Allowance for Loan and Lease Losses. III. Measuring Impairment Under ASC 310

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1 Allowance for Loan and Lease Losses III. Measuring Impairment Under ASC 310

2 Measuring Impairment Under ASC 310 Three Methods Present Value of Expected Future Cash Flows Fair Value of Collateral Observable Market Price of the Loan

3 Measuring Impairment Appropriate Discount Rate Balloon Payments and Terminating Cash Flows Reasonable Expected Future Cash Flow Present Value of Expected Future Cash Flows Method Default Risk Adjustment

4 Definition of Collateral Dependent A loan is collateral dependent if repayment of the loan is expected to be provided solely by the underlying collateral and there are no other available and reliable sources of repayment. Source: Call Report Instructions

5 Measuring Impairment Collateral Dependent Repayment from Selling the Collateral Loan Balance As is Fair Value Cost to Sell Charge Off

6 Measuring Impairment Loan Balance Collateral Dependent Stabilized Value Impairment Charge Off Remaining Impairment Charge Off Repayment from As Is Fair Value Operating the Income-Producing Real Estate Collateral Assurance Of Repayment Yes No No Stabilizing Yes Yes No

7 Measuring Impairment Observable Market Price of Loan This method is uncommon Price documentation must include: Amount Source Date

8 Measuring Impairment Measured Impairment Zero

9 Measuring Impairment Timing of Collateral Inspection Confidence in the Lien Position Timing and Reliability of Appraised Value Volatility of Fair Values Reliability of Fair Value Historical Losses on Similar Loans Other Factors as Appropriate

10 Measuring Impairment Example 1 Collateral initially owner occupied but now leased Lease income may be insufficient to service the loan Borrower has no other significant assets or other cash flow sources Sale or foreclosure of the collateral is not expected What is the appropriate method for measuring impairment? Fair Value of Collateral Method

11 Measuring Impairment Example 1 Collateral initially owner occupied but now leased Lease income may be insufficient to service the loan Borrower has no other significant assets or other cash flow sources Sale or foreclosure of the collateral is not expected Are selling costs deducted from the fair value of the collateral? No

12 Measuring Impairment Example 1 Collateral initially owner occupied but now leased Lease income may be insufficient to service the loan Borrower has no other significant assets or other cash flow sources Sale or foreclosure of the collateral is not expected Does the impairment amount remain in the ALLL, is there a confirmed loss to charge off, or is it a combination of both? It Depends

13 Measuring Impairment Loan Balance Collateral Dependent Stabilized Value Impairment Charge Off Remaining Impairment Charge Off Repayment from As Is Fair Value Operating the Income Producing Real Estate Collateral Assurance Of Repayment Yes No No Stabilizing Yes Yes No

14 Measuring Impairment Example 2 Working capital line for auto body shop Collateral is accounts receivable, inventory, fixed assets, and a 2 nd deed of trust on residence Business generates adequate cash flow to service the loan Internally identified as impaired due to delinquency What is the appropriate method for measuring impairment? Present Value of Expected Future Cash Flows

15 Measuring Impairment Example 2 Working capital line for auto body shop Collateral is accounts receivable, inventory, fixed assets, and a 2 nd deed of trust on residence Business generates adequate cash flow to service the loan Internally identified as impaired due to delinquency What assumptions should be considered when estimating cash flow? Best Estimate Amount, Timing, Default Assumptions

16 Measuring Impairment Example 2 Working capital line for auto body shop Collateral is accounts receivable, inventory, fixed assets, and a 2 nd deed of trust on residence Business generates adequate cash flow to service the loan Internally identified as impaired due to delinquency Does the impairment amount remain in the ALLL, is there a confirmed loss to charge off, or is it a combination of both? Impairment Remains in the ALLL

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