(ALLL)*

The views and opinions expressed are those of the presenter and are not necessarily those of the

Federal Reserve Bank of Atlanta or the Board of Governors of the Federal Reserve System.

Allowance for Loan and Lease Losses

Key observations during the financial crisis

What are the current conditions out in the field

Key asset quality indicators

Exam related issues

Proposed changes to the ALLL

1

Key Observations During the Financial Crisis

◦ ALLL levels not commensurate with the overall risk in the portfolio

◦ Charge offs over a short compressed timeframe

◦ Provision requirements led to a significant erosion of capital and in some cases bank failures

2

What are the Current Conditions Out in the Field?

◦ Improving economic indicators leading to a reduction in past due and nonaccrual loans

◦ Charge offs have reduced significantly

◦ Minimal provision requirements and in some cases reverse provisions.

3

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

2008Q2 2009Q2 2010Q2 2011Q2 2012Q2 2013Q2

Net

charg

e o

ffs/

Avera

ge L

oans

(%)

National Charge-off Ratio

Net charge offs/average loans

4 per. Mov. Avg. (Net charge offs/average loans)

Source: Bank Call Reports

4

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

2008Q2 2009Q2 2010Q2 2011Q2 2012Q2 2013Q2

Nonperf

orm

ing A

ssets

/Tota

l Loans

+ O

REO

(%

)National Nonperforming Assets

Source: Bank Call Reports

5

$0

$1

$2

$3

$4

$5

$6

$7

$8

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

$Billions

Sixth District Net Charge-Offs

Annualized Net Charge-Offs

4Q Moving Average

Source: Bank Call Reports

6

0%

1%

2%

3%

4%

5%

6%

7%

$0

$2

$4

$6

$8

$10

$12

$14

$16

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Noncurre

nt L

oans/T

ota

l Loans

$ B

illions

Sixth District Noncurrent Loans

Noncurrent Loans

Noncurrent Loans/Total Loans (%)

Source: Bank Call Reports

7

0%

50%

100%

150%

200%

250%

300%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Covera

ge R

atio

:Loan L

oss R

ese

rves/N

oncurre

nt L

oansL

oan L

oss

Rese

rves/

Tota

l Loans

(%)

Sixth District Loan Loss Reserves

Loan Loss Reserves/Total loans (%)

Coverage Ratio

Source: Bank Call Reports

8

4.00

0.90

1.81

0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2005 2006 2007 2008 2009 2010 2011 2012 2013Q1 2013Q2

25th Percentile

Median

Reserves/ Nonaccrual Loans (X)

Source: Bank Call Reports

9

0.40

-0.10

-0.13

-0.52

-1.0%

-0.8%

-0.6%

-0.4%

-0.2%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

2005 2006 2007 2008 2009 2010 2011 2012 2013Q12013Q2

25th percentile

Median

Building/Releasing Reserves

Source: Bank Call Reports

Perc

ent

Incre

ase

/ D

ecre

ase

in R

ese

rves

Building Reserves > 0%, Releasing Reserves < 0%

10

0%

50%

100%

150%

200%

250%

300%

350%

2010 2011 2012 2013

Me

dia

n V

alu

es

(%)

Sixth District CBG Median ALLL Coverage Trends

ALLL/Prior 4Q NCO Prior 4 Q Prov/ Prior 4 Q NCO ALLL/NA

ALLL/NA (Lowest Q) ALLL/NCO (Lowest Q) Prov/NCO (Lowest Q)

Source: Bank Call Reports

11

Exam Related Issues

◦ Loss periods need to transition back to normal time periods

◦ Support Unallocated portfolio

◦ Documentation

◦ Validation

12

Proposed Changes to Accounting for Credit Losses

◦ Reasons for change in accounting for credit losses

◦ Summary of proposed changes

◦ Improvements over existing model

13

Crisis led to calls for improvement in accounting for credit losses

In April 2009, G20 requested that standard setters “strengthen accounting recognition of loan-loss provisions...”

Weaknesses in current credit loss accounting model: ◦ Delayed recognition of credit losses until losses are

probable.

◦ Inability to factor in expectations of future conditions

14

What are the main provisions of the FASB model? ◦ Requires an estimate of losses expected over the

remaining life of a financial asset

Lifetime loss estimate now only used in FAS 114 and SOP 03-3

◦ Incorporate information about past events, current conditions, and reasonable and supportable forecasts of the future.

15

Will lead to early recognition of credit losses ◦ By recognizing credit losses expected over the life

rather than just losses that have been incurred as of the balance sheet date.

Will incorporate “reasonable and supportable” forecasts of the future.

Simple in concept but possibly not in application.

16

The proposal does not require the use of any specific method

The proposal will require data on historical lifetime loss experience that most banks may not have ◦ Will require banks to track new data

◦ May require new systems to track lifetime loss experience

17

◦ Regulators have pushed for long transition period

◦ Regulators have pushed for practical expedients to be allowed

◦ Regulatory guidance will be robust

◦ Regulators understand the challenge this will present to community banks.

18