CECL Methodology Series for Off-Balance-Sheet Credit Exposures

Sageworksanalyst.com
Neekis Hammond, CPA
Principal - Advisory Services
1
February 23, 2017
CECL Methodology Series
Off-Balance-Sheet Credit Exposure

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2

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Disclaimer
4
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
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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.

Neekis Hammond, CPA
Principal - Advisory Services
About Today’s Presenters
5

Agenda
• Series Overview
• Guidance
• Definitions/Glossary
• Instruction
• Example
• Background Information and Basis for Conclusion
• Measurement
• Contractual Life
• Net Advancement
• Net Curtailment
• Liability
6

Series Overview
• 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 16th, 2017, 2-3 p.m.: CECL Calculations in a Software Environment
• Thursday, March 23, 2017, 2-3 p.m.: Disclosures with CECL
Sign up at: web.sageworks.com/cecl-methodology-webinar-series/
7

Agenda
• Series Overview
• Guidance
• Instruction
• Example
• Measurement
• Net Advancement
• Net Curtailment
• Liability
8

Guidance
Line-of-Credit Arrangement (Topic 326 - Glossary):
• A line-of-credit or revolving-debt arrangement is an agreement that provides the borrower with
the option to make multiple borrowings up to a specified maximum amount, to repay portions of
previous borrowings, and to then re-borrow under the same contract.
• Line-of-credit and revolving-debt arrangements may include both amounts drawn by the debtor (a
debt instrument) and a commitment by the creditor to make additional amounts available to the
debtor under predefined terms (a loan commitment).
9

Guidance
Loan Commitment (Topic 326 - Glossary):
• Loan commitments are legally binding commitments to extend credit to a counterparty under
certain pre-specified terms and conditions. They have fixed expiration dates and may either be
fixed-rate or variable-rate. Loan commitments can be either of the following:
• Revolving (in which the amount of the overall commitment is reestablished upon repayment of previously drawn
amounts)
• Non-revolving (in which the amount of the overall commitment is not reestablished upon repayment of previously
drawn amounts)
• Loan commitments can be distributed through syndication arrangements, in which one entity acts
as a lead and an agent on behalf of other entities that will each extend credit to a single borrower.
Loan commitments generally permit the lender to terminate the arrangement under the terms of
covenants negotiated under the agreement.
10

Guidance
Standby Letter of Credit (Topic 326 - Glossary):
• A letter of credit (or similar arrangement however named or designated) that represents an
obligation to the beneficiary on the part of the issuer for any of the following:
• To repay money borrowed by or advanced to or for the account of the account party
• To make payment on account of any evidence of indebtedness undertaken by the account party
• To make payment on account of any default by the account party in the performance of an obligation
• A standby letter of credit would not include the following:
• Commercial letters of credit and similar instruments where the issuing bank expects the beneficiary to draw upon the
issuer and which do not guarantee payment of a money obligation
• A guarantee or similar obligation issued by a foreign branch in accordance with and subject to the limitations of
Regulation M of the Federal Reserve Board
11

Guidance
Off-Balance-Sheet Credit Exposures (Topic 326-20-30-11):
• In estimating expected credit losses for off-balance-sheet credit exposures, an entity shall estimate
expected credit losses on the basis of the guidance in this Subtopic over the contractual period in
which the entity is exposed to credit risk via a present contractual obligation to extend credit,
unless that obligation is unconditionally cancellable by the issuer.
• At the reporting date an entity shall record a liability for credit losses on off-balance-sheet credit
exposures within the scope of this Subtopic.
• An entity shall report in net income (as a credit loss expense) the amount necessary to adjust the
liability for credit losses for management’s current estimate of expected credit losses on off-
balance-sheet credit exposures.
• For that period of exposure, the estimate of expected credit losses should consider both the
likelihood that funding will occur (which may be affected by, for example, a material adverse
change clause) and an estimate of expected credit losses on commitments expected to be funded
over its estimated life.
12

Guidance
• In estimating expected credit losses for off-balance-sheet credit exposures, an entity shall estimate
expected credit losses on the basis of the guidance in this Subtopic over the contractual period in
which the entity is exposed to credit risk via a present contractual obligation to extend credit,
unless that obligation is unconditionally cancellable by the issuer.
• At the reporting date an entity shall record a liability for credit losses on off-balance-sheet credit
exposures within the scope of this Subtopic.
• An entity shall report in net income (as a credit loss expense) the amount necessary to adjust the
liability for credit losses for management’s current estimate of expected credit losses on off-
balance-sheet credit exposures.
• For that period of exposure, the estimate of expected credit losses should consider both the
likelihood that funding will occur (which may be affected by, for example, a material adverse
change clause) and an estimate of expected credit losses on commitments expected to be funded
over its estimated life.
13

Guidance
• An entity shall adjust at each reporting period its estimate of expected credit losses on off-balance-
sheet credit exposures.
• An entity shall report in net income (as credit loss expense or a reversal of credit loss expense) the
amount necessary to adjust the liability for credit losses for management’s current estimate of
expected credit losses on off-balance-sheet credit exposures at each reporting date.
• An estimate of expected credit losses on a financial instrument with off-balance-sheet risk shall be
recorded separate from the allowance for credit losses related to a recognized financial
instrument.
14

Guidance
• For off-balance-sheet credit exposures within the scope of this Subtopic, an entity shall present the
estimate of expected credit losses on the statement of financial position as a liability.
• The liability for credit losses for off-balance-sheet financial instruments shall be reduced in the
period in which the off-balance-sheet financial instruments expire, result in the recognition of a
financial asset, or are otherwise settled.
• An estimate of expected credit losses on a financial instrument with off-balance-sheet risk shall be
recorded separate from the allowance for credit losses related to a recognized financial
instrument.
15

Guidance
Disclosures/Credit Quality Information (Topic 326-20-50-4,5):
• 50-4; An entity shall provide information that enables a financial statement user to do both of the
following:
• Understand how management monitors the credit quality of its financial assets
• Assess the quantitative and qualitative risks arising from the credit quality of its financial assets.
• 50-5; To meet the objectives in paragraph 326-20-50-4, an entity shall provide quantitative and
qualitative information by class of financing receivable and major security type about the credit
quality of financial assets within the scope of this Subtopic (excluding off-balance-sheet credit
exposures and repurchase agreements and securities lending agreements within the scope of Topic
860), including all of the following:
• A description of the credit quality indicator(s)
• The amortized cost basis, by credit quality indicator
• For each credit quality indicator, the date or range of dates in which the information was last updated for that credit
quality indicator.
16

Guidance
Disclosures/Credit Quality Information (Topic 326-20-50-4,5):
• 50-4; An entity shall provide information that enables a financial statement user to do both of the
following:
• Understand how management monitors the credit quality of its financial assets
• Assess the quantitative and qualitative risks arising from the credit quality of its financial assets.
• 50-5; To meet the objectives in paragraph 326-20-50-4, an entity shall provide quantitative and
qualitative information by class of financing receivable and major security type about the credit
quality of financial assets within the scope of this Subtopic (excluding off-balance-sheet credit
exposures and repurchase agreements and securities lending agreements within the scope of
Topic 860), including all of the following:
• A description of the credit quality indicator(s)
• The amortized cost basis, by credit quality indicator
• For each credit quality indicator, the date or range of dates in which the information was last updated for that credit
quality indicator.
17

Guidance
Example 10: Application of Expected Credit Losses to Unconditionally Cancellable Loan
Commitments (Topic 326-20-55-54,55,56):
• 55-54; This Example illustrates the application of the guidance in paragraph 326-20-30-11 for off-
balance-sheet credit exposures that are unconditionally cancellable by the issuer.
• 55-55; Bank M has a significant credit card portfolio, including funded balances on existing cards and
unfunded commitments (available credit) on credit cards. Bank M’s card holder agreements stipulate
that the available credit may be unconditionally cancelled at any time.
• 55-56; When determining the allowance for credit losses, Bank M estimates the expected credit losses
over the remaining lives of the funded credit card loans. Bank M does not record an allowance for
unfunded commitments on the unfunded credit cards because it has the ability to unconditionally
cancel the available lines of credit. Even though Bank M has had a past practice of extending credit on
credit cards before it has detected a borrower’s default event, it does not have a present contractual
obligation to extend credit. Therefore, an allowance for unfunded commitments should not be
established because credit risk on commitments that are unconditionally cancellable by the issuer are
not considered to be a liability.
18

Guidance
Background Information and Basis for Conclusions(BC10):
• Some stakeholders may interpret Topic 326 as recognition guidance; however, Topic 326 is
measurement guidance. The recognition event occurs when the financial asset is recognized on the
statement of financial position through origination or purchase.
• Recognition is limited to assets and liabilities because the conceptual framework places primacy on
those accounts. Expenses and losses in the Conceptual Framework are secondary because they
represent changes in balance sheet accounts. Therefore, an expense is a re-measurement of an
asset after its recognition.
• The amendments in this Update provide guidance for the measurement of expected credit losses
for recognized financial assets and off-balance-sheet commitments.
• Following the Conceptual Framework, the measurements of credit losses for recognized financial
assets are reported in the income statement as an expense.
19

Guidance
Background Information and Basis for Conclusions(BC97):
• The Board decided that off-balance-sheet credit exposures not accounted for as insurance contracts are
within the scope of Subtopic 326-20. This includes financial guarantees and other similar instruments,
except for instruments within the scope of Topic 815 on derivatives and hedging.
• Topic 460 requires a liability to be initially recognized for the fair value of a guarantee liability, which is
applicable to both financial and nonfinancial guarantees.
• The Board concluded that the accounting for nonfinancial guarantees should not be affected by this
Update (that is, no bifurcation of the contingent and non-contingent aspects of a guarantee is
necessary). However, for financial guarantees within the scope of Subtopic 326-20, an entity must
account for expected credit losses in addition to and separately from the fair value of the guarantee.
• This approach is necessary to appropriately present expected credit losses on financial guarantees in
accordance with Subtopic 326-20 without affecting fee recognition, similar to unfunded loan
commitments.
20

Agenda
• Series Overview
• Guidance
• Instruction
• Example
• Measurement
• Net Advancement
• Net Curtailment
• Liability
21

Measurement
Allowance (Contra Asset) vs. Liability
• Funded portion = Allowance
• Unfunded = Liability
• 326-20-30-11; …the estimate of expected credit losses should consider the likelihood that funding will occur…
• 326-20-30-11 ; …the estimate of expected credit losses should consider an estimate of expected credit losses on
commitments expected to be funded over its estimated life.
22

Measurement
Allowance (Contra Asset) vs. Liability
• Funded portion = Allowance
• Determine average life of funded dollars for closed pool analysis
• Determine the rate at which the funded dollars curtail
• Straight-line or net periodic curtailment rate
• Unfunded = Liability
• Determine the likelihood that funding will occur (utilization rate)
• Net periodic advance rate compounded over the expected life
23

Date Exit Available Attrition Rate Annualized Expected Life
12/31/2011 150 1452 10.33% 35.35% 2.83
3/31/2012 146 1478 9.88% 34.03% 2.94
6/30/2012 152 1535 9.90% 34.10% 2.93
9/30/2012 183 1560 11.73% 39.29% 2.54
12/31/2012 152 1568 9.69% 33.49% 2.99
3/31/2013 173 1615 10.71% 36.44% 2.74
6/30/2013 180 1658 10.86% 36.85% 2.71
9/30/2013 160 1695 9.44% 32.74% 3.05
12/31/2013 186 1756 10.59% 36.10% 2.77
3/31/2014 204 1796 11.36% 38.26% 2.61
6/30/2014 179 1801 9.94% 34.21% 2.92
9/30/2014 149 1966 7.58% 27.04% 3.70
12/31/2014 175 2249 7.78% 27.68% 3.61
3/31/2015 238 2983 7.98% 28.29% 3.53
6/30/2015 239 3071 7.78% 27.68% 3.61
9/30/2015 310 3191 9.71% 33.55% 2.98
12/31/2015 252 3221 7.82% 27.81% 3.60
3/31/2016 241 3321 7.26% 26.02% 3.84
6/30/2016 268 3502 7.65% 27.27% 3.67
9/30/2016 296 3588 8.25% 29.14% 3.43
Grand Total 4033 45006 8.96% 31.31% 3.19
Measurement – C&I
24

Date Net Curtailment Annualized Estimated Life
12/31/2011 15.11% 48.07% 2.08
3/31/2012 18.04% 54.88% 1.82
6/30/2012 13.31% 43.51% 2.30
9/30/2012 14.71% 47.09% 2.12
12/31/2012 14.17% 45.73% 2.19
3/31/2013 14.04% 45.41% 2.20
6/30/2013 11.46% 38.55% 2.59
9/30/2013 11.20% 37.83% 2.64
12/31/2013 17.68% 54.07% 1.85
3/31/2014 14.48% 46.52% 2.15
6/30/2014 20.69% 60.43% 1.65
9/30/2014 14.87% 47.48% 2.11
12/31/2014 15.12% 48.10% 2.08
3/31/2015 13.30% 43.49% 2.30
6/30/2015 15.22% 48.34% 2.07
9/30/2015 17.84% 54.43% 1.84
12/31/2015 13.66% 44.42% 2.25
3/31/2016 13.15% 43.11% 2.32
6/30/2016 12.93% 42.53% 2.35
9/30/2016 12.86% 42.33% 2.36
Grand Total 14.67% 46.98% 2.13
Measurement – C&I
25

0
2
4
6
8
10
12
Average Life – C&I – Purpose
Measurement
26

0
2
4
6
8
10
12
Average Life – C&I – Purpose
Measurement
27

Date Exit Available Attrition Rate Annualized Expected Life
12/31/2011 60 975 6.15% 22.43% 4.46
3/31/2012 46 960 4.79% 17.83% 5.61
6/30/2012 87 1069 8.14% 28.79% 3.47
9/30/2012 91 1092 8.33% 29.39% 3.40
12/31/2012 78 1119 6.97% 25.10% 3.98
3/31/2013 114 1120 10.18% 34.91% 2.86
6/30/2013 101 1126 8.97% 31.33% 3.19
9/30/2013 93 1109 8.39% 29.56% 3.38
12/31/2013 77 1087 7.08% 25.46% 3.93
3/31/2014 87 1130 7.70% 27.42% 3.65
6/30/2014 66 1122 5.88% 21.53% 4.64
9/30/2014 315 1674 18.82% 56.56% 1.77
12/31/2014 255 1750 14.57% 46.74% 2.14
3/31/2015 374 1887 19.82% 58.67% 1.70
6/30/2015 347 1838 18.88% 56.70% 1.76
9/30/2015 335 1847 18.14% 55.09% 1.82
12/31/2015 317 1900 16.68% 51.82% 1.93
3/31/2016 378 1957 19.32% 57.62% 1.74
6/30/2016 360 1967 18.30% 55.45% 1.80
9/30/2016 406 1974 20.57% 60.19% 1.66
Grand Total 3987 28703 13.89% 45.02% 2.22
Measurement – C&D
28

Date Net Curtailment Annualized Expected Life
12/31/2011 10.50% 35.82% 2.79
3/31/2012 4.70% 17.52% 5.71
6/30/2012 10.97% 37.19% 2.69
9/30/2012 12.45% 41.25% 2.42
12/31/2012 10.18% 34.91% 2.86
3/31/2013 16.66% 51.75% 1.93
6/30/2013 12.67% 41.83% 2.39
9/30/2013 10.90% 36.98% 2.70
12/31/2013 6.32% 22.98% 4.35
3/31/2014 14.49% 46.54% 2.15
6/30/2014 20.73% 60.51% 1.65
9/30/2014 15.56% 49.17% 2.03
12/31/2014 11.09% 37.51% 2.67
3/31/2015 17.05% 52.66% 1.90
6/30/2015 12.67% 41.83% 2.39
9/30/2015 11.65% 39.06% 2.56
12/31/2015 13.22% 43.28% 2.31
3/31/2016 14.83% 47.39% 2.11
6/30/2016 12.45% 41.26% 2.42
9/30/2016 14.48% 46.50% 2.15
Grand Total 12.93% 42.52% 2.35
Measurement – C&D
29

0
0.5
1
1.5
2
2.5
Average Life – C&D - Purpose
Measurement
30

0
0.5
1
1.5
2
2.5
Average Life – C&D - Purpose
Measurement
31

Date Net Curtailment % Net Advancement % Curtailment Annualized Advancement Annualized Lifetime Advancement %
12/31/2011 6.92% -4.81% 24.94% -20.66% -75.68%
3/31/2012 8.98% -3.30% 31.37% -13.87% -47.66%
6/30/2012 10.13% -4.95% 34.76% -21.34% -78.65%
9/30/2012 7.56% -3.87% 26.97% -16.40% -57.70%
12/31/2012 7.49% -3.56% 26.77% -15.02% -52.16%
3/31/2013 7.68% -2.82% 27.36% -11.76% -39.61%
6/30/2013 7.52% -2.33% 26.87% -9.67% -31.90%
9/30/2013 7.09% -5.22% 25.50% -22.57% -84.15%
12/31/2013 7.96% -4.05% 28.23% -17.20% -61.00%
3/31/2014 9.14% -3.47% 31.84% -14.60% -50.50%
6/30/2014 5.46% -6.99% 20.10% -31.05% -125.07%
9/30/2014 4.89% -1.02% 18.16% -4.16% -12.99%
12/31/2014 7.59% -0.94% 27.08% -3.82% -11.91%
3/31/2015 8.03% -1.21% 28.45% -4.95% -15.59%
6/30/2015 8.81% -0.87% 30.85% -3.52% -10.94%
9/30/2015 14.64% -1.16% 46.92% -4.73% -14.86%
12/31/2015 9.38% -0.51% 32.58% -2.07% -6.35%
3/31/2016 10.83% -1.75% 36.78% -7.19% -23.15%
6/30/2016 8.18% -1.68% 28.91% -6.88% -22.08%
9/30/2016 8.03% -4.19% 28.44% -17.84% -63.65%
Grand Total 8.35% -2.88% 29.43% -12.02% -40.58%
Measurement – C&I
32

Date Net Curtailment % Net Advancement % Curtailment Annualized Advancement Annualized Lifetime Advancement %
12/31/2011 2.56% -1.26% 9.87% -5.15% -13.38%
3/31/2012 1.72% -2.51% 6.71% -10.43% -28.14%
6/30/2012 1.43% -2.52% 5.59% -10.48% -28.30%
9/30/2012 2.37% -4.74% 9.14% -20.34% -58.86%
12/31/2012 2.34% -5.86% 9.03% -25.60% -76.78%
3/31/2013 2.81% -3.25% 10.76% -13.63% -37.64%
6/30/2013 3.58% -3.58% 13.56% -15.13% -42.22%
9/30/2013 6.11% -3.34% 22.30% -14.05% -38.92%
12/31/2013 3.68% -4.11% 13.94% -17.49% -49.61%
3/31/2014 2.48% -2.21% 9.56% -9.12% -24.38%
6/30/2014 2.66% -2.94% 10.21% -12.30% -33.65%
9/30/2014 2.06% -1.10% 7.99% -4.47% -11.56%
12/31/2014 1.57% -2.32% 6.14% -9.60% -25.75%
3/31/2015 2.29% -1.34% 8.87% -5.48% -14.27%
6/30/2015 2.69% -2.17% 10.34% -8.95% -23.89%
9/30/2015 3.95% -1.52% 14.90% -6.22% -16.29%
12/31/2015 2.64% -1.83% 10.14% -7.50% -19.82%
3/31/2016 2.14% -2.07% 8.28% -8.54% -22.73%
6/30/2016 2.20% -2.69% 8.50% -11.21% -30.41%
9/30/2016 2.88% -2.61% 11.04% -10.86% -29.40%
Grand Total 2.72% -2.73% 10.44% -11.35% -30.85%
Measurement – C&D
33

Measurement
34
Segmentation Commitment Utilization Rate Expected Utilization Lifetime Loss % Unfunded Liability Unfunded Liability %
C&I 25,310,222 -40.58% 10,269,964.10 0.75% 77,024.73 0.30%
C&D 186,393,058 -30.85% 57,495,845.89 0.63% 362,223.83 0.19%

Summary
35
• Estimate off-balance-sheet credit losses over the contractual period - (Topic 326-20-30-11)
• Estimates should consider the likelihood that funding will occur - (Topic 326-20-30-11)
• Estimates should consider the aggregate amount that will fund over the life of the contract - (Topic
326-20-30-11)
• Off-balance-sheet credit loss estimates should be recorded as a liability - (Topic 326-20-30-11)
• Off-balance-sheet credit loss estimates should be updated each reporting period - (Topic 326-20-
35-3)
• Entities should report in net income the amount necessary to adjust the liability for off-balance-
sheet credit losses - (Topic 326-20-35-3)
• An estimate of off-balance-sheet risk shall be recorded separate from the allowance for credit
losses related to a recognized financial instrument - (Topic 326-20-35-3)

Summary (Continued)
36
• Inherent in the guidance is the requirement to bifurcate recognized financial instruments from off-
balance-sheet exposure; model expected losses accordingly – (Background Information and Basis
for Conclusions(BC10))
• There are multiple ways to estimate the likelihood of funding; the standard is non-prescriptive
• There are multiple ways to estimate the contractual life of recognized financial assets
• Note that there is value in taking a number of approaches
• Attempt to maintain symmetry between off-balance-sheet and recognized assets
• Not necessary to determine a liability for unfunded commitments where the contractual language
states that the obligation is unconditionally cancellable by the issuer.

Transition Planning and Execution
37

CECL Methodology Series for Off-Balance-Sheet Credit Exposures

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