Current Expected Credit Loss ModelCurrent Expected Credit Loss Model(“CECL”)

The Bonadio GroupNo ember 21 2013November 21, 2013

1

Topics CoveredTopics Covered

• Proposed standardDi t d h fl l th t t t d d• Discounted cash flow example that meets standard

• Input assumptions – prepayment, default, and loss severityseverity

2

FASB Proposed Accounting Standards Update (ASU)FASB Proposed Accounting Standards Update (ASU)• Issued on December 20, 2012• Will significantly change the allowance for loan and g y g

lease losses and other approaches to impairment• Newly created subtopic “Financial Instruments: Credit

Losses (Subtopic 825-15)”

FASB FAQFASB FAQ• Issued on March 25, 2013

3

Three versions:Three versions:• Original May 2010 proposal• FASB and IASB Supplementary Document “Accounting pp y g

for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging A ti iti I i t” i d J 31 2011Activities – Impairment” issued on Jan 31, 2011

• “Three bucket approach” developed jointly with IASBU S stakeholders raised a number of questions primarily– U.S. stakeholders raised a number of questions primarily related to migration

4

fNot just the Allowance for Loan and Lease Losses

I t t Cl ifi tiInstrument Classification– Applies to all financial assets not classified at Fair Value

5

Instrument TypeInstrument Type• All financial assets - - debt instruments, leases, and

loan commitments– The term “debt instrument” is defined in the proposal as “a

receivable or payable that represents a contractual right to receive cash (or other consideration) or a contractual obligationreceive cash (or other consideration) or a contractual obligation to pay cash (or other consideration) on fixed or determinable dates, whether or not there is any stated provision for interest.”Covers loans debt securities trace receivables reinsurance– Covers loans, debt securities, trace receivables, reinsurance receivables, lease receivables, and loan commitments

6

Amortized cost should be based on the present valueAmortized cost should be based on the present value of the cash flows an entity expects to collect

• Cash flows are adjusted for expected prepayments and defaults

• Cash flows expected to be collected are discounted at th ff ti i t t tthe effective interest rate

• Cash flows not expected to be collected are also discounted at the effective interest ratediscounted at the effective interest rate

7

Why the Change?Why the Change?• GAAP did not properly reflect risk pre-financial crisis

because of the delayed recognition of credit losses –Financial Crisis Advisory Group– 362 comment letters – investors generally in favor of CECL

and preparers generally notand preparers generally not

• Departs from the incurred loss model which means the probable threshold is removedprobable threshold is removed– Removes the prohibition on recording day one losses

8

Measuring Expected Credit LossesMeasuring Expected Credit Losses• Begin with historical loss rates for similar assets

(grouped approach)– Static pool for example

• Adjust for current conditions• Adjust for reasonable and supportable forecasts• Life of loan estimate - can assume economic conditions

after the end of the reasonable forecast time periodafter the end of the reasonable forecast time period remain the same or can revert to historical loss rates

9

Technical ConsiderationsTechnical Considerations

• Permits allowance calculation to be based on methods which “implicitly” include the time value of moneywhich implicitly include the time value of money– DCF explicitly considers time value of money– Loss-rate, roll-rates, probability of default methods and p y

provision matrices implicitly consider• Contemplates use of mean and not mode if using

statistical modelingstatistical modeling

10

For Purchased Credit-Impaired (PCI) financial assetsFor Purchased Credit Impaired (PCI) financial assets• Amortized cost would be the purchase price plus the

associated expected credit loss at acquisition. The diff b t ti d t d th tdifference between amortized cost and the par amount (noncredit discount or premium) is amortized or accreted into income

• The credit discount is not accreted - establish a day one allowance instead

• Permits increases in expected cash flows to be recognized immediately – significant shift from current GAAP

11

Proposed TDR guidance is largely unchangedProposed TDR guidance is largely unchanged• Use the modified contractual cash flows, discounted at

the original effective interest rate

• Difference would be recorded by a basis adjustment rather than an allowancerather than an allowance

12

No more “other than temporary impairment” (OTTI)No more other than temporary impairment (OTTI) model for debt securities

• Change from individual security evaluation to include pool evaluations

• Record an allowance instead of direct write-off (allows the opportunity for reversal)opportunity for reversal)

• For assets carried at FV/OCI, there is a practical expedient available. Credit losses do not have to be recognized if both:– Fair value equals or exceeds the amortized cost (which is the

first step in the existing OTTI model); and– Expected credit losses on the asset are insignificantExpected credit losses on the asset are insignificant

13

Redefines collateral dependent in the glossaryRedefines collateral dependent in the glossary• “A financial asset for which the repayment is expected

to be provided primarily or substantially through the operation (by the lender) or sale of the collateral, based on an entity’s assessment as of the reporting date.”Cl ifi th t ti i b th l d d th• Clarifies that operation is by the lender and removes the word “solely”

Defines nonaccrual, cost-recovery and cash-basis methods, write-off (charge-off)

14

Industry Approach to Valuation of Fixed IncomeIndustry Approach to Valuation of Fixed Income Investments

Key Valuation Inputs:

• Conditional Repayment Rate (CRR)• Conditional Default Rate (CDR)Conditional Default Rate (CDR)• Conditional Prepayment Rate (CPR = CRR + CDR)• Loss SeverityLoss Severity• Discount Rate – Depends on Accounting Context for CECL it

is original yield

15

2 Loan ExampleFixed Rate Mortgage Loan Valuation as of September 30, 2013

Discounted DiscountPrincipal Avg Future Discount Fair Fair Principal RateBalance FICO LTV WAC Age WAM Life CPR %CRR %CDR % Severity% Loss % Rate Value % Value $ Difference Losses Difference

100,000 740 67% 6.0% 58 302 2.8 29.7% 28.6% 1.1% 10.0% 0.3% 6.0% 99.5% 99,469 (531) (531) - 100,000 620 133% 6.0% 58 302 5.4 19.5% 7.8% 11.7% 36.7% 19.6% 6.0% 81.0% 80,997 (19,003) (19,003) -

16

Loan # 2 Annual Annual AnnualSched. P&I payment 642.46$ CRR% CDR% Severity%

7 8% 11 7% 36 7%7.8% 11.7% 36.7%

Loan Remaining Repo Total Total Repo Valuation Payment Loan Actual Voluntary Prin Prin P&I DQ Repo Prin Monthly Monthly Monthly

Month Month Balance Amort Prepays Recoveries Collected Interest Collected Balance Balance Liquidations Losses CRR% CDR% Severity%0 58 100,000 - 1 59 99,184 141 675 - 816 495 1,311 1,029 - - - 0.676% 1.029% 36.7%2 60 98 382 139 663 - 802 486 1 288 2 038 - - - 0 676% 1 029% 36 7%2 60 98,382 139 663 802 486 1,288 2,038 0.676% 1.029% 36.7%3 61 97,594 138 650 - 788 477 1,265 3,029 - - - 0.676% 1.029% 36.7%4 62 96,820 136 638 - 774 468 1,242 4,002 - - - 0.676% 1.029% 36.7%5 63 96,059 134 627 - 761 459 1,220 4,957 - - - 0.676% 1.029% 36.7%6 64 95,312 133 615 - 748 451 1,198 5,894 - - - 0.676% 1.029% 36.7%7 65 94,577 131 604 - 735 442 1,177 5,785 1,029 - - 0.676% 1.029% 36.7%8 66 93,855 129 592 - 722 434 1,156 5,678 2,038 - - 0.676% 1.029% 36.7%9 67 93,146 128 581 - 709 426 1,136 5,573 3,029 - - 0.676% 1.029% 36.7%9 67 93,146 128 581 709 426 1,136 5,573 3,029 0.676% 1.029% 36.7%

10 68 92,449 126 571 - 697 418 1,115 5,470 4,002 - - 0.676% 1.029% 36.7%11 69 91,764 125 560 - 685 411 1,095 5,369 4,957 - - 0.676% 1.029% 36.7%12 70 91,091 123 550 - 673 403 1,076 5,270 5,894 - - 0.676% 1.029% 36.7%

13 - 302 71 - 360 0 9,747 27,791 33,905 71,443 20,393 91,835 - - 53,553 19,648 0.676% 1.029% 36.7%Total 11,331 35,116 33,905 80,352 25,763 106,115 53,553 19,648 0.676% 1.013% 36.7%

17

CDR and Loss Severity InputsCDR and Loss Severity Inputs

• Credit Conditions Improving

Ri k f P t h D d• Risk of Prepayment has Decreased

18

Unemployment Rates (12/31/2006 6/30/2013)

12

14

16(12/31/2006 - 6/30/2013)

National 7.6

8

10

12

rcen

t (%

)

National 7.6

Arizona 8.0

California 8.8

Florida 7.1

2

4

6Pe

New York 7.5

Nevada 9.6

0

2

2007 2008 2009 2010 2011 2012 2013Year

Source: U.S. Bureau of Labor and Statistics

19

Loans Past Due 30 Days or More as a Percentage of

7.00

8.00

y gLoans with Outstandings

Auto Direct

4.00

5.00

6.00Auto Direct

Auto Indirect

1.00

2.00

3.00 Bank Card Credit

Noncard Revolving

0.00 Credit

Source: American Bankers Association – Consumer Credit Delinquency

20

Delinquency Rates on Loans and Leases at

4

4.5

5

q yCommercial Banks

2.5

3

3.5

4 Leases

C&I Loans

0.5

1

1.5

2 Agricultural Loans

0

Source: Federal Reserve Delinquency Rates

21

Delinquency Rates on Loans at Commercial Banks

8 00

9.00

10.00

q y

5.00

6.00

7.00

8.00

Commercial Real Estate

1 00

2.00

3.00

4.00Farmland

0.00

1.00

Source: Federal Reserve Delinquency Rates

22

30 Day Plus Residential Mortgage Loans By Region

10.00

12.00

Northeast (SA)

North Central

4 00

6.00

8.00 North Central (SA)South (SA)

West (SA)

-

2.00

4.00 United States (SA)

Source: Mortgage Bankers Association – National Delinquency Survey

23

Serious Delinquencies by State – 3rd Quarter 2013Serious Delinquencies by State 3rd Quarter 2013Florida 12.63 South Carolina 5.35 New Hampshire 3.77 New Jersey 12.13 Louisiana 5.29 Iowa 3.69 New York 9.25 New Mexico 5.28 Utah 3.59 Nevada 8.68 Georgia 5.26 Texas 3.57 Maine 7.77 Kentucky 5.23 California 3.56 Illinois 7.74 Vermont 5.11 Idaho 3.50 Maryland 7.53 Oregon 5.06 West Virginia 3.48 Connecticut 7.29 Oklahoma 5.06 Virginia 3.20 Rhode Island 6.84 Arkansas 5.04 Arizona 2.91 Delaware 6.48 Alabama 4.99 Nebraska 2.82 Ohio 6.42 Washington 4.92 Minnesota 2.81 Mississippi 6.23 Tennessee 4.77 Colorado 2.55 Pennsylvania 6.12 North Carolina 4.39 Montana 2.20Pennsylvania 6.12 North Carolina 4.39 Montana 2.20 Indiana 6.06 Wisconsin 4.35 Alaska 2.10 Hawaii 5.82 Michigan 4.25 South Dakota 2.07 Massachusetts 5.80 Kansas 3.85 Wyoming 1.89 District of Columbia 5.64 Missouri 3.81 North Dakota 1.38

Shaded states = Judicial

Source: Mortgage Bankers Association 24

FHFA Seasonally Adjusted House Price Index

10 00%

15.00%

Quarterly Appreciation Annualized Appreciation from Same Quarter 1 Year Earlier

0 00%

5.00%

10.00%

-10.00%

-5.00%

0.00%

-15.00%

Source: FHFA25

Housing Price Index (Seasonally Adjusted)2 d Q t 2012 Ch O L t t F Q t2nd Quarter 2012: Change Over Latest Four Quarters

>10%6%-10%3%-6%0-3%

Source: FHFA

26

Changes in Housing PricesChanges in Housing Prices

One Year Five Year Fore One Year Five Year ForeAtlanta 14 04% -13 24% N Orlando 17 56% -20 15% JAtlanta 14.04% 13.24% N Orlando 17.56% 20.15% JBakersfield 21.84% -12.04% N Phoenix 23.28% -13.38% NChicago 6.65% -19.49% J Riverside 21.92% -6.25% NFort Lauderdale 13.33% -9.25% J Sacramento 25.99% -2.66% N% % % %Fresno 13.72% -14.83% N San Diego 14.25% 4.57% NJacksonville 11.42% -19.20% J San Francisco 22.69% 13.37% NLas Vegas 26.60% -26.81% N San Jose 20.68% 13.73% NgLos Angeles 16.27% -0.15% N Seattle 14.01% -11.85% NMiami 12.84% -16.37% J Tampa 8.31% -13.15% JMilwaukee 5.37% -9.74% N Tucson 6.97% -24.01% N

Source: FHFA27

4 50%

Expected Home Price Long Term Average

3.50%

4.00%

4.50%

2.00%

2.50%

3.00%

Expected Home Price

0 50%

1.00%

1.50%Changes by Survey

0.00%

0.50%

Source: Pulsenomics/Zillow

28

Real Estate Loans – Key Loan AttributesReal Estate Loans Key Loan Attributes• Interest rate – fixed or variable• Contract term – balloons hybrids etcContract term balloons, hybrids, etc.• Lien position• Closed or open endedp• Source – retail vs. wholesale• Loan purpose – primary, second home, investor• Debt to income ratios• Credit score • Loan-to-value ratio

29

15.0%

Average 12 month CDR% by LTV% and FICO

10.0%

12.5%

%

> 125%

105% - 125%

95% - 105%

5.0%

7.5%

CD

R%

80% - 95%

< 80%

0.0%

2.5%

>775 725 - 774 700 - 724 650 - 699 600 - 649

30

FICO

Services and Contact Information

Asset Liability Management and Private Label MBS/CMOs:Frank Wilary fwilary@wilwinn.com

Mergers and Acquisitions, Fair Value Footnotes, and ASC 310-30:Brenda Lidke blidke@wilwinn.com

Mortgage Servicing Rights, Mortgage Banking Derivatives, and TDRs:

Eric Nokken enokken@wilwinn comEric Nokken enokken@wilwinn.com

Pooled Trust Preferred CDOs:Gregg Johnson gjohnson@wilwinn comGregg Johnson gjohnson@wilwinn.com

31

Contact Information

Wilary Winn Risk Management LLCWilary Winn Risk Management LLCAlliance Bank Center

55 East 5th Street, Suite 102055 East 5 Street, Suite 1020Saint Paul, MN 55101

651-224-1200

www.wilwinn.com

32