make our ALLL calculation more comprehensive, defensible, flexible & “audit-able”
+ Strategic Initiatives (The origination of new ideas and processes that lead to
accomplishment of goals)
+ Consider migration analysis or stronger methodology, shore up data processes, focus more
on analysis of results for more insight into portfolio
+ Action Plans (What needs to be done to implement the bank’s initiatives)
+ Evaluate existing model, the model’s data components, and existing system (can existing
system extract necessary data points?) Do we need system changes?
+ Begin capital planning
26. Questions
Garrett Morris
Managing Director of Consulting Services
Garrett.morris@sageworks.com
866.603.7029 ext. 568
Ed Bayer
Managing Director of Financial Institutions
Ed.bayer@sageworks.com
866.603.7029 ext. 698
LinkedIn Groups
+ALLL Forum for Bankers
+Commercial Credit Risk Professionals
Website
+www.sageworksanalyst.com
+Whitepapers, webinars,
thought leadership