In this webinar, Sageaworks presents some of the methodologies that institutions are most likely to use with CRE or commercial real estate pools under the CECL model. The recording is accessible here: http://web.sageworks.com/cecl-methodology-webinar-series/
1. Brandon Russell
Sageworks ALLL Specialist
CECL Methodology Series
CRE
January 12, 2016
P R E S E N T E D B Y
Neekis Hammond, CPA
Principal – Advisory Services
2. About the Webinar
2
• Ask questions throughout the session using the
GoToWebinar control panel
• We will answer as many questions as we can at the
end of the presentation
3. About Sageworks
• Risk management thought leader
for institutions and examiners
• Regularly featured in national and
trade media
• Loan portfolio and risk
management solutions
• More than 1,000 financial
institution clients
• Founded in 1998
3
4. Disclaimer
This presentation may include statements that constitute “forward-looking statements”
relative to publicly available industry data. Forward-looking statements often contain
words such as “believe,” “expect,” “plans,” “project,” “target,” “anticipate,” “will,” “should,”
“see,” “guidance,” “confident” and similar terms. There can be no assurance that any of the
future events discussed will occur as anticipated, if at all, or that actual results on the
industry will be as expected. Sageworks is not responsible for the accuracy or validity of
this publicly available industry data, or the outcome of the use of this data relative to
business or investment decisions made by the recipients of this data. Sageworks disclaims
all representations and warranties, express or implied. Risks and uncertainties include
risks related to the effect of economic conditions and financial market conditions;
fluctuation in commodity prices, interest rates and foreign currency exchange rates. No
Sageworks employee is authorized to make recommendations or give advice as to any
course of action that should be made as an outcome of this data. The forward-looking
statements and data speak only as of the date of this presentation and we undertake no
obligation to update or revise this information as of a later date.
4
6. Agenda
• Series Overview
• CRE Segmentation Principles
• CRE Sub-segmentation Principles
• CRE Methodologies and Calculations
» Migration
» PD/LGD (Probability of Default/Loss Given Default)
» DCF (Discounted Cash Flow)
• Questions
7. CECL Methodology Series
• Thursday, January 12, 2017, 2-3 p.m.: CRE Pool CECL Methodologies
• Thursday, January 26: Consumer Pool CECL Methodologies
• Thursday, February 9, 2017, 2-3 p.m.: C&I Pool CECL Methodologies
• Thursday, February 23, 2017, 2-3 p.m.: Unfunded Commitments & Construction Loan CECL
Methodologies
• Thursday, March 9, 2017, 2-3 p.m.: Forecasting with CECL
• Thursday, March 23, 2017, 2-3 p.m.: Disclosures with CECL
Sign up at: web.sageworks.com/cecl-methodology-webinar-series/
8. Considerations for Initial Segmentation
Segmentation.
• Amortization Structure
• Payment Structure
• Contract Term
• Interest Rate
» (Fixed v. Variable)
• Exposure Type
» Owner Occupied v. Non-Owner Occupied, Industry, Operational Risk, Etc.
9. Next Step; Include Risk Characteristic
Sub-segmentation.
• Risk Rating
» Accurate RR is primary indicator
• FICO
» Originated, most recent, banded, etc.
• Days Past Due
» Is this truly predictive of future losses?
• DSCR
• LTV
• Key - Integrating risk metrics with underwriting software makes this actionable
10. Fundamental Principles
Migration.
• Point-in-Time
» Categorize assets by attribute as of a specific date and observe subsequent activity
• Iterative
» Observe subsequent activity over n periods iteratively as of multiple points-in-time
• Flexible Range
» n periods should equal the life of the pool if performing life-of-loan loss analysis
• FDIC Technical Assistance Video Program
» https://www.fdic.gov/regulations/resources/director/technical/alll.html
11. Migration.
Pros and Cons
• Pros
» Good Feedback Loop – the analysis is segmented by attributes observed at
origination/renewal
» Practical – easier to perform than PD & LGD and/or DCF
» Familiarity – auditors and regulators are familiar with this approach
» Concentration Shifts – if done properly, migration will more accurately reflect changes in risk
concentrations than simple cumulative loss rate methods
• Cons
» Out-of-date – if n = 3, your most recent observed 3-yr. loss experience is 3 years old
» Vintage – origination and renewal date are typically not leveraged
19. Fundamental Principles – Probability of Default
PD & LGD.
• Point-in-Time
» Categorize assets by attribute as of a specific date and observe subsequent default activity
• Iterative
» Observe subsequent default activity over n periods iteratively as of multiple points-in-time
• Flexible Range
» n periods should equal the life of the pool if performing life-of-loan loss analysis
• Default Activity
» Default activity would apply to loans not in default as of the point-in-time under analysis. If
an available loan experiences a default in subsequent n periods the # or $ is considered
20. PD & LGD.
Pros and Cons
• Pros
» Better Feedback Loop – the analysis is segmented by attributes observed at
origination/renewal
» Wider Utilization – default and loss are separate underwriting considerations, this facilitates
more equipped underwriting practices
» Necessary for DCF – DCF models, when done properly, will include periodic default and
collection of default assumptions
• Cons
» Out-of-date – if n = 3, your most recent observed 3-yr. loss experience is 3 years old
» Vintage – origination and renewal date are typically not leveraged
27. Fundamental Principles
DCF.
• Go-forward Analysis
» Input periodic default, loss, prepayment, contractual, and collection assumptions and
amortize each credit accordingly
• Discount Expected Cash Flows
» Cash flows are discounted at the instrument level then aggregated into a pool for total NPV
• Timing vs. Credit
» Period to period, institutions will see fluctuation in NPV for timing related items. Such items
can be recorded as interest income. Institutions must disclose this amount
28. DCF.
Pros and Cons
• Pros
» Best Feedback Loop – Production and yield are great, but NPV represents how great
» Cross Application – Classification and Measurement; simply adjust discount rate assumptions
for fair value. 310-30 updating accretable yield/expected cash flows can be facilitated with
minimal changes to assumptions/inputs
» Increased Forecast Flexibility – Period level forecasts can be performed under this approach.
In other words, one can model a rise and fall in unemployment rate and correlate the impact
to losses
• Cons
» Less Practical – more difficult to perform than PD & LGD and/or DCF