using scenario building for your alll
TRANSCRIPT
USING SCENARIO BUILDING
FOR YOUR ALLL
Rob AshbaughSr. Risk Management Consultant
Sageworks
June 23, 2015
PRESENTED BY
AND HOW IT HELPS YOU PREPARE
FOR FASB’S CECL MODEL
Questions
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About Sageworks
+ Financial information company that provides credit and risk management
solutions to financial institutions
+ Data and applications used by thousands of financial institutions and
accounting firms across North America
+ Awards
+ Named to Inc. 500 list of fastest growing privately held companies in the U.S.
+ Named to Deloitte’s Technology Fast 500
+ NC Tech Awards: Excellence in Customer Service
Today’s Speaker
Rob AshbaughSr. Risk Management Consultant
Rob has more than twenty years of capital
markets and commercial banking experience as
both a portfolio manager and risk manager, with a
primary focus on mortgage-backed securities and
commercial loans. Among his responsibilities
were monthly ALLL calculations, institutional and
concentration stress testing, and risk analytics.
He is a past holder of the Series 7, 52 and 63
licenses.
Agenda
+ Proactive Risk Management
+ Introduction to Scenario Building
+ Where to Use It
+ Challenges
+ How to Get Started
Risk Management Maturity Model
Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer
ALLL Maturity Model
Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer
Introduction
+ Scenario building: assess the outcome of the ALLL under various
assumptions or “scenarios”
+ Create projections
+ Run multiple scenarios at once, compare results
+ Estimate the impact that ALLL-calculation variables may have without
performing a completely new calculation
+ Similar to stress testing
Introduction (cont’d)
+ Displays impact of individual factors on overall analysis
+ What if just “X” changed?
+ What would it do to my calculation?
+ Ex: If I adopted migration analysis, would it change my reserve?
+ Ex: If CRE took a hit, how much would I have to provision?
+ Ex: If I changed my look-back period, what would it do to my reserve levels?
+ Ex: If I began lending in a new segment, what losses would peer groups
reflect?
+ Helps show range for the reserve
Where to Use Scenario Building
+ Tactical planning for the quarterly (or monthly) provision
+ Altering look-back period
+ Changing loss methodologies
+ Capital planning for the FASB’s CECL model
+ Other areas?
Provision Expense Planning
+ Typical calculation process:
+ Complex
+ Time-consuming
+ Rushed
+ Little time for planning or analysis
+ Optimizing the process – ability to perform what-if scenarios in advance to
forecast an expected provision expense
+ Have an expected provision range pre-determined before the end of the
quarter (or month)
Provision Expense Planning - Benefits
+ Plan for changes
+ Prove your institution is proactive with risk management efforts
+ Leverage capital efficiently
Altering Look-Back Period
+ Analyze the impact of using different look-back periods
+ Ex: four quarters vs. eight quarters
Altering Look-Back Period – Other Ways
+ Change length of period
+ Use different time periods
+ Annual, quarterly, monthly loss rates – ex: 2-year vs. 24-month look-back
period
+ Weight certain periods
+ Ex:12 quarters may be most appropriate, but recent quarters may be
more indicative of the current economy
+ Weight most recent 4 quarters at 40%, remaining 8 at 60%
Changing Loss Methodologies
+ Scenario building allows for estimation of the impact of the change in loss
methodologies
+ Ex: Historical loss to migration analysis
+ The results could lead to one of these conclusions:
+ Negligible difference, and change could occur immediately
+ Sizable difference, wait until year-end to make the change
+ Large difference, wait for buy-in from examiners before changing
Changing Loss Methodologies - Example
Qualitative Factors
+ Can create scenarios based on changes to qualitative factors to reflect
their perception of the impact of:
+ New products / markets
+ Economic forecasts
+ Staffing changes – personnel or expertise
+ Changing regulations / underwriting guidelines
+ Changes in competition
+ Changes in CRE or other product concentrations
+ Scenario building allows you to see the impact of changing one or more
of these factors
Challenges of Scenario Building
+ Data management
+ Availability
+ Accessibility
+ Flexibility
+ Implementing
+ Does it create more work?
How to Get Started
+ Collect loan-level detail
+ Store and archive month-end loan files
+ Ensure easy access to data for reporting
+ Determine which variables to test
+ Consider automated scenario building solution
Capital Planning for CECL
+ Will require institutions to consider expected rather than incurred losses
+ Likely to expand the loss horizons institutions use for estimating
allowances for non-impaired loans
+ Likely to cause the allowance for non-impaired assets to rise from current
levels
+ One-time capital adjustment once guidance is effective
Capital Planning for CECL
Recent Developments
+ Basel releases “Guidance on accounting
for expected credit losses” – Feb. 2015
+ What is Basel?
+ “The objective of this paper is to set out
supervisory requirements on sound credit
risk practices associated with the
implementation and ongoing application
of expected credit loss (ECL) accounting
models.”
Recent Developments
+ “In addition to historical information and current conditions, forward-looking
information and macroeconomic factors are also critical when estimating future
cash shortfalls.”
+ “An institution should demonstrate and document how ECL estimates would fluctuate
with changes in scenarios…scenarios may be internally developed or, for less
sophisticated institutions, may be vendor-defined…Robust methodologies and
parameters should consider different potential scenarios and not rely purely on
subjective, biased or overly optimistic considerations.”
+ “Backtesting should be performed to ensure that appropriate factors are
considered and incorporated, in light of historical experience.”
+ “Methodologies for the determination of the cash flow shortfalls may start with simple
averages of an institution’s net loss experience on loans with shared credit risk
characteristics over a relevant credit cycle, progressing to more complex techniques,
such as migration analysis or models that estimate ECL.”
Timeframe for CECL
+ CECL expected to be issued in 2015
+ Final CECL model to be substantially the same to exposure draft of 2012
+ Take effect January 1, 2018?
+ IASB’s IFRS 9 Financial Instruments July 24, 2014
Preparing for CECL
+ Proactively review processes, methods and balances now to assess
flexibility to account for changes
+ Scenario building could show the institution’s worst-case scenario and
help answer questions like:
+ If I needed to adjust my reserve by +50 percent, do I have sufficient capital?
+ If the new model requires a 20 percent increase to the ALLL, how does that
affect my Tier 1 ratio?
+ How much of an increase to the ALLL can my bank handle without having
capital adequacy issues?
2015 Risk Management Summit
+ September 23-25 in Chicago
+ ALLL & Stress Testing, Peer Roundtables
+ Banker Appreciation Night on Lake Michigan
+ Early bird rate ends June 30
+ sageworks.com/summit
Todd Sprang
Principal
CliftonLarsonAllen
Ariste Reno
Partner
KPMG
John Behringer
Partner
McGladrey
Graham Dyer
Senior Manager
Grant Thornton
Contact Information & Additional Resources
Rob AshbaughSr. Risk Management Consultant
866.603.7029
LinkedIn Groups+ ALLL Forum for Bankers
+ Commercial Credit Risk Professionals
Websites+ www.sageworksanalyst.com
+ www.ALLL.com
CECL Webinar+ Following release of guidance
+ web.sageworks.com/CECL/