USING SCENARIO BUILDING

FOR YOUR ALLL

Rob AshbaughSr. Risk Management Consultant

Sageworks

June 23, 2015

PRESENTED BY

AND HOW IT HELPS YOU PREPARE

FOR FASB’S CECL MODEL

Questions

+ A copy of the slides and webinar recording will be emailed to you following the

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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

+ Awards

+ Named to Inc. 500 list of fastest growing privately held companies in the U.S.

+ Named to Deloitte’s Technology Fast 500

+ NC Tech Awards: Excellence in Customer Service

Today’s Speaker

Rob AshbaughSr. Risk Management Consultant

Rob has more than twenty years of capital

markets and commercial banking experience as

both a portfolio manager and risk manager, with a

primary focus on mortgage-backed securities and

commercial loans. Among his responsibilities

were monthly ALLL calculations, institutional and

concentration stress testing, and risk analytics.

He is a past holder of the Series 7, 52 and 63

licenses.

Agenda

+ Proactive Risk Management

+ Introduction to Scenario Building

+ Where to Use It

+ Challenges

+ How to Get Started

Risk Management Maturity Model

Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer

ALLL Maturity Model

Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer

Introduction

+ Scenario building: assess the outcome of the ALLL under various

assumptions or “scenarios”

+ Create projections

+ Run multiple scenarios at once, compare results

+ Estimate the impact that ALLL-calculation variables may have without

performing a completely new calculation

+ Similar to stress testing

Introduction (cont’d)

+ 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

Where to Use Scenario Building

+ Tactical planning for the quarterly (or monthly) provision

+ Altering look-back period

+ Changing loss methodologies

+ Capital planning for the FASB’s CECL model

+ Other areas?

Provision Expense Planning

+ Typical calculation process:

+ Complex

+ Time-consuming

+ Rushed

+ Little time for planning or analysis

+ Optimizing the process – ability to perform what-if scenarios in advance to

forecast an expected provision expense

+ Have an expected provision range pre-determined before the end of the

quarter (or month)

Provision Expense Planning - Benefits

+ Plan for changes

+ Prove your institution is proactive with risk management efforts

+ Leverage capital efficiently

Altering Look-Back Period

+ Analyze the impact of using different look-back periods

+ Ex: four quarters vs. eight quarters

Altering Look-Back Period – Other Ways

+ Change length of period

+ Use different time periods

+ Annual, quarterly, monthly loss rates – ex: 2-year vs. 24-month look-back

period

+ Weight certain periods

+ Ex:12 quarters may be most appropriate, but recent quarters may be

more indicative of the current economy

+ Weight most recent 4 quarters at 40%, remaining 8 at 60%

Changing Loss Methodologies

+ Scenario building allows for estimation of the impact of the change in loss

methodologies

+ Ex: Historical loss to migration analysis

+ The results could lead to one of these conclusions:

+ Negligible difference, and change could occur immediately

+ Sizable difference, wait until year-end to make the change

+ Large difference, wait for buy-in from examiners before changing

Changing Loss Methodologies - Example

Qualitative Factors

+ Can create scenarios based on changes to qualitative factors to reflect

their perception of the impact of:

+ New products / markets

+ Economic forecasts

+ Staffing changes – personnel or expertise

+ Changing regulations / underwriting guidelines

+ Changes in competition

+ Changes in CRE or other product concentrations

+ Scenario building allows you to see the impact of changing one or more

of these factors

Challenges of Scenario Building

+ Data management

+ Availability

+ Accessibility

+ Flexibility

+ Implementing

+ Does it create more work?

How to Get Started

+ Collect loan-level detail

+ Store and archive month-end loan files

+ Ensure easy access to data for reporting

+ Determine which variables to test

+ Consider automated scenario building solution

Capital Planning for CECL

+ Will require institutions to consider expected rather than incurred losses

+ Likely to expand the loss horizons institutions use for estimating

allowances for non-impaired loans

+ Likely to cause the allowance for non-impaired assets to rise from current

levels

+ One-time capital adjustment once guidance is effective

Capital Planning for CECL

Recent Developments

+ Basel releases “Guidance on accounting

for expected credit losses” – Feb. 2015

+ What is Basel?

+ “The objective of this paper is to set out

supervisory requirements on sound credit

risk practices associated with the

implementation and ongoing application

of expected credit loss (ECL) accounting

models.”

Recent Developments

+ “In addition to historical information and current conditions, forward-looking

information and macroeconomic factors are also critical when estimating future

cash shortfalls.”

+ “An institution should demonstrate and document how ECL estimates would fluctuate

with changes in scenarios…scenarios may be internally developed or, for less

sophisticated institutions, may be vendor-defined…Robust methodologies and

parameters should consider different potential scenarios and not rely purely on

subjective, biased or overly optimistic considerations.”

+ “Backtesting should be performed to ensure that appropriate factors are

considered and incorporated, in light of historical experience.”

+ “Methodologies for the determination of the cash flow shortfalls may start with simple

averages of an institution’s net loss experience on loans with shared credit risk

characteristics over a relevant credit cycle, progressing to more complex techniques,

such as migration analysis or models that estimate ECL.”

Timeframe for CECL

+ CECL expected to be issued in 2015

+ Final CECL model to be substantially the same to exposure draft of 2012

+ Take effect January 1, 2018?

+ IASB’s IFRS 9 Financial Instruments July 24, 2014

Preparing for CECL

+ Proactively review processes, methods and balances now to assess

flexibility to account for changes

+ Scenario building could show the institution’s worst-case scenario and

help answer questions like:

+ If I needed to adjust my reserve by +50 percent, do I have sufficient capital?

+ If the new model requires a 20 percent increase to the ALLL, how does that

affect my Tier 1 ratio?

+ How much of an increase to the ALLL can my bank handle without having

capital adequacy issues?

2015 Risk Management Summit

+ September 23-25 in Chicago

+ ALLL & Stress Testing, Peer Roundtables

+ Banker Appreciation Night on Lake Michigan

+ Early bird rate ends June 30

+ sageworks.com/summit

Todd Sprang

Principal

CliftonLarsonAllen

Ariste Reno

Partner

KPMG

John Behringer

Partner

McGladrey

Graham Dyer

Senior Manager

Grant Thornton

Contact Information & Additional Resources

Rob AshbaughSr. Risk Management Consultant

robert.ashbaugh@sageworks.com

866.603.7029

LinkedIn Groups+ ALLL Forum for Bankers

+ Commercial Credit Risk Professionals

Websites+ www.sageworksanalyst.com

+ www.ALLL.com

CECL Webinar+ Following release of guidance

+ web.sageworks.com/CECL/