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GAAP Guidance - FAS 5GAAP Guidance - FAS 5 Accounting standard for loss Accounting standard for loss

contingenciescontingencies Requires accrual for an estimated Requires accrual for an estimated

loss if two conditions are metloss if two conditions are met Applies to the estimation of credit Applies to the estimation of credit

losses on pools of loans, not to losses on pools of loans, not to individually impaired loansindividually impaired loans

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For a loss to be accrued, two conditions For a loss to be accrued, two conditions mustmust

be met:be met: It is probable that an asset has been It is probable that an asset has been

impaired as of the date of the financial impaired as of the date of the financial statements, andstatements, and

The amount of loss can be reasonably The amount of loss can be reasonably estimatedestimated

Definition:Definition:Probable – The future event or events confirming the loss is Probable – The future event or events confirming the loss is

likely to occur likely to occur

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Segment portfolio into pools of loans withSegment portfolio into pools of loans withsimilar risk characteristics, using one or similar risk characteristics, using one or

moremoreof the following:of the following: Risk classification or loan gradeRisk classification or loan grade

(e.g., Watch, Substandard, etc.)(e.g., Watch, Substandard, etc.) Past due statusPast due status Loan typeLoan type IndustryIndustry CollateralCollateral

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Starting point is to determine historical loss Starting point is to determine historical loss rate (or range of loss rates) for each pool of rate (or range of loss rates) for each pool of loans with similar risk characteristics based on loans with similar risk characteristics based on institution’s own loss experience for that poolinstitution’s own loss experience for that pool

Historical net charge-off rates generally usedHistorical net charge-off rates generally used Exceptions – De novo institutions, new loan Exceptions – De novo institutions, new loan

productsproductsNext, consider qualitative or environmentalNext, consider qualitative or environmentalfactors likely to cause estimated credit lossesfactors likely to cause estimated credit lossesto differ from historical loss experienceto differ from historical loss experience

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Qualitative or environmental factors includeQualitative or environmental factors include– Changes in lending policies and procedures, Changes in lending policies and procedures,

underwriting standards, and collection practicesunderwriting standards, and collection practices– Changes in economic and business conditionsChanges in economic and business conditions– Changes in volume and severity of past due and Changes in volume and severity of past due and

adversely classified loans and in volume of adversely classified loans and in volume of nonaccrual loansnonaccrual loans

– Changes in nature, volume, and terms of loansChanges in nature, volume, and terms of loans– Changes in lending management and loan Changes in lending management and loan

reviewreview– Changes in underlying collateral valuesChanges in underlying collateral values– Effect of concentrations and changes in levelsEffect of concentrations and changes in levels

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Reflect overall effect of qualitative factors on Reflect overall effect of qualitative factors on a loan pool as adjustments that increase or a loan pool as adjustments that increase or decrease the historical loss rate on the pooldecrease the historical loss rate on the pool

Alternatively, reflect effect of qualitative Alternatively, reflect effect of qualitative factors through separate standalone factors through separate standalone adjustments within FAS 5 component of the adjustments within FAS 5 component of the ALLLALLL

Evaluating effect of qualitative factors Evaluating effect of qualitative factors requires significant judgment because data to requires significant judgment because data to determine precise impact of factors may not determine precise impact of factors may not be reasonably available or directly applicablebe reasonably available or directly applicable

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If a range of loss rates is developed for a poolIf a range of loss rates is developed for a poolof loans, determine which rate is theof loans, determine which rate is thebest estimate from within the range.best estimate from within the range.

For each pool of loans, apply its adjustedFor each pool of loans, apply its adjustedhistorical loss rate (or its historical loss ratehistorical loss rate (or its historical loss rateand separate standalone adjustments) to theand separate standalone adjustments) to therecorded investment in the pool to determinerecorded investment in the pool to determinethe FAS 5 allowance allocation for each pool.the FAS 5 allowance allocation for each pool.

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Maintain supporting documentation for Maintain supporting documentation for historical loss rate (or range of loss rates)historical loss rate (or range of loss rates)developed for each pool of loansdeveloped for each pool of loans

To support qualitative adjustments, To support qualitative adjustments, maintainmaintain

reasonable documentation explaining howreasonable documentation explaining howadjustments reflect current information,adjustments reflect current information,events, and conditions events, and conditions

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FAS 5 Analysis:FAS 5 Analysis:For homogeneous loans that were not individually For homogeneous loans that were not individually reviewed, the following retail credits were classified reviewed, the following retail credits were classified based on delinquency status:based on delinquency status:

17 Residential mortgages17 Residential mortgages $1,324 Substandard$1,324 Substandard28 Consumer auto loans28 Consumer auto loans $ 248 Substandard $ 248 Substandard $ $ 16 16 LossLoss12 Unsecured consumer I/Ls12 Unsecured consumer I/Ls $ 102 Substandard$ 102 Substandard

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FAS 5 Analysis:FAS 5 Analysis: Management segments the portfolio and Management segments the portfolio and

compiles three-year historical loss data compiles three-year historical loss data (based on net charge-offs to the ALLL) for (based on net charge-offs to the ALLL) for each segment of the portfolio each segment of the portfolio

As of the analysis date, historical loss rates As of the analysis date, historical loss rates for the segments were:for the segments were:– Commercial loans - 0.51%Commercial loans - 0.51%– Commercial real estate loans - 0.5%Commercial real estate loans - 0.5%– Residential mortgages - 0.28%Residential mortgages - 0.28%– Consumer auto loans - 0.30%Consumer auto loans - 0.30%– Unsecured consumer installment loans - 0.42% Unsecured consumer installment loans - 0.42% – Loans fully secured by deposits in bank - 0.00% Loans fully secured by deposits in bank - 0.00%

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FAS 5 Analysis:FAS 5 Analysis: Management also assesses current environmental Management also assesses current environmental

factors and as of the balance sheet date found that:factors and as of the balance sheet date found that:– Due to an oversupply in commercial space in its trade area, Due to an oversupply in commercial space in its trade area,

occupancy rates have declined over the past year. The occupancy rates have declined over the past year. The bank had faced similar market conditions before and losses bank had faced similar market conditions before and losses on commercial real estate loans during those periods were on commercial real estate loans during those periods were about 10% higher than usual. about 10% higher than usual.

– In the past year, several local employers have reported In the past year, several local employers have reported earnings problems and two had already had lay-offs. earnings problems and two had already had lay-offs. Management estimates these factors have caused losses to Management estimates these factors have caused losses to rise on all consumer loans by 10%, on residential rise on all consumer loans by 10%, on residential mortgages by 6%, and on commercial loans by 7% mortgages by 6%, and on commercial loans by 7% compared to the prior three-year period. Management compared to the prior three-year period. Management based these estimates on the increase in loans in 10-30 day based these estimates on the increase in loans in 10-30 day delinquency status in each portfolio segment since the lay-delinquency status in each portfolio segment since the lay-offs began.offs began.

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FAS 5 Analysis:FAS 5 Analysis:Adjusted loss factors developed for the generalAdjusted loss factors developed for the generalloan pools:loan pools:

Commercial loansCommercial loans 0.546%0.546%Commercial real estate loansCommercial real estate loans 0.55%0.55%Residential mortgagesResidential mortgages0.2968%0.2968%Consumer auto loans Consumer auto loans 0.33%0.33%Unsecured consumer installment loansUnsecured consumer installment loans

0.462%0.462%

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FAS 5 Measurement:FAS 5 Measurement:Commercial loansCommercial loans $23,000 x 0.546%$23,000 x 0.546% = $125.6= $125.6

Commercial real estate lnsCommercial real estate lns $14,400 x 0.55%$14,400 x 0.55% = = 79.279.2

Residential mortgagesResidential mortgages $25,825 x 0.2968%$25,825 x 0.2968% = = 76.676.6

Consumer auto loansConsumer auto loans $ 3,784 x 0.33%$ 3,784 x 0.33% = 12.5= 12.5 $ 16 x 100%$ 16 x 100% = 16.0= 16.0

Unsecured consumer I/LsUnsecured consumer I/Ls $ 700 x 0.462%$ 700 x 0.462% = = 3.23.2

Total FAS 5 estimated losses measuredTotal FAS 5 estimated losses measured = $ 313.1= $ 313.1

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Total Allowance Estimate:Total Allowance Estimate:

FAS 114FAS 114 $ 755.0$ 755.0FAS 5FAS 5 313.1313.1

TotalTotal $1,068.1$1,068.1

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ALLL Balance ALLL Balance $1,068.1$1,068.1CRE Loan # 1 confirmed LossCRE Loan # 1 confirmed Loss <50> <50>CRE Loans # 2 & # 3 confirmed Loss CRE Loans # 2 & # 3 confirmed Loss

<72><72>Residential Mortgage # 4 LossResidential Mortgage # 4 Loss <10> <10>Consumer Auto lossConsumer Auto loss <16> <16>

______________Net total ALLLNet total ALLL $920.1 $920.1

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