How CECL Will Impact Your Credit Union & What You Can Do to Prepare For It: Part 2 Randy C Thompson, Ph.D. TCT Risk Solutions, LLC 1
Impact on ALLL Calculation Grade Balance Loss Factor ALLL Req. Baseline ALLL A+ $ 755,000 0.00% $ - Calculation with A $ 649,000 0.00% $ - Incurred Loss B $ 315,600 0.27% $ 852.12 Application C $ 126,000 0.00% $ - D $ 98,000 4.56% $ 4,468.80 E $ 57,000 6.54% $ 3,727.80 Missing $ 34,000 8.98% $ 3,053.20 $ 2,034,600 $ 12,101.92
Impact on ALLL Calculation The first point is the impact on base line ALLL Calculation • All loans must have a risk amount • All grades must have an loss factor and ALLL amount • No zero loss factors
Grade Balance Loss Factor ALLL Req. Impact on ALLL A+ $ 755,000 0.05% $ 377.50 A $ 649,000 0.15% $ 973.50 Calculation B $ 315,600 0.35% $ 1,104.60 C $ 126,000 0.79% $ 995.40 D $ 98,000 5.65% $ 5,537.00 E $ 57,000 9.87% $ 5,625.90 • Same baseline Auto loan pool Missing $ 34,000 10.25% $ 3,485.00 • Expected Loss factors added $ 2,034,600 $ 18,098.90 to all grades
Impact on ALLL Calculation The initial impact is noticeable Baseline Incurred requirement $ 12,101.92 Baseline Expected Loss requirement $ 18,098.90 Increase requirement $ 5,996.98 Increase Percent 49.6%
Impact on ALLL New Loans % of Growth A+ $ 50,000 24.39% Calculation A $ 50,000 24.39% B $ 50,000 24.39% • Next financial impact to C $ 25,000 12.20% consider relates to loan D $ 10,000 4.88% growth • Lets assume this credit E $ 10,000 4.88% union increases loans Missing $ 10,000 4.88% by $205,000 • No incurred losses in $ 205,000 100.00% the period
Impact on ALLL Calculation Steps 1. Increase each grade by indicated amount 2. Apply ALLL loss factor to each grade 3. Total new ALLL requirement
Grade Balance Loss Factor ALLL Req. Impact on ALLL A+ $ 805,000 0.00% $ - Calculation A $ 699,000 0.00% $ - B $ 365,600 0.27% $ 987.12 C $ 151,000 0.00% $ - New ALLL D $ 108,000 4.56% $ 4,924.80 calculation for E $ 67,000 6.54% $ 4,381.80 this pool Missing $ 44,000 8.98% $ 3,951.20 $ 2,239,600 $ 14,244.92
Impact on ALLL Calculation Impact of loan growth with incurred loss model Baseline Incurred requirement $ 12,101.92 Loan growth incurred requirement $ 14,244.92 Increase requirement $ 2,143.00 Increase Percent 17.7%
Impact on ALLL Calculation Now calculate the impact with CECL Grade Balance Loss Factor ALLL Req. A+ $ 805,000 0.05% $ 402.50 A $ 699,000 0.15% $ 1,048.50 B $ 365,600 0.35% $ 1,279.60 C $ 151,000 0.79% $ 1,192.90 D $ 108,000 5.65% $ 6,102.00 E $ 67,000 9.87% $ 6,612.90 Missing $ 44,000 10.25% $ 4,510.00 $ 2,239,600 $ 21,148.40
Impact on ALLL Calculation Adjusting to CECL early minimizes the overall impact Baseline Incurred requirement $ 12,101.92 Loan growth incurred requirement $ 21,148.40 Increase requirement $ 9,046.48 Increase Percent 74.8% Baseline CECL requirement $ 18,098.90 Loan growth CECL requirement $ 21,148.40 Increase requirement $ 3,049.50 Increase Percent 16.8%
Preparing for CECL 1 2 3 Build on Identify Apply • Build on Credit • Identify losses rates • Apply to existing Migration Base methodology
Focus is on Regression is Expected The primary Regression the Independent an analysis statistical analysis is relationship variable(s) = for For our Dependent tool for widely used between a Those factors estimating purposes we variable = quantifying for dependent that are the causal will consider Expected Credit Losses causality is prediction variable and connected to relationship that: Loan Losses Multiple and one or more (or predict) among Regression forecasting independent losses variables variables 13
Expected Credit Losses Regression analysis identified the following Loan to value (subject to factors as the primary existing risk change) predictors of impending loss Changing economic Deterioration of credit conditions (relates to score employment and cash flow) Changing income or Advanced Delinquency discretionary cash flow
Formula for describing Expected Risk of Loss R T = (R C + G A ) + (R IC + R EC ) Where: Expected R T = Total Risk Credit Losses R C = Core Risk G A = Grade Adjustment R IC = Individual Risk Change R EC = Economic Risk Change 15
Initial Loss Expectation based on: Should be addressed in • R C = Core Risk Loan Pricing • G A = Grade Adjustment Expected They provide a starting Implies that we are using point for calculating a valid pricing model that expected credit loss at quantifies loss risk in Credit Losses loan funding loan rates This formula repeats for each loan type addressing the CECL requirement regarding similar loan analysis 16
Expected Credit Losses The remaining variables in the formula deal with changes 1. R IC = Individual Risk Change 2. R EC = Economic Risk Change Movement of credit score, as indicated in credit migration provides the measurement of these variable. 17
Expected Credit Losses A reminder of foundational considerations in CECL • Similar loans • Life of loan • Probability of Loss • Likelihood of loss or no loss • Based on solid statistical analysis 18
Key Aspects of CECL Response Initial Risk based These on: factors Establishes • Core Risk should be the starting • Grade Adjustment incorporated point for any in Loan and all loans Pricing 19
How to Implement • Step 1: Calculate historical loss model for “similar loans”. • Analyzed actual loss rates over an entire economic cycle. • Identified minimum loss and maximum loss • Multiple distinct pools to match iterations of loans 20
How to Implement Step 1: Calculate historical loss model for “similar loans”. • Sample Loan Pool – New Auto Repeat for each Credit Grade • Isolate Credit Grade – A+ • Identify minimum loss factor – 0.001% • Identify maximum loss factor – 0.091% 21
How to Implement • Step 2: Consider conditions that led to loss over life of loan. • Conduct MANOVA to partition losses into sub-ranges for each grade • Connect sub-ranges to economic condition • Calculate mid-point for use in ALLL calculation 22
How to Implement • Step 2: Consider conditions that led to loss over life of loan. • Sample Loan Pool – New Auto • Range 0.001% to 0.091% • Sub-ranges 1 2 3 4 5 6 0.001% 0.019% 0.037% 0.055% 0.073% 0.091% 23
How to Implement • Step 3: Compare with present day conditions. • Maintain a 3-5 year rolling average loan loss • Connect actual loss to projected • Consider all risk factors in ALLL calculation 24
How to Implement 1 2 3 4 5 6 0.001% 0.019% 0.037% 0.055% 0.073% 0.091% • Step 3: Compare with present day conditions • Sample Loan Pool – New Auto • 5 Year Loss Ratio – 0.29% 25
How to Implement • Step 4: Evaluate future conditions • Conduct annual update of population loss experience • Update ranges and sub-ranges for all pools • Adjustments to historical loss model can increase or decrease the overall allowance 26
Sample CECL Matrix 1 2 3 4 5 6 A+ 0.001% 0.019% 0.037% 0.055% 0.073% 0.091% A 0.003% 0.052% 0.102% 0.151% 0.201% 0.250% B 0.008% 0.144% 0.280% 0.416% 0.552% 0.688% C 0.021% 0.395% 0.769% 1.144% 1.518% 1.893% D 0.057% 2.002% 3.946% 5.891% 7.835% 9.780% E 0.157% 3.303% 6.448% 9.594% 12.739% 15.885% No Score 0.315% 5.977% 11.638% 17.300% 22.962% 28.624%
How to Implement Adjustments to Movement of credit historical loss model can scores may increase or increase or decrease the decrease overall overall allowance allowance 28
1 2 3 4 5 6 A+ 0.001% 0.019% 0.037% 0.055% 0.073% 0.091% A 0.003% 0.052% 0.102% 0.151% 0.201% 0.250% Starting point B 0.008% 0.144% 0.280% 0.416% 0.552% 0.688% for sample loan C 0.021% 0.395% 0.769% 1.144% 1.518% 1.893% D 0.057% 2.002% 3.946% 5.891% 7.835% 9.780% E 0.157% 3.303% 6.448% 9.594% 12.739% 15.885% No Score 0.315% 5.977% 11.638% 17.300% 22.962% 28.624%
Credit grade drops to D 1 2 3 4 5 6 A+ 0.001% 0.019% 0.037% 0.055% 0.073% 0.091% A 0.003% 0.052% 0.102% 0.151% 0.201% 0.250% B 0.008% 0.144% 0.280% 0.416% 0.552% 0.688% C 0.021% 0.395% 0.769% 1.144% 1.518% 1.893% D 0.057% 2.002% 3.946% 5.891% 7.835% 9.780% E 0.157% 3.303% 6.448% 9.594% 12.739% 15.885% No Score 0.315% 5.977% 11.638% 17.300% 22.962% 28.624%
Expected loss increases to Range 3 1 2 3 4 5 6 A+ 0.001% 0.019% 0.037% 0.055% 0.073% 0.091% A 0.003% 0.052% 0.102% 0.151% 0.201% 0.250% B 0.008% 0.144% 0.280% 0.416% 0.552% 0.688% C 0.021% 0.395% 0.769% 1.144% 1.518% 1.893% D 0.057% 2.002% 3.946% 5.891% 7.835% 9.780% E 0.157% 3.303% 6.448% 9.594% 12.739% 15.885% No Score 0.315% 5.977% 11.638% 17.300% 22.962% 28.624%
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