LOAN LOSS PROVISIONING

Brian S. McDaniel

ALLOWANCE FOR LOAN LOSSD

efinit

ionReserve for Bad Debts

Valuation reserve established and maintained by charges against a bank’s operating incomeEstimate of uncollectible amounts used to reduce the book value of loans and leases to the amount that a bank expects to collect.

HOW IT WORKSIncome 5% 10% 20%

Loan Income 50,000$ 50,000$ 50,000$ Other Income 3,500$ 3,500$ 3,500$

Total Income 53,500$ 53,500$ 53,500$ Operating Expenses

Loan Servicing 500$ 500$ 500$ Provision for Loss 2,500$ 5,000$ 10,000$

Total Expenses 3,000$ 5,500$ 10,500$ Net Operating Income 50,500$ 48,000$ 43,000$ Non-Operating Expenses

Interest Paid to Depositors 500$ 500$ 500$ (Gain) Loss on Sale of Investment -$ -$ -$

Total Non-Operating Expenses 500$ 500$ 500$ Net Income 50,000$ 47,500$ 42,500$

NET LOAN CHARGE-OFFS

2004 2005 2006 2007 2008 2009 2010 2011 2012 20130.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

0.53%0.54%0.45%

0.51%

0.81%

1.21%1.14%

0.91%

0.73%0.60%

NET CHARGE-OFFS BY TYPE

Credit Card

First Mortgage

Second Mortgage

Business Loans

0.00%0.50%1.00%1.50%2.00%2.50%3.00%3.50%4.00%4.50%5.00%

200720082009201020112012

IASB/FASBJOINT PROPOSALMade at the request of the G20Will Change IFRS 9: Financial InstrumentsWill Replace IFRS 39: Recognition

Comment Deadline: 5 July 2013

WHY ADDRESS IMPAIRMENT?

The existing model delays recognition of credit losses until there is evidence of a credit loss event

HOW WOULD IT HELP?

Expected credit losses would be updated at each reporting date to reflect changes in credit quality

WHO IS AFFECTED?

All entities that hold financial assets or commitments to extend credit that are not accounted for at fair value

PROPOSALStage

I12 Month Expected

Credit Loss

Effective Interest on

Gross Carrying Amount

Stage II

Lifetime Expected

Credit Losses

Effective Interest on

Gross Carrying Amount

Stage III

Lifetime Expected

Credit Losses

Effective Interest on Amortized

Cost Carrying Amount

GAAP/IFRS CONVERGENCE GAAP and IFRS use Incurred Loss Model Both want Expected Loss Model

FASB Proposed Different ModelAn entity would not measure loss allowance

for any financial instrument using 12 Month Expected Credit Loss provisions in IASB proposal

IMPLICATION

• This is a great idea!

IFRS/FASB

• Are you kidding me?

Industry

CITED SOURCES http://www.ifrs.org/Alerts/ProjectUpdate/

Pages/IASB-publishes-revised-proposals-for-loan-loss-provisioning.aspx

http://www.ifrs.org/Current-Projects/IASB-Projects/Financial-Instruments-A-Replacement-of-IAS-39-Financial-Instruments-Recognitio/Impairment/Exposure-Draft-March-2013/Documents/ED-Impairment-Snapshot-March-2013.pdf

http://www.occ.gov/topics/credit/commercial-credit/allowance-loan-lease-losses.html