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The Art & Science of Provisioning for Impaired Assets. Dave Grace Managing Partner Dave Grace & Associates February 2013. Is this an Asset?. Who is Dave? www.DaveGraceAssociates.com. 6 years central bank in USA 13 years World Council of Credit Unions (WOCCU) 18 months consultant IMF/WB

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the art science of provisioning for impaired assets

The Art & Science of Provisioning for Impaired Assets

Dave Grace

Managing Partner

Dave Grace & Associates

February2013

who is dave www davegraceassociates com
Who is Dave?www.DaveGraceAssociates.com
  • 6 years central bank in USA
  • 13 years World Council of Credit Unions (WOCCU)
  • 18 months consultant IMF/WB
  • Worked in 60+ countries
agenda
Agenda
  • Impairment of Assets in Financial Institutions
  • Terminology
  • Determining when to create provisions for loans and investments
  • How to create provision and recognize collateral
  • Writing off assets
  • Recognition of Recoveries
ifrs 9 response to provisioning process that didn t work in crisis
IFRS 9 – Response to Provisioning process that didn’t work in Crisis
  • FASB and IFRS have had different approaches resulting in complex proposals.
  • Standard is taking a long time.
  • Core Issue: Likelihood of a loss event in the next 12 months -- forward looking provisioning.
terminology
Terminology
  • Impaired Asset = bad loan or investment.
  • Non-performing loan = delinquency.
  • Provisioning is an expense to the Income Statement.
  • Allowance for loan/investment loss is a cumulative account on the balance sheet.
  • Write off = Charge off.
provisions all
Provisions & ALL
  • When is a loan delinquent?
  • What is the aging schedule?
  • Can collateral Values be counted?
  • How to determine collateral values?
when is a loan delinquent
When is a loan delinquent?
  • Current Regs: 91st day
  • PEARLS: 31st day
can collateral off set the required provision expense
Can Collateral off set the required provision expense?

Yes, if:

  • It’s a loan secured by land, building or new car loan.
  • CU will realistically repossess collateral in a timely manner & courts allow it.
  • The CU can sell the collateral.
  • CU has recent valuations of collateral meeting the following criteria.
  • If process too complex or CU does not have records to validate collateral values, then collateral CANNOT be used to off set the amount needed for provisions.
valuing criteria
Valuing Criteria
  • Collateral independently appraised within last 2 years & appraisal shows at least two comparable sales to justify the value.
  • 2 years of data on showing actual forced sale prices for collateral types vs. appraised values. Determine haircut and apply this amount.
example
Example:
  • Mortgage is 8 months delinquent. Value of remaining loans is $220,000. Member has $500 is shavings & shares. Exposure to be provisioned is $110,000-$500 = $109,500
  • Recent appraisal (including comparable sales) assesses value at $240,000.
  • Actual experience at this Financial Institution (FI)is that forced sales sell for 30% less than appraised value.
  • Exposure =$109,500
  • Collateral value less 30% haircut =$168,000

(ie. $240,000*.70)

  • Amount to provision= $109,500 - $168,000= -$58,500 =$0
near real life example
Near Real Life Example
  • A FI has a $465,000 loan for restaurant equipment that is 7 years past due. The restaurant has been vacant and vandalized for 7 years. Only collateral is a parcel that the FI does not have title to.
    • What should it do?
writing off assets
Writing off assets
  • You first need to make provisions to create the allowance for loan/investment loss.
  • Any loan or investment not performing for 12 months should be written off.
    • Example a FI that has not written off loans in 30 years. A FI that has never repossess as asset for a bad loan in 26 year history.
recognition of recoveries
Recognition of Recoveries
  • Once a loan is written off any proceeds from additional collection activities should come into the income statement as recoveries, not into the allowance for loan loss.
thank you
Thank you.

dgrace@DaveGraceAssociates.com

www.DaveGraceAssociates.com