COMMON QUESTIONS SURROUNDING THE ASC 310-10-35 (FAS 114) CALCULATION

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Aaron LenhartSr. Risk Management Consultant

Wednesday January 21st, 2014PRESENTED BY:

Garrett MorrisManaging Director of Consulting

Services

Questions

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About Sageworks

+ Financial information company that provides credit and risk management solutions to financial institutions

+ Data and applications used by thousands of financial institutions and accounting firms across North America

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Who will be speaking?

Garrett MorrisManaging Director of Consulting Services

Aaron LenhartSr. Risk Management

Consultant

Learning Objectives

+ What is ASC 310-10-35 (FAS 114)?

+ Key characteristics of ASC 310-10-35

+ Difference between ASC 310-10-35 and ASC 450-20 (FAS 5)

+ Three valuation methods

+ Common challenges in calculating the ASC 310-10-35 reserve

+ How automated ALLL solutions help in complying with ASC 310-10-35

What is ASC 310-10-35 (FAS 114)?

+ ASC 310-10-35 is a source of guidance on accounting for impairment in a loan portfolio under GAAP

+ Under ASC 310-10-35, a loan is impaired when it is probable that the bank will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the loan agreement

Key Characteristics

+ ASC 310-10-35 (FAS 114) loans often include:

+ Substandard loans

+ TDR loans

+ Nonaccrual loans

+ Loans > 90 days past due

+ Tiered for asset size?

ASC 310-10-35 vs. ASC 450-20 (FAS 5)

+ Specific reserve vs. General reserve

+ Impaired loans vs. Non-Impaired loans

+ Individual loans vs. Homogeneous pools

More About ASC 310-10-35

+ Requires the evaluation of impaired loans on an individual basis, not in pools

+ Three valuation methods

+ Applies to all loans except:

+ Large groups of smaller-balance homogeneous loans that are collectively

evaluated for impairment (such as credit card, residential mortgage, etc.)

and which have not been restructured as troubled debt

+ Loans that are recorded at fair value or at the lower of cost or fair value

(e.g., loans held for sale)

+ Leases

+ Debt securities

Three Valuation Methods

1. Fair market value of collateral

2. Present value of future cash flows

3. Loan pricing

Total Recorded Investment

+ For all three methods, institutions need to take into account all items that should be included in the “total recorded investment” for the loan

+ These items include:

+ Outstanding principal balance

+ Accrued interest

+ Net deferred fees or costs

+ Unamortized premium / discount

Fair Market Value of Collateral

+ Method used for all collateral-dependent loans

+ Calculate reserves by using the loan balance above the collateral’s fair market value (less selling costs)

+ Also consider:

+ Use a current appraisal or make adjustments to older appraisal

+ Consider any cross-collateralization, prior liens and/or loan guarantees to ensure the appropriate equity value

+ Document assumptions for any selling costs

Fair Market Value of Collateral

Appraised collateral value minus discounts and/or liquidation costs = Fair Value/Valuation

amount

The Total Recorded Investment exceeds the valuation amount

Therefore, the difference is the reserve amount

Present Value of Future Cash Flows

+ Method used for loans still expected to be supported by repayment from the borrower

+ Used for most troubled debt restructures (TDR)

+ Reserve for the present value of all expected payments

+ Be able to justify expected monthly payment

+ Also consider:

+ Use the effective (original) interest rate as a discount rate

+ Set up a month-by-month analysis with the expected payment discounted appropriately for each month

+ Be wary of the “NPV” function in Excel

Present Value of Future Cash Flows

Loan Pricing

+ Used infrequently

+ Reserve amount derived from loan’s observable market price

+ Reserve for any portion of the loan balance which exceeds the loan’s market value

Moving a Loan Back to ASC 450-20 (FAS 5) Status

+ Can a loan be ASC 310-10-35, but non-impaired?

+ Nonaccruals that return to performing status

+ What about TDRs?

+ What if I evaluate all my substandard loans individually at first?

+ Can I apply an ASC 450-20 (FAS 5) reserve rate instead of a specific reserve rate even if a loan is actually impaired?

Common ASC 310-10-35 Challenges

+ Determining which loans to evaluate under ASC 310-10-35

+ Ensuring loans are not double-counted for reserves

+ Determining the appropriate valuation method

+ Using appropriate values for impairment analysis

+ Knowing when and how to move an ASC 310-10-35 loan back to its appropriate ASC 450-20 pool

How ALLL Solutions Can Help

+ Save time in data aggregation

+ Reduce manual errors in calculations

+ Generate documentation

+ Reduce examiner criticism

+ Create custom reports

Key Takeaways

+ ASC 310-10-35 is a source of guidance on accounting for impairment in a loan portfolio under GAAP

+ Determine and consistently apply an institution-specific standard for identifying loans to be evaluated under ASC 310-10-35

+ Individual impairment may be calculated utilizing one of three different valuation methods afforded by the guidance

+ Beware of moving loans from ASC 310-10-35 back to ASC 450-20

+ Automated ALLL solutions can help

+ Document, Document, Document & don’t be afraid to defend!

Contact Information

Aaron LenhartSenior Risk Management ConsultantSageworksAaron.lenhart@sageworks.com 919.851.7474 ext. 702

Garrett MorrisManaging Director of Consulting ServicesSageworksGarrett.morris@sageworks.com 919.851.7474 ext. 568

Resources

+ The destination website for the ALLL calculation

+ ALLL Forum for Bankers+ Commercial Credit Risk Professionals

+ www.sageworksanalyst.com+ Whitepapers, webinars, thought leadership

+ Brief survey following webinar: topics for upcoming webinars? Speaker feedback?

Questions?