AICPA National Conference on Banks & Savings Institutions

The Widening Gap in Bank Technology

September 9, 2014

Speaker Bio – John Lankenau

John LankenauVP, Head of Product Management at Primatics Financial

John Lankenau is the head of valuation and accounting product solutions at Primatics

Financial. He has extensive consulting and financial services industry experience, with an

emphasis on complex loan systems integrating risk and finance. John’s experience

includes auditing the models and estimation processes for some of the biggest financial

institutions in the United States for a Big 4 firm.   John is a frequent speaker on emerging

issues such as stress testing and the integration of risk and finance, as well as a regular

contributor to industry publications, including a monthly article in Bank Systems and

Technology.  John has a bachelor’s degree in Mathematics and Economics from Carleton

College in Minnesota and a Master’s degree in Operations Research from the University

of Michigan, Ann Arbor.

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Agenda

• Where we’ve been – Things used to be much simpler

• Where we are – Today’s gap in technology means a lot of pain (Technology as frenemy)

• Things continue to become more complex – Regulatory and accounting changes

• How to make the pain go away – Use technology appropriately and turn your frenemy into your best friend forever

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The Golden Age of Loan Accounting

• Accounting for loans per the contractual terms of the agreement

• Costs to originate were expensed as incurred

• Origination fees were recognized as received

• Loans were usually written off as they were deemed to be uncollectable

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Evolution of Accounting – Interest Recognition

Low-Medium ComplexMedium

Effective: After December 31, 1977

Applies to all modified loans in which the modification is considered a troubled debt restructuring (TDR)

• Identification of a TDR Initially the determination was

mostly quantitative

• Effective yield calculation for the recognition of interest

• Population identification• Comparison of two results

Effective: Fiscal years beginning after December 15, 1987

Applies to all originated and acquired loans

• Effective yield calculation applied to a larger number of loans

• Calculation of the costs to originate the loans

Effective: Fiscal years beginning after December 15, 2004

Purchased Credit Impaired Loans

Deterioration in credit Probable the contractual

terms will not be collected

• New method for recognizing interest Entity does not leverage

contractual terms of the agreement

Accounting entries based on the expected cash flows

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FAS 15 FAS 91 SOP 03-3

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Evolution of Accounting - Impairment

Low-Medium ComplexMedium

Effective: Fiscal years beginning on or after July 1, 1975

Applies to all loans

• Reserve usually covers 12 to 24 months of losses

• Based primarily on historical loss rates incurred by the financial institution May have a qualitative

reserve Required estimated input

from outside of finance

Effective: Fiscal years beginning after December 15, 1994

Applies to loans considered impaired

An impaired loan is one where it is probable the contractual terms will not be collected

• Reserve covers life of loan

• Primarily done on a specific reserve basis; some models• Collateral value may be used

in some cases

Effective: Fiscal years beginning after December 15, 2004

Purchased Credit Impaired Loans

Deterioration in credit Probable the contractual

terms will not be collected

• Reserve covers life of loan, with change in yield possible

• Calculated on a non-specific and specific reserve basis Models leveraged for non-

specific reserve

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FAS 5 FAS 114 SOP 03-3

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Why is there a technology gap in the first place?

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Time

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Many Sources of Complexity Post-Crisis

• High levels of loans requiring more than vanilla accounting treatment

• Increased disclosures

• Increased regulatory expectations

• Accounting changes for non-performing loans driven by regulators

• Stress testing

• CECL?

This is not calculational complexity. It’s process complexity. It is population identification, aggregation, using other groups’

calculations, etc.

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Current State Fills Technology Gap With Point Solutions and Manual Processes

Core Banking / Servicing Systems

Recon

Credit Quality Reports

PCI

REO

NPL

F91

M2M

What if?

Loss Models

DFASTF114

F5

TDR

Finance Tables

Recon

Cash and Operational

Entries

• GAAP Entries /

• Adjusting Entries

• Reserving Entries

• Forecasting Data / Regulatory

CRE Servicing System

Mortgage Servicing System

Consumer Servicing System

C&I Servicing System

Sources

Transaction Data

Risk Data

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Lif

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and

Fin

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Views

Current (GL and

Regulatory)

Future (Forecast)

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“The Muck” Matters to Many Stakeholders

• Preparers of Financial Statements

• Inefficient

• Hard to control

• No time to analyze

• Auditors

• Difficult to audit

• Increased audit risk

• Regulators

• Decreased reliability of numbers

• Risk management not as strong as it could be

• Analysis requests often time-consuming and difficult

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Stress Testing Has Complicated Bank Processes

Current Data

Aggregated View

Forward Looking

Repeatable Process

CCAR / DFAST

Templates

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Stress Testing: What Challenges Exist?

> $50 B

• Lacks integration between teams

• Technology gaps• Many Manual

Processes Reconciliation

challenges Aggregation

Challenges Insufficient controls Time consuming

$50 B - $10 B

• Some Banks lack skills / technology to complete

Inconsistencies exist Operational

challenges Modeling

• Many Manual Processes

Reconciliation challenges

Aggregation challenges

Weak controls Time consuming Challenging to

repeat

< $10 B

• Regulatory expectations still emerging

• Most Banks lack skills/ technology

Some complete templates, others don’t

No models

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CECL Will Further Complicate Bank Processes

Controlled Process

New Disclosures & Reports

Forward Looking

Integration between Accounting & Credit

Life of Loan Loss

Estimate

Not a modeling, accounting, credit or data problem…This will be a multi-faceted challenge.

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CECL: Significant Changes

• Life of loan allowance for all loans not classified as FV/NI

• Must include forward looking assumptions along with historical loss experience

• Impairment model changes for TDRs

• Broadens population of loans for which collateral value can be leveraged to determine impairment

• Significant changes to PCI loans

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CECL: Significant Operational Challenges

• Modeling lifetime credit loss

• Deeper integration of accounting and credit

• Credit Quality Disclosures

• Supporting changes in assumptions

• Must disclose the impact changes assumptions have on the allowance

• Auditors and regulators will require documentation to support current assumptions, and support why updated assumptions were not previously applicable

• Conversion from ASC 310-30

CECL will necessitate changes to data architecture, enhanced reporting capabilities, new models and a place to run them. Point

solutions will add significant complexity to “The Muck”.

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Continued Change Widens the Gap

Core Banking / Servicing Systems

Cash and Operational

Entries

Sources

Transaction Data

Risk Data

Op

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ion

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Lif

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isk

and

Fin

ance

L

ifec

ycle

Views

Current (GL and

Regulatory)

Future (Forecast)

New regulations are:

• Increasing in complexity

• Requiring more integration across teams (e.g. reconciliation / aggregation)

• Changing more frequently

• Requiring treating different populations differently

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Point Solutions and Spreadsheets are Unsustainable

Core Banking / Servicing Systems

Cash and Operational

Entries

Sources

Transaction Data

Risk Data

Op

erat

ion

al

Lif

ecyc

leR

isk

and

Fin

ance

L

ifec

ycle

Views

Current (GL and

Regulatory)

Future (Forecast)

People for Processing

Point Solutions and Production Spreadsheets

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Core Banking / Servicing Systems

CRE Servicing System

Mortgage Servicing System

Consumer Servicing System

C&I Servicing System

Properly Designed Technology Cleans “The Muck”

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Integrated Risk and Finance Solution for Loans

1. No More Point Solutions, Production Spreadsheets, Manual Processes

2. Efficiency = Cost Savings

3. People Analyzing Instead of Processing

4. Better Controls and Defensible Compliance

5. Preparedness for Future Change

Sources

Transaction Data

Risk Data

Views

Current (GL and

Regulatory)

Future (Forecast)

Cash and Operational

Entries

Op

erat

ion

al

Lif

ecyc

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Accounting and

Analytics

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Questions?

John LankenauVP, Head of Product Managementjlankenau@primaticsfinancial.com