cecl methodology - cre loan pools

Brandon RussellSageworks ALLL Specialist

CECL Methodology Series

CREJanuary 12, 2016

P R E S E N T E D B Y

Neekis Hammond, CPAPrincipal – Advisory Services

About the Webinar

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• 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

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

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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.

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About Today’s Presenters

Sageworks ALLL Specialist

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B R A N D O N R U S S E L L

Principal – Advisory Services

N E E K I S H A M M O N D , C PA

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

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/

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.

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

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

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

Inputs

Migration.

14.1%

0.0% 0.2% 0.1% 0.5% 0.8%2.4%

12.6%

24.0%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

0 1 2 3 4 5 6 7 8

36 MONTH LOSS RATE - MIGRATION

Outputs

Migration.

0.69% 0.65%

1.36%1.24%

1.06%0.97% 1.04%

0.95% 0.91%

9/30/2011 12/31/2011 3/31/2012 6/30/2012 9/30/2012 12/31/2012 3/31/2013 6/30/2013 9/30/2013

36 MONTH LOSS RATE - MIGRATION

Outputs

Migration.

1 2 3 4 5 6 7 8

1 98.4% 1.5% 0.0% 0.1% 0.0% 0.0% 0.0% 0.0%

2 0.3% 99.4% 0.2% 0.2% 0.0% 0.0% 0.0% 0.0%

3 0.0% 0.4% 98.0% 1.3% 0.2% 0.0% 0.1% 0.0%

4 0.0% 0.0% 0.7% 98.1% 0.4% 0.2% 0.6% 0.0%

5 0.0% 0.0% 0.6% 13.7% 83.0% 1.5% 1.1% 0.0%

6 0.0% 0.0% 0.0% 7.8% 3.7% 84.5% 4.0% 0.0%

7 0.0% 0.0% 0.0% 1.4% 1.5% 0.3% 96.7% 0.0%

8 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 13.6% 86.4%

Outputs

Migration.

Beginning Risk Grade Analysis Date 36 Month Migration Loss %

4 9/30/2011 0.2%

4 12/31/2011 0.2%4 3/31/2012 0.6%4 6/30/2012 0.6%4 9/30/2012 0.6%4 12/31/2012 0.5%

4 3/31/2013 0.5%4 6/30/2013 0.2%

4 9/30/2013 0.7%

4 Total 0.5%5 9/30/2011 0.0%5 12/31/2011 1.2%5 3/31/2012 0.8%

5 6/30/2012 0.7%5 9/30/2012 0.0%

5 12/31/2012 0.0%5 3/31/2013 1.4%5 6/30/2013 2.1%5 9/30/2013 1.6%

5 Total 0.8%

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

0.8%

9/3

0/2

01

1

12

/31

/20

11

3/3

1/2

01

2

6/3

0/2

01

2

9/3

0/2

01

2

12

/31

/20

12

3/3

1/2

01

3

6/3

0/2

01

3

9/3

0/2

01

3

4

Poll Question.

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

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

Inputs

PD & LGD.

Outputs

PD & LGD.

21.74%

1.02% 1.88% 1.07%2.77% 3.10%

16.00%

28.38%

0.00%0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

0 1 2 3 4 5 6 7 8

36 MONTH PROBABILITY OF DEFAULT

3.25% 3.27%3.01%

3.40% 3.40%2.93%

3.15%2.73%

2.43%

9/30/2011 12/31/2011 3/31/2012 6/30/2012 9/30/2012 12/31/2012 3/31/2013 6/30/2013 9/30/2013

36 MONTH PROBABILITY OF DEFAULT -TREND

Outputs

PD & LGD.

Collateral Code # Defaults # Available to Default Probability of Default

300 - Real Estate IUB Other 5 30 16.67%

304 - Car Wash 4 119 3.36%

306 - Auto Dealer 5 167 2.99%

317 - Manufacturing Facility 13 320 4.06%

319 - Industrial Facility 34 632 5.38%

320 - Office 45 1662 2.71%

321 - Medical Office 31 599 5.18%

322 - Warehouse 41 646 6.35%

323 - Commercial Lot 10 33 30.30%

324 - Retail 53 1291 4.11%

326 - Commercial Condo 11 125 8.80%

328 - Golf Course 8 58 13.79%

329 - Recreation Facility 9 284 3.17%

330 - Church/Related 13 569 2.28%

331 - Hospital 10 25 40.00%

332 - Vacant Land 1-5 Acres 2 11 18.18%

337 - School/Education Related 2 86 2.33%

342 - Restaurant 31 743 4.17%

344 - Strip Center 5 40 12.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

36 MONTH PD – OWNER OCCUPIED CRE

11.9%10.5%

5.2%

9.3% 8.8% 8.1%6.4%

14.7%

9/30/2011 12/31/2011 6/30/2012 9/30/2012 12/31/2012 3/31/2013 6/30/2013 9/30/2013

LOSS GIVEN DEFAULT - TREND

15.0%

22.8%

15.7%12.8%

15.0% 15.0%

4.8%

18.1%

9/30/2011 12/31/2011 6/30/2012 9/30/2012 12/31/2012 3/31/2013 6/30/2013 9/30/2013

RECOVERY GIVEN LOSS - TREND

Outputs

PD & LGD.

Poll Question.

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

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

Outputs

DCF.

Segment 1.e.1

GL Balance 1,565,565,815

PV 1,559,569,236

Reserve 5,996,579

Reserve % 0.38%

NPV (Effective) (5,977,900)

NPV (Pricing) 59,902,862

Defaulted Principal 2.98%

Principal 904,883,630

Interest 118,508,137

Prepayment 614,045,605

Estimated Loss 0.30%

Estimated Recovery 41,972,922

Cash Flow 1,679,410,293 $0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

$45,000

THO

USA

ND

S

Prepaid Principal Interest Collection Estimated Default

Amortization Schedule

DCF.

Date NPER/Period Beginning Balance Principal Interest PrepaymentDefaulted Principal Estimated Loss

Estimated Recovery

End of Month Balance Cash Flow

TOTAL 903,989,324 118,343,162 612,879,479 46,443,050 4,644,305 41,798,745 1,677,010,710

- (1,563,311,854) (1,563,311,854)

12/31/2015 1 1,563,311,854 10,763,327 4,879,366 40,485,455 1,914,877 191,488 - 1,510,148,194 56,128,148

1/31/2016 2 1,510,148,194 10,929,260 4,713,433 38,576,701 1,849,758 184,976 - 1,458,792,475 54,219,394

2/29/2016 3 1,458,792,475 11,089,550 4,553,143 36,732,858 1,786,853 178,685 - 1,409,183,213 52,375,551

3/31/2016 4 1,409,183,213 11,244,389 4,398,304 34,951,719 1,726,087 172,609 - 1,361,261,017 50,594,412

4/30/2016 5 1,361,261,017 11,393,963 4,248,730 33,231,151 1,667,388 166,739 - 1,314,968,515 48,873,844

5/31/2016 6 1,314,968,515 11,538,450 4,104,243 31,569,095 1,610,685 161,069 - 1,270,250,286 47,211,788

6/30/2016 7 1,270,250,286 11,678,023 3,964,670 29,963,560 1,555,910 155,591 - 1,227,052,792 45,606,253

7/31/2016 8 1,227,052,792 11,812,850 3,829,843 28,412,625 1,502,999 150,300 - 1,185,324,319 44,055,318

8/31/2016 9 1,185,324,319 11,943,091 3,699,601 26,914,433 1,451,886 145,189 - 1,145,014,908 42,557,126

9/30/2016 10 1,145,014,908 12,068,904 3,573,789 25,467,190 1,402,512 140,251 - 1,106,076,303 41,109,882

10/31/2016 11 1,106,076,303 12,190,438 3,452,255 24,069,163 1,354,816 135,482 - 1,068,461,886 39,711,856

11/30/2016 12 1,068,461,886 12,307,839 3,334,854 22,718,679 1,308,743 130,874 - 1,032,126,625 38,361,372

Amortization Schedule and Remaining Principal Chart

DCF.

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

$1,600,000

$1,800,000

Tho

usa

nd

s

Date NPER/Period Beginning Balance Principal Interest Prepayment Defaulted Principal Estimated Loss Estimated Recovery End of Month Balance Cash Flow

TOTAL 903,989,324 118,343,162 612,879,479 46,443,050 4,644,305 41,798,745 1,677,010,710

- (1,563,311,854) (1,563,311,854)

12/31/2015 1 1,563,311,854 10,763,327 4,879,366 40,485,455 1,914,877 191,488 - 1,510,148,194 56,128,148

1/31/2016 2 1,510,148,194 10,929,260 4,713,433 38,576,701 1,849,758 184,976 - 1,458,792,475 54,219,394

2/29/2016 3 1,458,792,475 11,089,550 4,553,143 36,732,858 1,786,853 178,685 - 1,409,183,213 52,375,551

3/31/2016 4 1,409,183,213 11,244,389 4,398,304 34,951,719 1,726,087 172,609 - 1,361,261,017 50,594,412

4/30/2016 5 1,361,261,017 11,393,963 4,248,730 33,231,151 1,667,388 166,739 - 1,314,968,515 48,873,844

5/31/2016 6 1,314,968,515 11,538,450 4,104,243 31,569,095 1,610,685 161,069 - 1,270,250,286 47,211,788

6/30/2016 7 1,270,250,286 11,678,023 3,964,670 29,963,560 1,555,910 155,591 - 1,227,052,792 45,606,253

7/31/2016 8 1,227,052,792 11,812,850 3,829,843 28,412,625 1,502,999 150,300 - 1,185,324,319 44,055,318

8/31/2016 9 1,185,324,319 11,943,091 3,699,601 26,914,433 1,451,886 145,189 - 1,145,014,908 42,557,126

9/30/2016 10 1,145,014,908 12,068,904 3,573,789 25,467,190 1,402,512 140,251 - 1,106,076,303 41,109,882

10/31/2016 11 1,106,076,303 12,190,438 3,452,255 24,069,163 1,354,816 135,482 - 1,068,461,886 39,711,856

11/30/2016 12 1,068,461,886 12,307,839 3,334,854 22,718,679 1,308,743 130,874 - 1,032,126,625 38,361,372

12/31/2016 13 1,032,126,625 12,421,248 3,221,445 21,414,121 1,264,236 126,424 1,723,389 997,027,020 38,780,203

1/31/2017 14 997,027,020 12,530,800 3,111,893 20,153,927 1,221,243 122,124 1,664,782 963,121,050 37,461,402

2/28/2017 15 963,121,050 12,636,626 3,006,067 18,936,589 1,179,712 117,971 1,608,168 930,368,123 36,187,449

3/31/2017 16 930,368,123 12,738,854 2,903,839 17,760,649 1,139,594 113,959 1,553,479 898,729,026 34,956,820

4/30/2017 17 898,729,026 12,837,605 2,805,088 16,624,699 1,100,840 110,084 1,500,649 868,165,883 33,768,041

5/31/2017 18 868,165,883 12,932,998 2,709,695 15,527,379 1,063,403 106,340 1,449,617 838,642,103 32,619,689

6/30/2017 19 838,642,103 13,025,146 2,617,546 14,467,376 1,027,240 102,724 1,400,319 810,122,340 31,510,389

7/31/2017 20 810,122,340 13,114,161 2,528,531 13,443,421 992,307 99,231 1,352,699 782,572,451 30,438,813

8/31/2017 21 782,572,451 13,200,149 2,442,543 12,454,288 958,561 95,856 1,306,697 755,959,453 29,403,678

9/30/2017 22 755,959,453 13,283,213 2,359,480 11,498,792 925,963 92,596 1,262,260 730,251,485 28,403,745

10/31/2017 23 730,251,485 13,363,452 2,279,241 10,575,789 894,474 89,447 1,219,335 705,417,770 27,437,816

11/30/2017 24 705,417,770 13,440,962 2,201,730 9,684,175 864,056 86,406 1,177,869 681,428,576 26,504,737

12/31/2017 25 681,428,576 13,515,837 2,126,856 8,822,883 834,672 83,467 1,137,813 658,255,185 25,603,388

1/31/2018 26 658,255,185 13,588,165 2,054,528 7,990,880 806,287 80,629 1,099,119 635,869,853 24,732,692

2/28/2018 27 635,869,853 13,658,033 1,984,659 7,187,171 778,867 77,887 1,061,741 614,245,781 23,891,605

3/31/2018 28 614,245,781 13,725,526 1,917,167 6,410,795 752,380 75,238 1,025,635 593,357,080 23,079,122

4/30/2018 29 593,357,080 13,790,723 1,851,970 5,660,820 726,794 72,679 990,756 573,178,743 22,294,268

5/31/2018 30 573,178,743 13,853,703 1,788,990 4,936,350 702,078 70,208 957,063 553,686,612 21,536,106

6/30/2018 31 553,686,612 13,914,541 1,728,151 4,236,517 678,202 67,820 924,516 534,857,351 20,803,726

7/31/2018 32 534,857,351 13,973,311 1,669,382 3,560,483 655,139 65,514 893,076 516,668,418 20,096,252

8/31/2018 33 516,668,418 14,030,082 1,612,611 2,907,439 632,859 63,286 862,705 499,098,038 19,412,837

9/30/2018 34 499,098,038 14,084,922 1,557,771 2,276,604 611,338 61,134 833,367 482,125,175 18,752,663

10/31/2018 35 482,125,175 14,137,897 1,504,796 1,667,221 590,548 59,055 805,027 465,729,509 18,114,940

11/30/2018 36 465,729,509 14,189,071 1,453,622 1,078,561 570,465 57,047 777,650 449,891,412 17,498,904

12/31/2018 37 449,891,412 14,238,504 1,404,189 509,920 551,065 55,107 751,204 434,591,922 16,903,818

1/31/2019 38 434,591,922 14,286,257 1,356,436 - 532,325 53,233 725,658 419,773,340 16,368,351

2/28/2019 39 419,773,340 14,332,508 1,310,185 - 514,174 51,417 700,981 404,926,658 16,343,673

3/31/2019 40 404,926,658 14,378,847 1,263,846 - 495,989 49,599 677,142 390,051,823 16,319,835

4/30/2019 41 390,051,823 14,425,274 1,217,419 - 477,769 47,777 654,115 375,148,780 16,296,808

5/31/2019 42 375,148,780 14,471,789 1,170,904 - 459,514 45,951 631,870 360,217,478 16,274,563

6/30/2019 43 360,217,478 14,518,392 1,124,301 - 441,225 44,122 610,382 345,257,861 16,253,075

7/31/2019 44 345,257,861 14,565,084 1,077,609 - 422,901 42,290 589,625 330,269,876 16,232,318

8/31/2019 45 330,269,876 14,611,864 1,030,829 - 404,543 40,454 569,573 315,253,470 16,212,266

9/30/2019 46 315,253,470 14,658,732 983,960 - 386,149 38,615 550,204 300,208,588 16,192,897

10/31/2019 47 300,208,588 14,705,690 937,003 - 367,721 36,772 531,493 285,135,177 16,174,186

11/30/2019 48 285,135,177 14,752,737 889,956 - 349,258 34,926 513,419 270,033,183 16,156,111

12/31/2019 49 270,033,183 14,799,873 842,820 - 330,760 33,076 495,959 254,902,550 16,138,651

1/31/2020 50 254,902,550 14,847,098 795,595 - 312,226 31,223 479,093 239,743,226 16,121,785

2/29/2020 51 239,743,226 239,449,568 748,280 - 293,658 29,366 462,757 - 240,660,605

3/31/2020 52 - - - - - - 446,390 - 446,390

4/30/2020 53 - - - - - - 429,992 - 429,992

5/31/2020 54 - - - - - - 413,563 - 413,563

6/30/2020 55 - - - - - - 397,102 - 397,102

7/31/2020 56 - - - - - - 380,611 - 380,611

8/31/2020 57 - - - - - - 364,088 - 364,088

9/30/2020 58 - - - - - - 347,534 - 347,534

10/31/2020 59 - - - - - - 330,949 - 330,949

11/30/2020 60 - - - - - - 314,332 - 314,332

12/31/2020 61 - - - - - - 297,684 - 297,684

1/31/2021 62 - - - - - - 281,004 - 281,004

2/28/2021 63 - - - - - - 264,292 - 264,292

PD

Migration N/A

PD & LGD 3.69%

DCF 2.98%

Migration/PD&LGD/DCF

Comparison.

Loss Rate

Migration 0.49%

PD & LGD 0.34%

DCF 0.38%

GL Balance

Migration 1,565,565,815

PD & LGD 1,565,565,815

DCF 1,565,565,815

Poll Question.

Q&A

• Follow up email

• ALLL.com

• SageworksAnalyst.com – latest whitepapers and archived webinars

• SageworksAnalyst.com – product and advisory services information

• Risk Management Summit 2017 –September 24-27 in Denver, CO

34

RESOURCES

Brandon RussellSageworks ALLL Specialist

[email protected]

Neekis Hammond, CPASageworks Advisory Services

[email protected]

PRESENTERS

cecl methodology - cre loan pools

Economy & Finance