Successfully Transition to the New CECL Standard · A template for CECL implementation exists in the Federal Government The Federal Credit Reform Act of 1990 (FCRA) mandated that

©2017 FI Consulting. All rights reserved.

Successfully Transition to the New CECL Standard

Insights and Lessons Learned from

U.S. Federal Credit Agencies

August 8, 2017


FI Consulting (FI) helps financial institutions address complex challenges across

risk, finance, and operations. We combine credit modeling, data, and technology

expertise with unique experience across the commercial and government sectors

to deliver solutions that apply leading practices from each.

ROBERT CHANG

Modeling Lead

ROMAN IWACHIW

CEO

MARK JORDAN

GSE Account Leader

INTRODUCTIONS

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AGENDA

BACKGROUND

LESSONS LEARNED

RECOMMENDATIONS Q&A

INTRODUCTIONSAGENDA

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CECL VS INCURRED:

AN ILLUSTRATION


BACKGROUND

FINANCIALS

AUDITS

STAKEHOLDERS

DATA

MODELS

TODAY 2020

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A template for CECL implementation exists in the Federal Government

▪ The Federal Credit Reform Act of 1990 (FCRA) mandated that US government credit

agencies model, financial report, and budget using a lifetime losses approach

▪ Today, more than $3.6 trillion in outstanding credit is reported under FCRA

▪ Estimates are audited and subject to high degree of scrutiny from external oversight

bodies

END OF YEAR 2016 TOTAL ($B)

Outstanding Credit 3,605

NPV of Future Costs 102

BACKGROUND

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Federal agencies who have transitioned to a lifetime credit losses approach

learned the following lessons:

INSIGHTS & LESSONS LEARNED

Financial impact is hard to predict but can be large

There are important stakeholders beyond finance

More data provides more capabilities

Audits are harder and more expensive

Level of model sophistication drives ability to control results

FINANCIAL

STAKEHOLDERS

DATA

AUDITS

MODELS

LESSONS LEARNED BY AGENCIESKEY LESSONS LEARNED

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Financial impact is hard to predict but can be large

FINANCIAL


How will CECL impact the ALLL, earnings, and capital?

“30-50%

increase”

Source: ABA

“Potential high

volatility in credit

loss allowances

under CECL”

FINANCIAL STAKEHOLDERSDATA AUDITSMODELS

“May actually

lower allowances

in some portfolios”

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Impact is uncertain until you make substantial progress towards implementation

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The impact of the transition can be large

The US Government’s shift to lifetime losses

approach raised their credit loss provision by 50% in

year 1 (provision for credit losses increased from

approximately $20B to $30B on a $770B portfolio).


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IMPACT ON FINANCIAL RESULTS CAN BE LARGE, BUT IS UNCERTAINVolatility is not limited to upfront but can persist…

As views of future economic conditions change:

As models are enhanced and updated:

The $14.4 billion increase in liability can be mostly attributed to the

nationwide decrease in projected house price appreciation, which results

in increased claims and lower proceeds from the sale of foreclosed

properties (FHA 2009)


…Net upward reestimate of $209.4 million…due in large part to updated

model assumptions, which will allow for more accurate projections of future

cash flows

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Adjusted

Strategy

Managed

Expectations

Ran New

Process In

Advance

Started

Implementing

Early

The Best Organizations


12


0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

1 2 3 4 5 6 7 8 9 10 11

Loan Age

Lifetime vs Incurred Allowance by Loan Age, Loan-Level Breakdown


*Based on Commercial Business Loans Originated from 1992 – 2017

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More data provides more capabilities

DATA


Federal agencies dealt with serious data challenges

Data is the foundation for “reasonable and supportable”

loan performance estimates


What data do I have?

What is its quality?

How does my data impact my modeling options?

How much data is enough to support my estimates and pass audit?

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Data availability was the first challenge

▪ Organizations scrambled to understand what they had

▪ Federal standards provided a waterfall of options: 1) Use your own historical

data, 2) Use proxy data, 3) Use expert judgement

▪ Data availability challenges are ongoing for new programs and unique

credit products

15

Assembling and Preparing Data Took Significant Time and

Resources



▪ For most organizations, this became a focus after auditors made it one

▪ Typical efforts included profiling, outlier detection, quality business rules

▪ Regime changes were an important consideration

Data quality and suitability followed

16

Assembling and Preparing Data Took Significant Time and

Resources


Shared

Trusted Data

Across the

Organization

Evaluated Data

in Context of

Modeling Goals

Invested Time

to Understand

In-depth



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Built Data

Quality into

Modeling

Processes


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Level of model sophistication drives ability to control results

MODELS



Assumptions-based

Credit Spread Default

Structural Model

Bottom-up Approach

Historical Roll-Rates

Vintage Analysis

Transition Matrix

Discounted Cash Flows

Dynamic Simulation

Many Modeling Options Exist

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INSIGHTS & LESSONS LEARNED MODEL SOPHISTICATION SPECTRUM

LESS COMPLEX MORE COMPLEX

Low Performance Volatility

Small Geographic Footprint

Low Macroeconomic Sensitivity

Small Material Impact on Financials

Wide Range of Performance Outcomes

Presence in Different States/MSAs

Sensitive to Macroeconomic Trends

Large Material Impact on Financials


Fewer resources needed

Less effort to maintain

Generates results quickly

More insight, diagnostics

Allows what-if analysis

Greater long-run benefit

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Monitored

Performance

and Made

Enhancements

Proactively

Used Model

Diagnostics

Calibrated

Model

Complexity to

Portfolio



Embedded

Model in Other

Business

Functions

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There are important stakeholders beyond finance

STAKEHOLDERS


Stakeholders outside of Finance must be engaged to meet CECL’s requirements


INTERNAL

STAKEHOLDERS

EXTERNAL

STAKEHOLDERS

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Formalized

Their

Engagement

Model

Maintained

Engagement

Throughout

the Transition

Proactively

Identified and

Reached Out

Understood

Early Impacts

Would Be

Broad


IDENTIFY & ENGAGE STAKEHOLDERSFINANCIAL STAKEHOLDERSDATA AUDITSMODELS

24


25

Audits are harder and more expensive

AUDITS


INSIGHTS & LESSONS LEARNED AUDIT COMPLEXITY AND COST

Audits will demand additional resources and close interaction with auditors

Data, models and processes more complex

Comprehensive documentation to justify and validate

Stronger governance and control data, models, and documentation

Longer beginning-to-end audit timeframe

Clean Audit


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Planned for

an Extended,

Complex and

Costly Audit

Invested in

Building

Strong

Governance

Justified

Methods with

Clear

Documentation

Established

Better Control

Over Data

and Models


IDENTIFY & ENGAGE STAKEHOLDERSINSIGHTS & LESSONS LEARNED AUDIT COMPLEXITY AND COSTFINANCIAL STAKEHOLDERSDATA AUDITSMODELS

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RECOMMENDATIONSRECOMMENDATIONS

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▪ Start now

▪ Determine where on the modeling options spectrum is

best for your company

▪ Do your best and be able to show it

▪ Make stakeholder management a priority

▪ Recognize the opportunities that CECL can present


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CECL VS INCURRED

An illustration


0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

2002 2004 2006 2008 2010 2012 2014 2016

Lifetime vs Incurred Allowance, FY 2002-2017

CECL Allowance Incurred Allowance Actuals


CECL VS INCURRED ILLUSTRATION

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The reserve for the lifetime allowance is already increasing a few years before the financial crisis. The incurred allowance has a 1-year loss emergence period and does not incorporate future information.


0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Loan Age

Lifetime vs Incurred Allowance by Loan Age

CECL Allowance Incurred Allowance Actuals



Seasonality effects are smoother under the lifetime allowance, because lifetime losses are recognized at loan acquisition. The lifetime and incurred allowances start to converge after the first several years of loan life.


0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

1 2 3 4 5 6 7 8 9 10 11

Loan Age

Lifetime vs Incurred Allowance by Loan Age and Industry Segment

CECL - Construction Incurred - Construction Actuals - Construction

CECL - Professional Services Incurred - Professional Services Actuals - Professional Services

*Based on Commercial Business Loans Originated from 1992 – 2017 32


The level and shape of the allowance curve can be significantly different for different portfolio segments. Identifying each segment's contribution to the overall allowance provides more control and insight.


0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

1 2 3 4 5 6 7 8 9 10 11

Loan Age

Lifetime vs Incurred Allowance by Loan Age, Loan-Level Breakdown

*Based on Commercial Business Loans Originated from 1992 – 2017 33


A loan level model will calculate an allowance curve for each loan in the portfolio depending on that unique borrower’s profile and product type. A loan level model provides powerful flexibility and control.


Q&A

RECOMMENDATIONS

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Roman Iwachiw, CEO | [email protected] Iwachiw is the co-founder and CEO of FI Consulting. He has led financial modeling efforts and developed data and analytics-focused solutions at clients that comprise US government agencies, financial regulators, the GSEs, banks, and non-profit sector lenders.

Mark Jordan, GSE Account Leader | [email protected] Jordan is a portfolio and project management expert with over 15 years of experience working with federal and commercial clients to create best practices for financial management and organizational effectiveness. At FI, he manages teams of modelers and technology experts at our commercial and GSE clients.

Robert Chang, Model Lead |[email protected] Chang has over 12 years experience in financial modeling, risk management, and large scale data analysis working for investment banks and hedge funds. He leads teams that build and validate CCAR, DFAST, and ALLL models for banks and other financial institutions.

ABOUT THE PRESENTERS

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Documents

Successfully Transition to the New CECL Standard · A template for CECL implementation exists in the Federal Government The Federal Credit Reform Act of 1990 (FCRA) mandated that