Loan Fair Value Overview for Banks market, liquidity & credit risk measurement and validation solutions for banks Fred Poorman Jr., CFA, Managing Principal fpoorman@bankriskadvisors.com

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Objectives of Best Practices Loan Fair Value analytics Financial reporting

Quarterly and annual Fair Value Disclosures Step 2 Goodwill impairment analysis

Best practices analytics for ALM analysis Calculation of internal economic capital and/or economic value of equity Comprehension of value creation & value change drivers

Loan pricing Congruence between loan pricing and loan valuation Comprehension of market value-based pricing Another tool for pricing and transfer pricing

ALLL analytics Congruence in analytics for loan value and ALLL analytics

M&A analysis Pre- & post- M&A analysis of loan values and Goodwill

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Approach to Loan Fair Value analytics

Use ALM model(s) to produce accurate loan Fair Values Reliable, repeatable, documented ALM modeling and valuation

processes Accurate =

Granular, loan level or clearly delineated homogenous pools Benchmark to market values/factors, whenever practicable

– Market curve= LIBOR/Swaps (Bloomberg USSW or c23 screens)

– Credit spreads based on mapping – Liquidity spreads based on market data and mapping

Signed off by external audit firms

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Approach to Loan Fair Value analytics

Loan Fair Values to be congruent with FASB/IFRS Standards Hierarchy of Level 1, 2, 3 (old SFAS 157) Congruence between Jan 2011 release and old SFAS 115:

Trading, or mark through Income AFS, or mark through OCU HTM, or amortized cost

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Mapping Overview

Map internal loans to external (market) factors for level 2 disclosure approach

Loan level mapping requirements for granular, loan level best practices approach Commercial: Internal risk grade; 1-10 Residential: Appraisal, LTV, FICO data Consumer: FICO

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Mapping Example: Commercial Loans

Map internal loan grades to external (market) grades Commercial mapping uses internal loan grades

Internal ratings are mapped to S&P/Moody’s equivalents Works best if PD is part of internal rating Use peer/benchmark banks

Mapping considerations Internal

Loan policy Loss history/ALLL analysis

External S&P/Moody’s histories RMA eStatement studies (uses Moody’s for benchmarks) Basel II/III FED E2 release Benchmark banks from proprietary database

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Issues & Resolutions

Issue: Loan level data may not be available from current core systems/extracts Resolution: Use current extracts along with BI or other internal data to

create supportable weighted average spreads at the ALM model line level.

Issue: Uncertainty about mapping process Resolution: Bank Risk Advisors can assist with mapping. Consultants

backgrounds include market, liquidity, and credit risk backgrounds.

Issue: Uncertainty about reliable 3rd party sources of spreads Resolution: Bank Risk Advisors updates benchmark spreads monthly

and/or quarterly, depending on loan types. Posted to SharePoint site free of charge for clients.

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