Back By Popular Demand!

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1 Back By Popular Demand! 1

2 Calculating the Allowance for Loan and Lease Losses 2

3 WHAT IS THE ALLL? 3

4 WHAT IS ITS PURPOSE? A valuation account that estimates the carrying value of your credit union s loans 4

5 BALANCE SHEET PRESENTATION The ALLL is a contra-asset account on the asset side of the balance sheet. CREDIT UNION BALANCE SHEET 12/31/2009 Assets Liabilities & Equity Loans $2,000,000 Accts Pay. $10,000 Less: ALLL -$28,000 Total Liabilities $10,000 Net loans $1,972,000 CREDITS increase the account Recoveries on charged off loans Provision for Loan and Lease Losses Expense DEBITS decrease the account Charge offs 5

6 NCUA s Accounting Bulletin 06-01, Letter to Credit Unions & IRPS 02-3 Guidance for the ALLL: Incorporates Generally Accepted Accounting Principles through: FAS covers large, non-homogeneous loans and Troubled Debt Restructured loans FAS # 5 covers The Pooling method small homogeneous loan pools FAS 114 and FAS 5 apply to all credit unions regardless of size. FAS 114 will generally be limited to Troubled Debt Restructurings (TDRs) for smaller credit unions. 6

7 Factors In Determining ALLL Lending policies and procedures Underwriting standards Nature and volume of asset portfolio Experience and ability of the lending staff Overall quality of loan portfolio Quality of loan review system Degree of oversight by the Board Amount of credit concentrations, economic & business conditions for the credit union 7

8 FAS 5 POOLING METHOD FAS 5 component of ALLL consists of: Losses that are probable The loss can be estimated 8

9 FAS 5 - POOLING METHOD To comply with FAS 5: Group loans by type, delinquency status, credit risk, category, purpose, etc. Step 1 Develop historical loss factor for each pool. Adjust loss factor for relevant external factors Step 2 Apply adjusted loss factors to respective loan pools Step 3 9

10 What are some ways to incorporate STEP #1? What s your Methodology? 10

11 Step 1 Pool (group) loans by type, delinquency status, credit risk, category, purpose, etc. 11

12 Step 2 DEVELOP a historical loss factor for each pool. ADJUST for relevant external factors 12

13 Step 3 Apply adjusted loss factor to individual loan pools 13

14 FAS 5 - RECAP 1. Pool loans by type and delinquency status at a minimum 2. Calculate a loss factor for each pool and adjust for relevant external factors QUESTIONS? 3. Apply adjusted loss factor individually to each loan pool 14

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16 FAS 114 INDIVIDUAL IMPAIRMENT Covers large, non-homogeneous loans like: Unique business loans (material credit exposure) Large business loans Large agricultural loans Troubled Debt Restructured Loans This analysis is separate and distinct from the FAS #5 pooling analysis 16

17 FAS 114 INDIVIDUAL IMPAIRMENT Three acceptable means of measurement: Present Value of expected future cash flows discounted at the loan s effective interest rate Fair Value of collateral (for collateral dependent loans) Market Value of collateral (observable) 17

18 ITEMS FOR CONSIDERATION Volatility of the market value of the collateral; Reliability and date of the appraisal or other valuation; Date of the inspection of the collateral; Historical losses on similar loans; Confidence in the credit union s lien or security position Other factors as appropriate for the loan type. 18

19 What are TDRs? Troubled Debt Restructurings 19

20 Debt settled at less than carrying value Modification of debt terms 20

21 A TDR IS NOT THE FOLLOWING: 21

22 FAS 114 Individual Impairment Example Individually Impaired Loans Acct Name Loan type Balance Notes Impairment 4733 F. Astaire Travel Trailer $65,000 TDR member Bankrupt - $45,000 appraisal and $3,000 costs of sale, restructured loan per court order and reduced balance to $45,000 $23, T. Smith Real Estate $70,000 TDR member unemployed for 14 months $60,000 appraisal and $7,600 costs of sale and $2,400 repairs (reduced rate to below market) $20,000 Total Individually Impaired $135,000 $43,000 22

23 You Call It! 23

24 Is it or Isn t it a TDR? John Member has asked for a one month extension because he had some unexpected expenses. Credit union grants one month extension. The credit union regularly grants extensions. 24

25 Is it or Isn t it a TDR? Mary C. has two loans with the credit union. She is having trouble making both payments so the credit union is refinancing the two loans into one, thus reducing Mary C. s payment. The interest rate granted is a market rate. 25

26 Is it or Isn t it a TDR? Joe M. is four months behind on his HELOC. Joe informs the credit union that he is unemployed with no additional income. The credit union allows Joe to pay six months interest only payments under a short-term plan The credit union also agrees to waive all of the accrued interest to-date on the loan. The interest amounts to $3,

27 Fred S. is consistently two months late on his auto payments for a 2008 Saturn due to his business faltering over the past year. Since the auto is no longer manufactured and Fred s income is reduced, he wants to give the vehicle back to the credit union. Fred S. owes the credit union $13,233 and the same year Saturn has an auction wholesale value of $8,500. The credit union agrees to lower Fred s interest rate from 5.90% to 1.90%, write down the loan to its current market value of $ 11,700 and reduce his monthly payments. 27

28 FAS RECAP TDRs must be assessed under FAS 114. Reminder!!! an impaired loan under an FAS 114 analysis is not included in the FAS 5 analysis. Document the analysis and don t double count. 28

29 PRACTICE SETS FOR FAS

30 ELEMENTS OF THE ALLL Your ALLL analysis must include FAS 5 and FAS 114 elements Pooling/Historical Factor (FAS 5) External Factors (FAS 5) Individual Impairment (FAS 114) Required Allowance 30

31 ADJUSTING THE ALLL If summary report shows ALLL is underfunded increase the balance to the appropriate amount by: Debit Provision for Loan and Lease Losses EXPENSE Credit Allowance for Loan and Lease Losses If summary report shows the ALLL is overfunded decrease the balance to the appropriate amount by: Debit Allowance for Loan and Lease Losses Credit Provision for Loan and Lease Losses EXPENSE 31

32 VALIDATING ALLL METHODOLOGY Establish procedures to re-evaluate & periodically test the appropriateness of your methodology. Include a look back to see if estimates were subsequently confirmed or if necessity exists to adjust estimates accordingly. Review by a party independent of ALLL estimation process (e.g. Supervisory Committee, auditor). As long as your methodology is reasonable, defensible, and documented, it should be acceptable. 32

33 WHAT IS THE RESPONSIBILITY OF THE BOARD IN MAINTAINING THE ALLL? Ensure controls are in place Instruct management to develop a process Ensure that all related policies specifically address the credit union s unique goals Review the amount of periodic ALLL and PLLL adjustments Validate Methodology 33

34 POLICIES AND PROCEDURES Roles & Responsibilities Accounting policies Description of methodology Documentation requirements Internal control system Well defined loan review process 34

35 TDRs and the Call Report 35

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38 KEY POINTS SUMMARY Credit unions should follow Supervisory guidance consistent with GAAP Management is responsible Pooling and Individual Impairment Analyses (FAS 5 &114) Review for environmental factors Independent review (validation) Maintain documentation! 38

39 FAS 5 FAS 114 Pool loans Develop loss factor Apply to loan pools Analyze individual loans Fair value, cash flow, market price Estimated ALLL 39

40 QUESTIONS 40