Understanding the NEW DISCLOSURES FOR THE ALLOWANCE FOR CREDIT LOSSES

Understanding the NEW DISCLOSURES FOR THE ALLOWANCE FOR CREDIT LOSSES

Executive Summary & Recommendations This document refers to the recent changes in disclosure requirements for financing receivables and the allowance for credit losses that became effective during 2010 for public companies and are effective for nonpublic companies during 2011 (including at December 31, 2011). These changes are applicable for all companies with long-term financing receivables. At first glance the disclosure seems to be a straightforward expansion of current requirements. However, upon further review, there are many details to be addressed before a well thought out plan can be implemented. Nonpublic companies may be thinking, We don t have to deal with this until the end of 2011. However, roll- forward information is required for both public and nonpublic companies for 2011 activity. Accordingly, in order to prevent a painful fire drill, we recommend focusing attention and allocating resources to this matter as soon as possible and well in advance of December 31, 2011. In fact, for nonpublic companies that have not yet adopted any of the new disclosure provisions, we feel it is a best practice to obtain or develop a template for the new disclosures applicable to your company and prepare a dry run of the disclosures in advance of your initial implementation date. The new standard requires expanded disclosures focused around segments and classes of financing receivables. After initial discussions with some clients, it was clear that there were many possible answers, but no clear cut answers. On a positive note, some of this data is similar to a board report or call report data which is causing some of our clients to say, This is great, we have a head start! However, what is the documentation expectation for the board reports and call reports? As a friendly reminder, please remember to consider your auditor when compiling the necessary information because it will be audited. The more documentation you have to support your numbers, the easier it will be on both parties. Finally, our recommendations are clear. Don t wait, to address the following topics: What are our segments? What are our classes? Does our system have sufficient coding to extract data easily? Are we sure the coding in our system is correct? Who is compiling the data (accounting, lending, etc.)? Who is writing the new credit quality narrative and policy disclosures? Have we been effectively tracking roll-forward information since January 1, 2011? If not, do not delay any further. Can the data be audited easily? Table of contents Executive Summary and Recommendations Disclosure Changes for the Allowance for Credit Losses ASU 2010-20 1 Allowance Disclosures ASU 2010-20: Segment Data & Activity 3 Credit Quality Indicators 4 Modifications 5 Impaired Credits 6 Past Due 7 Nonaccrual 8 Effective Date 8 Glossary 9

Disclosure Changes for the Allowance for Credit Losses ASU 2010-20 1 Overview The FASB has issued Accounting Standards Update ( ASU ) 2010-20 to address concerns about the sufficiency, transparency, and robustness of credit risk disclosures for financing receivables and the related allowance for credit losses. The ASU requires that companies disclose information at disaggregated levels, specifically defined as portfolio segments and classes. Among other things, the expanded disclosures include roll-forward schedules of the allowance for credit losses and information regarding the credit quality of receivables (including their aging) as of the end of a reporting period. Certain finance receivables that were modified during a reporting period and those that were previously modified and have redefaulted require enhanced disclosures. For public companies, the new disclosures are required for interim and annual periods ending after December 15, 2010. Although the disclosures of reporting period activity (i.e., allowance roll-forward and modification disclosures) are required for interim and annual periods beginning after December 15, 2010. For nonpublic companies, all disclosures are effective for interim and annual periods ending after December 15, 2011. This disclosure change stems from a combination of the economic downturn, receivable losses, and a lack of consistency related to the disclosures related to the problem assets. The SEC noted that some registrants tried to address the issues by disclosing more in the MD&A; however, there was a lot of diversity and inconsistency. This update also requires increased disclosure regarding the allowance for credit losses, specifically activity in the allowance (by portfolio segment), and the factors and methodologies used in estimating the allowance for each portfolio segment. A significant change from the current requirements includes accounting policy disclosures by portfolio segment. These disclosures include the general allowance policy, any changes in the policy, and the charge-off policy.

Disclosure Changes for the Allowance for Credit Losses ASU 2010-20 Scope and Definitions The update includes definitions related to certain terms. This update includes the term finance receivables, which is defined as: A contractual right to receive money, on demand or on fixed or determinable dates, that is recognized as an asset in the creditor s balance sheet, whether originated or acquired by the creditor. Accounts receivable with terms exceeding one year are considered finance receivables subject to the provisions of the new requirements. Other in-scope lending arrangements include notes receivable and receivables relating to lessors rights to payments from leases (other than operating leases) that have been recorded as assets (i.e., leveraged, direct financing, and sales-type leases). The update excludes: Trade account receivables with maturities of one year or less (not including credit card receivables); Debt securities; and Receivables measured at fair value with changes recorded in earnings and receivables measured at lower of cost or market (LCM). This update requires disclosures on portfolio segments and classes. Classes are defined as a level of information below the portfolio segment level. Examples in the update and industry norms will drive the disclosures; however, there are many ways to address the requirement. As a practical expedient, one may be able to use the disaggregation within the call report. Classes include a more descriptive, disaggregated level of information (such as commercial construction loans within the commercial loans portfolio segment). The class disclosure may include the method used for assessing and monitoring credit risk (large non-homogenous vs. smaller homogenous). Finally, class disclosure also factors credit quality (such as loan-to-value, credit score, internal ratings, etc.). 2

Allowance Disclosures ASU 2010-20 Segment Data & Activity The update requires disclosures at a segment level. The disclosure example below has typical examples of segments (commercial loans, commercial real estate loans, etc.). Each company can vary widely as it relates to the number and nature of segments that are disclosed. A relevant factor is how internal systems are coded. Another factor might be that segmentation exists in the existing allowance for credit losses (ALLL) analysis prepared each quarter. Allowance for Credit Losses and Recorded Investment in Financing Receivables For the Years Ended December 31,, and Real Estate Consumer Residential Finance Leases Unallocated Total Allowance for credit losses: Beginning balance Charge-offs Recoveries Provision Ending Balance $230 (86) 22 273 $439 $300 (113) 24 356 $567 $80 (29) - 95 $146 $130 (48) - 154 $236 $50 (23) 4 59 $90 $10 - - 12 $22 $800 (299) 50 949 $1, Ending balance: individually evaluated for impairment $108 $141 $37 $60 $20 $6 $372 Ending balance: collectively evaluated for impairment $255 $329 $84 $142 $55 $12 $877 Ending balance: loans acquired with deteriorated credit quality $76 $97 $25 $34 $15 $4 $251 Financing Receivables: Ending balance $34, $45,000 $1 $19, $7, $1, $120,000 Ending balance: individually evaluated for impairment $8,600 $11,300 $3,000 $4,900 $1,800 $400 $30,000 Ending balance: collectively evaluated for impairment $20,100 $26,200 $7,000 $11,400 $4,400 $900 $70,000 3 Ending balance: loans acquired with deteriorated credit quality $5,800 $7, $ $3,200 $1,300 $200 $20,000

Allowance Disclosures ASU 2010-20 Credit Quality Indicators The update requires disclosures regarding credit quality at a class level. As mentioned above, credit quality includes many items but specifically the following is required: Description of the indicator and related carrying amount; Disclosure of the date or range of dates when the indicators were last updated; Discussion related to the meaning of internal descriptions and the likelihood of loss if internal quality indicators are used, such as internal risk ratings. The above disclosures can vary widely as they relate to how detailed a company will be in disclosing internal ratings and the related definitions. Regardless, FASB felt that the increased disclosure will be an improvement and more informative than before. Corporate Credit Exposure Credit Risk Profile by Creditworthiness Category Credit Quality Indicators As of December 31,, and Real Estate Construction Real Estate Other 1 2 3 4 5 6 7 $8,000 7,000 1 5,000 $4,000 9,000 400 $9,000 8,000 13,000 6,000 1,900 $5,000 3,000 4,000 4,000 3, $ 900 600 100 $900 700 400 900 100 total $34, $18,400 $39,900 $20,000 $5,100 $4,000 Residential Credit Exposure Credit Risk Profile by Internally Assigned Grade Residential Prime Residential Subprime Grade Pass Special mention Substandard $8,000 400 1, $4,000 1,100 $7,300 600 1,700 $3,000 900 450 total $9,900 $6,100 $9,600 $4,350 Consumer Credit Exposure Credit Risk Profile Based on Payment Activity Consumer Credit Card Consumer Other Finance Leases Consumer Auto Performing Nonperforming total $2,700 800 $3, $1, 200 $1,700 $3,000 $5,000 $1,200 1,800 $3,000 $7,300 200 $7, $ 1,940 $3,940 $1,100 2,400 $3, $1, 200 $1,700 4

Allowance Disclosures ASU 2010-20 Modifications Another significant change relates to increased disclosures for modified credits. The TDR rules now apply to leases which were previously scoped out of the disclosure requirements. The new requirements include more qualitative information about how credits were modified (by class). Further, more quantitative information about the extent and financial effects of modifications (by class) is now required. A description of how modifications are factored in the determination of the allowance for credit losses. Finally, disclosures related to TDRs that have defaulted under the new terms are new and required by class and the amount. Effective dates are the third quarter for public filers and 12/31/12 for private companies. Modifications As of December 31,, and Troubled Debt Restructurings Number of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Number of Contracts Pre-Modification Outstanding Recorded Investment Post-Modification Outstanding Recorded Investment Residential prime Residential subprime Consumer other Finance leases 20 1 3 $ $1,800 $2,900 $1,900 $1,700 $2,550 4 1 1 $400 $700 $1,800 $360 $640 $1,700 Troubled Debt Restructurings That Subsequently Defaulted Number of Contracts Recorded Investment Number of Contracts Recorded Investment 5 Residential prime Residential subprime Consumer other Finance leases 2 1 $200 $700 1 $100

Allowance Disclosures ASU 2010-20 IMPAIRED Much of the delinquency and impaired credit disclosures are the same. The sample table below covers the required amounts at the class level. There are additional narrative or policy disclosures. The full disclosures related to impaired credits include: The policy by which assets are assessed for impairment; The policy for recognizing interest income on impaired credits (could include impaired and nonaccrual, impaired and accruing); The total amount of impaired assets (with and without an allowance allocated) for each period that a balance sheet is presented; Factors used to determine the impairment; and The average carrying value and related interest income recognized (and related cash basis) for each period that an income statement is presented. Impaired Loans For the Years Ended December 31,, and Recorded Investment Unpaid Principal Balance Related Allowance Average Recorded Investment Interest Income Recognized With no related allowance recorded: Consumer credit card Consumer other Consumer auto With an allowance recorded: Real Estate construction Real Estate other Residential prime Residential subprime Total: Real Estate Consumer Residential $450 690 380 9, 1,100 4,300 3,850 $450 $10,600 $2,070 $8,150 $ 800 1,100 9,900 1,200 4, 4,000 $ $11,100 $2,400 $8, 128 15 58 52 $143 $110 $380 650 865 320 7,200 920 3,800 2,900 380 $8,120 $1,835 $6,700 $11 40 45 12 240 29 99 97 $11 $269 $97 $196 6

Allowance Disclosures ASU 2010-20 Past Due Many of the delinquency and nonaccrual disclosures are the same; the new one relates to the aging detail. The sample table below covers the required amounts at the class level. There are additional narrative or policy disclosures. The full disclosures related to past due credits include: Disclosing the policy for determining past due or delinquency status; Disclosing the age of the carrying amount of the delinquent assets at the end of the period; Disclosing the amount past due 90 days and still accruing interest; Disclosing the nonaccrual policy (putting assets in, taking them out, and recognizing income); and Disclosing the carrying amount of the nonaccrual assets at the end of the period. Age Analysis of Past Due Financing Receivables As of December 31,, and 30-59 Days Past Due 60-89 Days Past Due Greater Than 90 Days Total Past Due Current Total Financing Receivables Recorded Investment > 90 Days and Accruing 7 Real Estate: Real Estate construction Real Estate other Consumer: Consumer credit card Consumer other Consumer auto Residential: Residential prime Residential subprime Finance leases Unallocated Total $2, 200 600 1,200 700 300 100 $9,100 $1, 3, 800 300 400 900 300 300 $8, $6,000 6, 2, 1,600 1, 1,800 1,900 80 100 $22,480 $10,000 1 4,300 2, 3,000 3,300 3,100 680 200 $78,620 $24, 27,900 800 2, 2, 6,600 6, 6,820 1,300 $78,620 $34, 39,900 5,100 3, 5,000 3, 9,900 9,600 7, 1, $120,000 $900 900 730 40 20 50 650 90 80 $3,460

Allowance Disclosures ASU 2010-20 Nonaccrual Financing Receivables on Nonaccrual Status As of December 31,, and real estate: Real Estate - construction Real Estate - other Consumer: Consumer - credit card Consumer - other Consumer - auto Residential: Residential - prime Residential - subprime Finance leases Total $400 9,000 690 380 4,300 3,850 $20,620 $4,000 7,000 700 400 2, 1,800 $18,900 Allowance Disclosures ASU 2010-20 summary The roll-forward activity requirement in 2011 encourages, but does not require, the disclosure of earlier periods. Internal reporting will likely change. With so much disclosure required by class, the reporting changes internally are irrelevant until the class issue is resolved. The bigger question is the bank s identification and definition of portfolio segment and class. 8

Glossary Below is a glossary that discusses potential definitions of common terms used in the ASU: RECORDED INVESTMENT The recorded investment means the exposure amount reported on the financial company s balance sheet. Thus, the recorded investment would mean the net outstanding credit balance as carried on the balance sheet. For example, an impaired credit with a $ unpaid principal balance that had a $100 partial charge-off and a current $250 specific reserve could have a recorded investment of $650. AVERAGE RECORDED INVESTMENT This guidance does not specify how a creditor shall calculate the average recorded investment but does indicate that averages based on month-end balances may be considered an appropriate method. CREDIT QUALITY INDICATORS Judgment should be used in determining the appropriate credit quality indicator for each class of financing receivables. Examples of credit quality indicators include: An company s internal credit risk grades Consumer credit risk scores Credit rating agency ratings Loan-to-value ratios Collateral Collection experience Other internal metrics PORTFOLIO SEGMENT FASB defines the portfolio segment to be consistent with the way a creditor is expected to develop its allowance for credit losses method on the basis of the guidance set forth by the FFIEC Interagency Policy Statement on Allowance for Credit and Lease Losses. All of the following are examples of portfolio segments: Type of financing receivable (commercial, commercial real estate, consumer, etc.) Industry sector of borrower (food, real estate, agriculture, construction, etc.) Risk rate(s) 9 CLASSES Further disaggregation of portfolio segments are not prescribed by the FASB. However, the FASB does indicate that the classes generally should be consistent for each type of disclosure. An example of a class could be auto credits under the consumer portfolio segment.

To answer any questions you may have, please contact one of our financial institutions specialists: Jon Chism 616.643.4023 jon.chism@plantemoran.com Kris Hoefler 614.222.9083 kris.hoefler@plantemoran.com John Miller 248.375.7225 john.miller@plantemoran.com Chris Ritter 312.602.3601 chris.ritter@plantemoran.com