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FASB's Proposed Modification of Calculations for Credit Losses

FASB's Proposed Modification of Calculations for Credit Losses. REACHtalks – 2013 CCUL Annual Convention. Objectives:. At the end of this discussion, you will be able to: Have a clearer understanding of the proposed rule and how it may impact you

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FASB's Proposed Modification of Calculations for Credit Losses

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  1. FASB's Proposed Modification of Calculations for Credit Losses REACHtalks – 2013 CCUL Annual Convention

  2. Objectives: At the end of this discussion, you will be able to: • Have a clearer understanding of the proposed rule and how it may impact you • Assess the potential impact to your credit union’s allowance for loan loss methodology and calculation • Ideas to plan for the future

  3. Background – Why Introduced? Weaknesses identified following the global economic crisis: • Many financial statement users noted that the current incurred loss model may have prevented institutions from recognizing credit losses that were imminent in 2007 and 2008 • Complexity of multiple credit impairment models

  4. Incurred Loss Model (Existing Method) The existing method generally: • Delays recognition of credit losses until the loss is considered “probable” • FASB believes that entities should accrue for their expectation of loss • Considers losses that have been incurred and will most likely be reflected as charge-offs during the next operating cycle (12 months after the reporting date) • Considered by FASB to be overly complex and cumbersome

  5. Expected Loss Model (Proposed Method) • This method to reflect management’s estimate of all credit losses currently expected to be realized • Originate a loan increased exposure to credit losses • Payment is received in full exposure decreased • FASB believes that users of the financial statements desire transparency with regard to management’s full estimate of all expected credit losses and the proposed model would provide users with a consistent balance sheet objective

  6. Expected Loss Model (Proposed Method) Expected credit loss is an estimate of the present value of cash flows NOT expected to be collected based on quantitative and qualitative information over life of loan, such as: • Past events • Historical loss experience • Prepayments • Collateral value • Current conditions • Borrower credit worthiness • Forecasts of expected credit losses • Current point and forecast direction of economic cycle • Current and expected economic conditions

  7. Expected Loss Model (Proposed Method) Selection from possible scenarios • FASB expects estimate largely formed by historical loss information • Probability weighted calculation not required Prohibited from using: • Worst-case scenario • Best-case scenario • Solelyon the most likely outcome (statistical outcome)

  8. Expected Loss Model (Proposed Method) Items to consider in developing expected loss model: • Historical loss experience • Weighted average life • Static pool analysis • FICO and LTV migration analysis How to forecast? • Implementation tools and sample calculations not yet available

  9. What Does This ALLL Mean? • Current model • ALLL covers a little over 1 year of loan losses • For example if your credit union has a loan loss ratio of 1% for a specific loan product the calculation would be: Current loan balance $100,000,000 * 1% loss rate = $1,000,000

  10. What Does This ALLL Mean? • Proposed model • ALLL to cover estimate losses over life of loan so could be more than 2 times annual loan losses • For example same loss rate of 1% and your ALM model predicts average life of these loans is 2 years the simplified (non-discounted) calculation would be: Current loan balance $100,000,000 * 1% loss rate * 2 years average life = $2,000,000 Results in a $1,000,000

  11. Preliminary Thoughts • One impairment model instead of multiple models • More realistic estimate of probable future losses inherent in the loan portfolio • ALLL more responsive to changes in the economy and loan portfolio • Our best estimate at this time would new model not effective for credit unions until 2017 or later

  12. Preliminary Concerns • Judgments susceptible to interpretation/influence • Concerns over regulatory scrutiny may dampen management’s willingness to lower ALLL • Attempting to predict the future • Where we are in the economic cycle • Identify when a downturn/recovery begins • Predict the severity of a downturn • Discourages long-term lending • Longer the term the greater the potential ALLL

  13. How to Plan for Future Impact • Develop models to determine what your ALLL may look like under new standard • Forecast financials for next 3-5 years • Determine impact to ALLL and also on Net Worth • Monitor NCUA and potential changes to Net Worth • Risk-based model or 9% net worth to be Well Capitalized? • Fine tune strategic plan to ensure future financials get you where you need to be • Can you remain Well Capitalized after implementation?

  14. Thank You For Your Time Questions? Please stop by our booth – D33

  15. Bryan W. Mogensen, CPA Principal Bryan.Mogensen@claconnect.com (602) 604-3551

  16. Bruce Fox EVP, Chief Investment Officer

  17. Institutional Asset ManagementTrends Tom Telford Principal Burns-Fazzi Brock

  18. Permissible Investments • Do not adhere to special consideration as outlined by NCUA § 701.19 • Following NCUA § 703.13-14 • Certificates of Deposit • Government Treasuries • Various Bonds

  19. Otherwise Impermissible Investments • NCUA § 701.19 • Allows a Credit Union to reallocate permissible investment dollars or cash to alternative investments, provided future earnings of those investments have been dedicated to offsetting the Credit Union’s current or future employee benefit obligations

  20. Trends in Investment Asset Management 1. Outsourcing Investment Expertise • NCUA Letter No. 10-CU-18 • Investment Due Diligence • Risk Mitigation • Safety & Soundness

  21. Trends in Investment Asset Management • Blending “Otherwise Impermissible” Investments with Permissible Investments • Low-to-moderate-risk and institutionally priced investment portfolios

  22. “Manage the Managers” • Delegation to full-time external firm with track record of managing billions of non-profit assets • Asset manager to adhere to Credit Union investment policy statement • Added Credit Union human capital efficiency • Potential yield increase in Credit Union investment portfolio performance • Portfolio risk mitigation and assessment • Regulatory oversight of portfolio management

  23. Questions?Please see me after the REACHtalksor Wednesday morning visit my colleagues at the BFB display table D3! Securities and Investment Advisory Services may be offered through NFP Securities, Inc. (NFPSI), member FINRA/SIPC. Burns-Fazzi, Brock & Associates, LLC is a member of PartnersFinancial, an affiliate of NFPSI. Burns-Fazzi, Brock and NFPSI are not affiliated.

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