CECL - The Relationship Between Credit and Finance

CECL - Credit & FinanceENSURING YOUR CECL MODEL BENEFITS LENDING,

CREDIT, ACCOUNTING AND F INANCE

October 19 · 2017

Disclaimer

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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.

About Sageworks

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CECL - Credit & Finance

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AGENDA

• CECL Paradigm: Governing thought pattern that maximizes success for all stakeholders

» What, When, How to execute

• Cross Application: Leverage CECL models and model results for more than journal entries

» Quantify value

• Evaluation: The observed performance of underlying assets can provide meaningful managerial insight

» Quantify experience

• Summary: The relationship between CECL, valuation, and evaluation


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AGENDA

• CECL Paradigm: Governing thought pattern that maximizes success for all stakeholders



» Quantify value




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• Link to FASB

http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176168232528&acceptedDisclaimer=true

CECL Paradigm – Why

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FASB – ASU 2016 -13

Example balance sheet (assets) contains long-term instruments in the form of loans and leases.

“An entity shall estimate expected credit losses over the contractual term of the financial asset(s)”

“When developing an estimate of expected credit losses on financial asset(s), an entity shall consider available information relevant to assessing the collectability of cash flows”

• Link to FASB

http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB/Document_C/DocumentPage&cid=1176160587925

CECL Paradigm – Why

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KEY QUESTIONS

Flexibility, methodology comparisons, volatility, and cross-application are key considerations for implementation.

Will the first attempt be the final model?

Will the industry evolve in it’s interpretation and application?

Will other stakeholders within the institution leverage the analytical outputs for managerial purposes?

CECL Paradigm

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What When How

CECL Paradigm

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What specific objectives need to be accomplished

When How

CECL Paradigm

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When does each objective need to be accomplished

How

CECL Paradigm

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When does each objective need to be accomplished

How will each objective be accomplished

CECL Paradigm – What

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Data – Adequacy, Accuracy, Availability


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Historical Performance – Life, Loss, Methodology


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Historical Performance – Life, Loss, Methodology

Forecasting – Impact to Life, Loss, and Methodology

CECL Paradigm – What/When

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Data – Adequacy, Accuracy, Availability/LATE

Historical Performance – Life, Loss, Methodology/NOW/2018

Forecasting – Impact to Life, Loss, and Methodology/2019/20

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2 0 1 8 Q 1 Q 2 Q 4 2 0 1 9 Q 2 Q 3 Q 4 2 0 2 0 2 0 2 1

2 0 1 8 • Data assurance is complete/remediation started• Methodology/Segmentation comparisons• Forecasting exploration

• Formal/documented parallel calculations• Disclosure preparation• Processes, procedures, and control documentation

2 0 1 9

• SEC filers go-live/record journal entries• Non-SEC filers common size comparisons with analogous SEC filers

2 0 2 0


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2 0 1 8 Q 1 Q 2 Q 4 2 0 1 9 Q 2 Q 3 Q 4 2 0 2 0 2 0 2 1



2 0 1 9


2 0 2 0


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2 0 1 8 Q 1 Q 2 Q 4 2 0 1 9 Q 2 Q 3 Q 4 2 0 2 0 2 0 2 1



2 0 1 9


2 0 2 0


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2 0 1 8 Q 1 Q 2 Q 4 2 0 1 9 Q 2 Q 3 Q 4 2 0 2 0 2 0 2 1



2 0 1 9


2 0 2 0


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Poll Question

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CECL Transition - Example

Continued >>

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CECL Transition - Example

<< Continued


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AGENDA

CECL Paradigm: Governing thought pattern that maximizes success for all stakeholders



» Quantify value





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AGENDA




» Quantify value




Loan Valuation – Why

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FASB – DECEMBER 20 , 2012

Example balance sheet (assets) contains long-term instruments in the form of loans and leases.

“The CECL model uses a single expected credit loss measurement objective for the allowance for credit loss. Under this model, the allowance for expected credit losses would reflect management’s current estimate of the contractual cash flows that the company does not expect to collect, based on its assessment of credit risk as of the reporting date.”

• Link to FASB

http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB/Document_C/DocumentPage&cid=1176160587925


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WHO OWNS THE PROCESS NOW?


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WHO WILL OWN THE NEW PROCESS?


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CROSS -FUNCTIONAL OPPORTUNIT IES

• Credit Risk Evaluation: Leverage risk-level history for underwriting/pricing considerations

» Are better rated credits experiencing better default and loss performance

• Risk Rating Testing: Do risk ratings correlate to risk and are risk ratings being updated

» Do loans move to loss from pass quickly and are loans migrating or stagnant

• ALM: Prepayment speed and/or life assumption confirmation and/or testing

» Ensure symmetry or explain asymmetry

• Stress Testing: Some CECL methodologies align with stress testing exercises

» What happens to the loan portfolio under defined economic conditions

• Fair Value: Some CECL methodologies align with fair value exercises

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• Link to FASB

http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176167762170&acceptedDisclaimer=true

Loan Valuation/Fair Value/Exit Price

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What When How


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What are the purposes of loan valuations

When How


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When are loan valuations required

How


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When are loan valuations required

How are loan valuations executed

Loan Valuation – What is the Purpose

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Classification and Measurement – ASU 2016-1 (PBE/SEC)


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Fair Value – How market participants value the loan portfolio


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Profitability – Lifetime profitability not next year’s net income


Fair Value – How market participants value the loan portfolio

Loan Valuation – When

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Profitability – Whenever earnings are of interest

Classification and Measurement – Q1 2018 PBE and SEC filers

Fair Value – “As of” an acquisition, merger or asset purchase

Period Balance Principal Interest Payment Prepayment Defaults Estimated Loss Cash Flow NPV

1 200,511 1,228 769 1,996 2,478 422 63 4,474 4,457

2 196,383 1,103 749 1,852 2,427 414 62 4,279 4,246

3 192,439 1,229 738 1,966 2,376 405 61 4,343 4,293

4 188,429 1,097 718 1,815 2,327 397 60 4,142 4,078

5 184,608 1,143 707 1,851 2,277 389 58 4,128 4,048

6 180,798 1,147 693 1,839 2,229 381 57 4,068 3,974

7 177,042 1,125 674 1,799 2,181 373 56 3,980 3,873

8 173,363 1,247 664 1,911 2,133 365 55 4,044 3,920

9 169,618 1,388 646 2,033 2,086 357 54 4,120 3,979

10 165,787 1,197 635 1,832 2,040 349 52 3,872 3,724

11 … … … … … … … … …

Loan Valuation – How

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DISCOUNTED CASH FLOW – CECLAggregated loan-level - presented in 000’s


1 200,511 1,228 769 1,996 2,478 422 63 4,474 4,457

2 196,383 1,103 749 1,852 2,427 414 62 4,279 4,246

3 192,439 1,229 738 1,966 2,376 405 61 4,343 4,293

4 188,429 1,097 718 1,815 2,327 397 60 4,142 4,078

5 184,608 1,143 707 1,851 2,277 389 58 4,128 4,048

6 180,798 1,147 693 1,839 2,229 381 57 4,068 3,974

7 177,042 1,125 674 1,799 2,181 373 56 3,980 3,873

8 173,363 1,247 664 1,911 2,133 365 55 4,044 3,920

9 169,618 1,388 646 2,033 2,086 357 54 4,120 3,979

10 165,787 1,197 635 1,832 2,040 349 52 3,872 3,724

11 … … … … … … … … …


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1 200,511 1,228 769 1,996 2,478 422 63 4,474 4,457

2 196,383 1,103 749 1,852 2,427 414 62 4,279 4,246

3 192,439 1,229 738 1,966 2,376 405 61 4,343 4,293

4 188,429 1,097 718 1,815 2,327 397 60 4,142 4,078

5 184,608 1,143 707 1,851 2,277 389 58 4,128 4,048

6 180,798 1,147 693 1,839 2,229 381 57 4,068 3,974

7 177,042 1,125 674 1,799 2,181 373 56 3,980 3,873

8 173,363 1,247 664 1,911 2,133 365 55 4,044 3,920

9 169,618 1,388 646 2,033 2,086 357 54 4,120 3,979

10 165,787 1,197 635 1,832 2,040 349 52 3,872 3,724

11 … … … … … … … … …


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1 200,511 1,228 769 1,996 2,478 422 63 4,474 4,457

2 196,383 1,103 749 1,852 2,427 414 62 4,279 4,246

3 192,439 1,229 738 1,966 2,376 405 61 4,343 4,293

4 188,429 1,097 718 1,815 2,327 397 60 4,142 4,078

5 184,608 1,143 707 1,851 2,277 389 58 4,128 4,048

6 180,798 1,147 693 1,839 2,229 381 57 4,068 3,974

7 177,042 1,125 674 1,799 2,181 373 56 3,980 3,873

8 173,363 1,247 664 1,911 2,133 365 55 4,044 3,920

9 169,618 1,388 646 2,033 2,086 357 54 4,120 3,979

10 165,787 1,197 635 1,832 2,040 349 52 3,872 3,724

11 … … … … … … … … …


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1 200,511 1,228 769 1,996 2,478 422 63 4,474 4,457

2 196,383 1,103 749 1,852 2,427 414 62 4,279 4,246

3 192,439 1,229 738 1,966 2,376 405 61 4,343 4,293

4 188,429 1,097 718 1,815 2,327 397 60 4,142 4,078

5 184,608 1,143 707 1,851 2,277 389 58 4,128 4,048

6 180,798 1,147 693 1,839 2,229 381 57 4,068 3,974

7 177,042 1,125 674 1,799 2,181 373 56 3,980 3,873

8 173,363 1,247 664 1,911 2,133 365 55 4,044 3,920

9 169,618 1,388 646 2,033 2,086 357 54 4,120 3,979

10 165,787 1,197 635 1,832 2,040 349 52 3,872 3,724

11 … … … … … … … … …


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Period Balance Cash Flow NPV

1 200,511 4,474 4,457

2 196,383 4,279 4,246

3 192,439 4,343 4,293

4 188,429 4,142 4,078

5 184,608 4,128 4,048

6 180,798 4,068 3,974

7 177,042 3,980 3,873

8 173,363 4,044 3,920

9 169,618 4,120 3,979

10 165,787 3,872 3,724

11 … … …

Aggregate NPV of projected cash flow (effective yield discount rate) relative to book balance/amortized cost basis.


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1 200,511 4,474 4,457

2 196,383 4,279 4,246

3 192,439 4,343 4,293

4 188,429 4,142 4,078

5 184,608 4,128 4,048

6 180,798 4,068 3,974

7 177,042 3,980 3,873

8 173,363 4,044 3,920

9 169,618 4,120 3,979

10 165,787 3,872 3,724

11 … … …

Aggregate NPV of projected cash flow (effective yield discount rate) relative to book balance/amortized cost basis.


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DISCOUNTED CASH FLOW – VALUATION “LEVEL 3” INPUTSAggregated loan-level - presented in 000’s


1 200,511 1,228 769 1,996 2,478 422 63 4,474 4,457

2 196,383 1,103 749 1,852 2,427 414 62 4,279 4,245

3 192,439 1,229 738 1,966 2,376 405 61 4,343 4,292

4 188,429 1,097 718 1,815 2,327 397 60 4,142 4,077

5 184,608 1,143 707 1,851 2,277 389 58 4,128 4,047

6 180,798 1,147 693 1,839 2,229 381 57 4,068 3,973

7 177,042 1,125 674 1,799 2,181 373 56 3,980 3,871

8 173,363 1,247 664 1,911 2,133 365 55 4,044 3,918

9 169,618 1,388 646 2,033 2,086 357 54 4,120 3,976

10 165,787 1,197 635 1,832 2,040 349 52 3,872 3,722

11 … … … … … … … … …


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1 200,511 4,474 4,457

2 196,383 4,279 4,245

3 192,439 4,343 4,292

4 188,429 4,142 4,077

5 184,608 4,128 4,047

6 180,798 4,068 3,973

7 177,042 3,980 3,871

8 173,363 4,044 3,918

9 169,618 4,120 3,976

10 165,787 3,872 3,722

11 … … …

Aggregate NPV of projected cash flow (effective yield discount rate vs. fair value discount rate).

Period Balance Cash Flow NPV Discount

Total 200,511 225,705 196,619 1.94%

Period Balance Cash Flow NPV ALLL

Total 200,511 225,705 197,931 1.29%

Period Balance Cash Flow NPV Variance

Total 200,511 225,705 -1,312 -.65%


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1 200,511 4,474 4,457

2 196,383 4,279 4,245

3 192,439 4,343 4,292

4 188,429 4,142 4,077

5 184,608 4,128 4,047

6 180,798 4,068 3,973

7 177,042 3,980 3,871

8 173,363 4,044 3,918

9 169,618 4,120 3,976

10 165,787 3,872 3,722

11 … … …


Total 200,511 225,705 196,619 1.94%


Total 200,511 225,705 197,931 1.29%

Period Balance Cash Flow NPV Variance

Total 200,511 225,705 -1,312 -.65%

Aggregate NPV of projected cash flow (effective yield discount rate vs. fair value discount rate).


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DISCOUNTED CASH FLOW – L IFET IME PROFITABIL ITYAggregated loan-level - presented in 000’s


1 200,511 1,228 769 1,996 2,478 422 63 4,474 4,459

2 196,383 1,103 749 1,852 2,427 414 62 4,279 4,249

3 192,439 1,229 738 1,966 2,376 405 61 4,343 4,298

4 188,429 1,097 718 1,815 2,327 397 60 4,142 4,085

5 184,608 1,143 707 1,851 2,277 389 58 4,128 4,057

6 180,798 1,147 693 1,839 2,229 381 57 4,068 3,985

7 177,042 1,125 674 1,799 2,181 373 56 3,980 3,885

8 173,363 1,247 664 1,911 2,133 365 55 4,044 3,934

9 169,618 1,388 646 2,033 2,086 357 54 4,120 3,994

10 165,787 1,197 635 1,832 2,040 349 52 3,872 3,740

11 … … … … … … … … …


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1 200,511 4,474 4,459

2 196,383 4,279 4,249

3 192,439 4,343 4,298

4 188,429 4,142 4,085

5 184,608 4,128 4,057

6 180,798 4,068 3,985

7 177,042 3,980 3,885

8 173,363 4,044 3,934

9 169,618 4,120 3,994

10 165,787 3,872 3,740

11 … … …


Total 200,511 225,705 196,619 1.94%


Total 200,511 225,705 197,931 1.29%

Period Balance Cash Flow NPV +/- bps

Total 200,511 225,705 199,922 -0.29%

Aggregate NPV of projected cash flow (effective yield discount rate vs. fair value discount rate vs. profitability & cost build-up discount rate).


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1 200,511 4,474 4,459

2 196,383 4,279 4,249

3 192,439 4,343 4,298

4 188,429 4,142 4,085

5 184,608 4,128 4,057

6 180,798 4,068 3,985

7 177,042 3,980 3,885

8 173,363 4,044 3,934

9 169,618 4,120 3,994

10 165,787 3,872 3,740

11 … … …


Total 200,511 225,705 196,619 1.94%


Total 200,511 225,705 197,931 1.29%

Period Balance Cash Flow NPV +/- bps

Total 200,511 225,705 199,922 -0.29%

Aggregate NPV of projected cash flow (effective yield discount rate vs. fair value discount rate vs. profitability & cost build-up discount rate).


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AGENDA



Cross Application: Leverage CECL models and model results for more than journal entries

» Quantify value





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AGENDA



Cross Application: Leverage CECL models and model results for more than journal entries

» Quantify value




Loan Evaluation

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What When How

Loan Evaluation

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What PD, LGD, migration, cumulative loss, average life, etc.

When How

Loan Evaluation

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When Often –observe changes in levels and trends

How

Loan Evaluation

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When Often –observe changes in levels and trends

How Proper CECL models will allow for a variety of independent evaluations

Loan Evaluation – What/How

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Period Start Date Risk Rating Loss Rate

6/30/2011 4 1.48%

9/30/2011 4 1.09%

12/31/2011 4 .95%

3/31/2012 4 .72%

6/30/2012 4 .67%

9/30/2012 4 .63%

… … …

MIGRATION – 3 YEAR LOSS %

Weighted average 3-year loss rate observations summarized within Sageworks’ ALLL solution.

0.00% 2.00% 4.00% 6.00% 8.00% 10.00%

7

6

5

4

3

2

3-Year Loss Experience

Ris

k R

ati

ng

Loan Evaluation

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0%

2%

4%

6%

8%

10%

12%

0.5 1.0 2.0 3.0 4.0

Lo

ss E

xper

ien

ce

Duration

2 3 4 5 6 7

0%

2%

4%

6%

8%

10%

12%

0.5 1.0 2.0 3.0 4.0

Lo

ss E

xper

ien

ce

Duration

2 3 4 5 6 7

Loan Evaluation

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Loan Evaluation

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-2%

0%

2%

4%

6%

8%

10%

12%

0.5 1.0 2.0 3.0 4.0

Lo

ss E

xper

ien

ce

Duration

Risk Rating - 1 2 3 4 5 6 7 8 9 Exit

- 100% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

1 0% 100% 0% 0% 0% 0% 0% 0% 0% 0% 30%

2 0% 0% 93% 5% 2% 0% 0% 0% 0% 0% 10%

3 0% 0% 0% 99% 0% 0% 0% 0% 0% 0% 14%

4 0% 0% 0% 3% 94% 2% 1% 1% 0% 0% 15%

5 0% 0% 0% 19% 8% 48% 12% 13% 0% 0% 21%

6 0% 0% 0% 11% 16% 17% 37% 20% 0% 0% 24%

7 0% 0% 0% 4% 0% 1% 6% 89% 0% 0% 38%

8 0% 0% 0% 0% 0% 0% 0% 0% 100% 0% 100%


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MIGRATION – ANNUAL CHANGE Summary of loan migration – the percentage of all loans’ ending Risk Rating relative to their beginning Risk Rating

Risk Rating - 1 2 3 4 5 6 7 8 9 Exit

- 100% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

1 0% 100% 0% 0% 0% 0% 0% 0% 0% 0% 30%

2 0% 0% 93% 5% 2% 0% 0% 0% 0% 0% 10%

3 0% 0% 0% 99% 0% 0% 0% 0% 0% 0% 14%

4 0% 0% 0% 3% 94% 2% 1% 1% 0% 0% 15%

5 0% 0% 0% 19% 8% 48% 12% 13% 0% 0% 21%

6 0% 0% 0% 11% 16% 17% 37% 20% 0% 0% 24%

7 0% 0% 0% 4% 0% 1% 6% 89% 0% 0% 38%

8 0% 0% 0% 0% 0% 0% 0% 0% 100% 0% 100%


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MIGRATION – ANNUAL CHANGE Summary of loan migration – the percentage of all loans’ ending Risk Rating relative to their beginning Risk Rating


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PD/LGD – 3 YEAR

3-year probability of default trend observed within Sageworks’ ALLL solution.

Risk Rating PD x LGD

0 .90%

2 1.52%

3 .61%

4 1.22%

5 1.75%

6 3.58%

7 9.62%


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PD/LGD – 3 YEAR

Risk Rating PD x LGD

0 .90%

2 1.52%

3 .61%

4 1.22%

5 1.75%

6 3.58%

7 9.62%

3-year loss given default trend observed within Sageworks’ ALLL solution.


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PD/LGD/DCF/FORECAST

Probability of default expectation based on forecasted current and future conditions

Aggregate NPV of projected cash flow relative to book balance/amortized cost basis.


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AGENDA



Valuation: The economic worth of our institutions and underlying assets

» Quantify value

Evaluation: The observed performance of underlying assets can provide meaningful managerial insight




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CECL – Ensure that your process benefits the organization


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Valuation – Understand the value of each loan in our portfolio


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Evaluation – Understand the performance of our loan portfolio


Valuation – Understand the value of each loan in our portfolio

Economy & Finance

CECL - The Relationship Between Credit and Finance