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good afternoon everybody and thank you for joining us for this afternoon's webinar we are very excited to have mr. Anson Cooley synergy Bank consulting with us today to talk about a triple a triple L methodology how to justify and document your Q factors a couple of quick housekeeping items before we get going with the presentation today we are going to make the presentation available after after today's session on our website so you will be able to get access to that after the fact also in terms of questions there is a question interface on the go to webinar that you have on your screen please feel free to submit those throughout the presentation we are going to go through those at the end and have ants and respond to those briefly about sageworks sageworks is based in beautiful while in North Carolina and we are financial information company that provides credit and risk management solutions to financial institutions as well as data and applications that are used by thousands of financial institutions and accounting firms across America we are very excited to have a sand coulee with us today Anson's firm synergy Bank consulting specializes in a triple L consulting loan reviews as well as providing in-house training for his bank clients so without further ado let me please introduce mr. Anson Cooley hello everybody my name is Anson kuliah s Tim just mentioned I'm the founder and principal of synergy Bank consulting and what we primarily focus on is a triple o consult consultations as well as loan reviews also we do some pre examination preparation is also we help financial institutions remediate issues with that come up during their bank examination so let's go ahead and get right into it without further ado let's go ahead and set the stage for our other day I was talking one of my clients and I they call their allowance the Cookie Monster as you can see up here on the screen and that's why so well it seems like time I look around I have to constantly feed it and I'm feeding with my earnings and it's it's concerning and I want to figure out a way to better document and understand our budgetary process and also while we're constantly having to put more and more in our and our allowance so what we're going to do today we're going to discuss a very specific topic within allowance which is which is your qualitative facts okay so briefly this is just a housekeeping know we have a wide range of institutions here on a call today we have institutions from a hundred million dollars to four billion dollars on a call as well as we have different parts individuals and with different responsibilities within the institution with a wide range of skills and expertise with the allowance so some of the topics I may talk about may seem a little elementary for some individuals and then some topics if we talk about migration analysis may seem a little bit high shelf or some other individuals so just bear with me because I'm going to try to cover things that can appease both constituents feel free to type any questions during the presentation I'll be available afterwards to fill any questions that you may have offline that you want do you don't want to accident a presentation afterwards so without further ado let's get started so if you can look at this graph here it's basically communicating that over the last 10 years from two thousand to two thousand to two now roughly about to mid-2012 we've seen an uptick in pastures and now accruals or just problem loans if you will please note that the gray shaded area it indicates the u.s. recession that we're currently on the either still in or on our way out of depending on your perspective so you can see the sharp contrast there and how past due sonata crews have increased honest slide you see net loan losses as a percentage average total loans for all US banks it kind of follows the same trend lined with non-performing loans as well so this is also looking back from 2002 all the way to 2012 and then here we have our loan loss reserve as a percentage of total loans for all US banks and so also you notice the same the shape is the same as our non-performing loans have increased and as our charge-offs have increased our loan loss reserves have decreased as well what we're concerned about primarily though what's what's going to happen here because we're noting noticing that allowance revisions are starting to decrease and that also falls in line with also banks also starting to level off with the problem assets this is an interesting slide though here its assets at banks who's a triple L exceeds their non performing loans so in other words what percentage of allow wentz right now only thirty-four percent of banks in the u.s. allowance balance covers the amount of non-performing loans in their portfolio now look from 2002 to 2008 roughly about it was a steady trend ninety percent of institutions in the United States had their allowance covering their non performing loans but as loan portfolios got weird and the allowance balances started the non-performing loans started to exceed allowance balance you can see right there in that grade shared appreciated area that's indicated by the recession but we're also starting to see it uptick as non-performing loans start to decrease but right now only thirty-four percent of institutions non-performing loans exceed their allowance Oh going back to the Cookie Monster question my client wanted to figure out how he maybe take less or perhaps make less provisions but my question him is how are you going to document that and how are you going to support that because as I was going through his ratios in particular um he has a severe amount of non-performing loans and his problem loans aren't leveling off on all crossed all this portfolio so my concern for him is that you just can't take money out of your allowance or reduce your provisions because of earnings concerns you have to be able to support it with with analysis and be able to communicate the trends so what's the elephant in the room if you will and allowance committee meetings it's a discussion that's happening all across the country where as we have slow loan growth weak earnings and just to kind of put it out there a lot of institutions use the allowance or perhaps reducing provisions as a way to normalize or improve earnings and here's here's the key each institution is unique and you're responsible to support and document all the provisions and all the additions that you make to your allowance and it's incumbent on the institution to make sure that you're communicating properly with your orders and your examiner's the wives and the house behind your allowance methodology so today we're going to approach this topic qualitative factors from a couple of different angles from you as the financial institution and also from the examiner perspective so for agenda today what are we going to discuss what our qualitative factors what are your regulatory expectations and it will improve the documentation of our qualitative factors so what is ASC 450 dash 20 or formerly Fast Five and for the rest of the presentation I'm just going to call it fast 5 interagency policy statement on the lease losses the guidance at your allowance methodology must estimate credit losses on a group of loans with similar risk characteristics homogeneous pools in accordance with generally accepted accounting principles under ASC 450 accounting for contingencies what does all that mean and please speak English for me okay quite simply this is your loan portfolio this just think of this basket of fruit of your loan portfolio you have different types of loans you have credit card loans you have real estate loans you have C&I loans you have commercial real estate loans all in your loan portfolio basket now all really communicating when you say can you separate them into homogeneous pools you're taking your different types of loans and you're basically separating the fruit so if you will the commercial loans or your apples and your lone individuals are your oranges and your real estate loans are your your pears this is your loan before you'll segmented into homogeneous pools or baskets like fruit okay so you have two portions of your Fast Five you have your historical net charge-offs which is a backward look look at your how well these particular loan pools have performed in the past and your qualitative factors which is what's currently happening is and it's a forward-looking measure so commercial loans your Apple so you for example your net average loss over just a three-year 0.25 for loans to individuals your net average loss that's been 1.15 or your real estate loans net average lost and one for each one or separate pools that we've made okay or your homogeneous pools so what are your two factors they allow you to look forward so you know your environment factors are used to reflect changes in the collectability of your portfolio not captured by what's happened in the past these factors augment actual loss experience and help to estimate the probability of loss within a portfolio based on emerging or inherent risk within your portfolio so these are your normal q factors that you typically see and these are straight from the 2006 interagency guidance on a triple L and we're going to go I'm just regular show we're going to go over not go each one in and depth but these are the the core q factors that we typically see when we review a triple L do a triple consultations but you're not limited to these particular qualitative factors and what I've noticed is all of them typically aren't used in institutions allowance nails for example typically don't see a lot of allocations for the institution's loan review changes in loan review systems or changes in experience and ability in depth and lending advance for another relevant staff and what I'm going to get at today is how you can better support and document by making sure you're communicating why you don't have an allocation for a particular area so again your qualitative help you look forward the quality expects you to reflect changes in the collectability not captured by the net charge-offs historical net charge-off senior in your portfolio and just as an aside a side note um there's different opinions as to which measure you should use for your net historical charge-offs and what i want to impress on you is that it's management's judgment to decide whether or not you want to use a rolling 12 quarters or three-year average or a five-year average or some type of weight there are individuals that have preferences as to what they think could be a better measure but it's incumbent on the institution to decide which measure you're going to use and just be consistent with it you don't want to one-quarter use a three-year average because it gives you a more favorable outlook or favorable allowance number then in the next quarter use a five year and then constantly switch back you want to use a consistent historical methodology if you're going to use a three-year average user three-year average if you're going to use a rolling 12 coldest quarters use that but don't switch back and forth so what are you regulatory expectations simply put you want to have sound judgment and documentation so this is just some experts you always want to go to the guidance itself and so just so couple things I want to point out to you to kind of just equip you in your conversations with your examiner's in your auditor she said the determination of you a triple L should be based on management's current judgments about the quality of the loan portfolio second with the Board of Directors is responsible for overseeing management significant judgments and estimates to protect in pertaining to the appropriate a triple L third determining the appropriate atrial L is requires a degree of management judgment and that it's important to recognize that because with me dealing with the quality the fact that this is the most judgmental portion of your a triple L your historical losses are what they are that's in the past that can be verified and documented quite easily just by going to your uniform bank performance report with your impaired loans that's also document you have to have an updated appraisal of your class support your your particular impairment amount but with your qualitative factors this is the area that has the highest degree of judgment management should maintain responsible documentation to support which factors affected the analysis and the impact of those factors on the loss measurement so that's important documentation so what is my regulatory review of my a triple L consists of examiners assess the appropriateness of your allowance in the supporting documentation during review they assess the effectiveness of how well your board is oversight in reviewing the a triple L methodology to look at your allowance policies and your methodology that that's where the institution is appropriate considering historical loss experiences and also very look at your qualitative factors and one of the things that I it happens to a lot institution if you're not documenting the whys and hows as to why you're taking or adding to your Q factors you you leave it up to your examiner your auditor kind of guess if you will or try to employ their own judgement as opposed to your judgment as to why your local economy is being affected by a factory closing down if you will the examiners also look to assure that the reviewing your loss estimation models and also reviewed appropriateness and really reasonable overall a triple L and a review the adequacy of your documentation its documentation is so important what are the most common issues related to quality examine issues relating to qualitative factors poor for folio segmentation this is real important for example imagine or just in real life you have a client that recently purchased two institutions that are roughly about 50 miles away from there their main location and what we did with their a triple L we took their segmentation and we added a geographic segmentation to it because for example you see just I'll use a name dekalb illinois is more of a rural town here in Illinois but the Chicagoland area is it's much different well the institutions that this Bank purchased is in the Chicagoland should we allocate the same type of qualitative factors that we would for the loans that we have in decal is a commercial real estate loan in decal the same have the same risk as maybe commercial real estate loan in Chicago and so what we did we increase the segmentation or we further segmented their portfolio to say okay we not only now that we just have commercial real estate loans we have commercial real estate loans in chicagoland and now we have commercial real estate loans in the decal area so further in and out that also was significantly improved the outlook on our a trip below because we were allocating everything all across the board in the same way another big issue and your human most uh when examines their presentations on H abilities directional consistency and it's if you're past dues and non accruals are increasing why are your allowance provisions going down at the same time or if you're you're you're classified assets are increasing or are just given over overview if the asset quality indicators are indicating that your portfolio is weakening then why isn't your allowance increasing to cover those those potential losses and so you're here you hear a lot about directional consistency and we're going to we're going to go specifically how to how to address that and again just poor documentation your examiner's coming in and them not being able to understand why you added 25 basis points to one Q factor in a particular portfolio but took out 75 basis points against another pool in another portfolio you have to be able to communicate that best way to do that is to connect your Q factors to to factor drivers and so for example changes in lending policies and procedures is one that isn't often used but what drives that particular key factors or what supporting documentation can we use to supplement and support whether or not we have 25 basis points or 50 basis points against a particular pool and so some of the drivers for th s is financial statement exceptions a high degree of loan documentation Weber waivers and what I mean by loan documentation Weber's waivers what's happening is a lot of institutions when alone comes up to maturity either the the bar hasn't provided updated financial statements there's a lot a lot of bangers are kicking it for another 90 days to give the borrower an opportunity to provide updated financials another driver is a financial statement exceptions or originating loans without having current financials so not having current financials and not having the information that you need to properly assess the weakness in a particular credit that weakens your your ability to understand the risk in your portfolio and that's something that can be accounted for within your Q factors as i mentioned directional consistency if one of the qualitative factors is problem loan trends and one of the drivers is volume and severity of past due loans what is what is what does your your 30 to 60 90 day pass do for your commercial real estate portfolio look like how how is that trended over the last ten quarters this information is readily available in its it's on it's in your uniform bank performance report or your ubp are you can go to that information and from at the FD FFIEC website and create graphs or just get the information directly from it so that you can say okay look at my my C&I loans uh and look at how over the last 12 quarters my past dues and mine on accrues have decreased and so the correlation is over the past over the past 12 quarters my past dues that decrease and that's why we went from perhaps if you will 75 basis points in that particular pool 44 passes and non accruals to maybe 40 basis points that's the that's the unit you're making a correlation between the two that's directionally consistent also you want to consider the level of TDRs as well as your level of classified assets your level classified assets is that's not communicated on your uniform bank performance report you have that internally and on your on your various watch list and you whether or not you communicate it be a special mention a substandard so you want to make sure that you're assessing that and saying okay well during our last exam or last going to last review our classified assets as a percentage of tier one was eighty percent and through collection efforts and through different modification programs or just borrowers getting on their feet our classified assets based on our assessment is now at fifty percent of tier 1 and so there's some improvement there you want you but you have to get that documentation in your a triple L to to be able to support that to your in your auditor changes in collateral values this really just really big here you want to make sure that you communicate your decline value the declining evaluation environment and also you want to make sure that you're properly communicating the changes that are happening in your particular local environment for example you can use case-shiller core logic and also information as well as from your local realtor and to discuss housing trends that are occurring in your specific local market and you want to make that correlation between maybe housing prices and from the case-shiller index or just days housing days on markets whatever data you can provide to support what's occurring in your specific location and your specific community use that to support this particular Q factor so for I've seen institutions put grass this is a graph of the case-shiller index here this information can be found at the the st. Louis Fed website and interesting enough uh this stage work surety program actually interfaces directly with this the st. Louis Fed so that you can get that information in real time from that from the same Luis fest so you don't have to go into at each time once you set it and say okay I want to watch for unemployment numbers in a particular area once you set that it'll go up and it'll go to the same Lewis said an update once new information comes comes available so you know here from within the last looks like the last year that there's been some improvement in a dallas texas area for based on that the case-shiller index here and so you want to use that to support that particular changes in collateral values let's look at atlanta here's atlanta from two thousand eleven to two thousand six there it seems to be look at the trend with a declining trend but also there seems to be a slight uptick over the last the last quarter here so you just want to make sure that you're getting the information that's relevant to your community that's right and also relevant to your institution to support each Q factor so you're documenting your qualitative factors one of them that I've noticed that it's always not always with most of time left blank and doesn't have something against this changes and experience ability and depth of lending management other relevant staff you always see something in volume and severity of past due loans but changes and experience ability and depth usually is left blank for a lot of institutions and what I'm recognizing is this change occurring between galata community banks are shifting their focus from commercial real estate lending to now cni lending and if just for example if you were a lender or if your community bank that has been doing a lot of commercial real estate lending over the last five or six years scene Island is a different animal so the same type of credit analyst or the same staff with the same control mechanisms that you use to manage your commercial real estate portfolio isn't the same skill set that you need to manage a CNI portfolio and so it's time to take another look at this particular to factor in SF hey we may be there is a weakness there in our in our CNI expertise Oliver we do it for example have a client we going to loan presentations and getting a lot of CN I opportunities yet they're assessing their C&I loans using commercial real estate methodologies just traditional cash flow for example whereby they're taking the the net income back depreciation and interest in things that nature well when you're looking at a CNI loan you want to use more sophisticated measures you want to consider you see a cash flow you want to consider three classroom measures and so you want to make sure that your accounting for your knowledge and your especially and or lack thereof in this particular area of this two factors ok also changes in equality if your loan review your loan review is your your radar if you will if your loan review program is if you're going through some turnover or if you've recently switched longer view of firms or what have you if your loan review process is broken you won't know what's coming down the pipeline and so you won't know when a when you need to assess a loan for impairment perhaps you need to make you have to make sure that you're properly reviewing your loan review process and making sure if you have to account for it inequality factors you do that here change this changes in existence of different concentrations a lot of as I mentioned the institutions are shifting from commercial real estate to see and I and so you and if there's like you're creating another concentration you want to make sure you account for that with this by documenting within this particular Q factor so what are some keys to improving your documentation of your qualitative one big thing is don't wait to the last day before your board meeting to document your qualitative factors I see this a lot in East institutions different levels of people are involved some it's uh I'm banks you go into this one person in a spreadsheet and he's the person he or she is responsible for putting together the qualitative there's and putting together the everything themselves and they it's just one it's just a process but when you think about the process and an amount of money involved uh it's incumbent of institutions to put more time into committing and putting more resources behind documenting your qualitative factors so sure to low use a team approach to documenting your qualitative factors one of the allowance process is one of the places where credit and accounting kind of intersect and so I found the best processes occur when you have your senior lender or your chief risk officer or credit officer meeting with the CFO and and discuss the atl discussing running issues related to impairment or just understanding the budgetary process when those two individuals are sitting at the same table I've noticed that you get a better quality product when you have your credit officer you see lender and your CFO all involved in the allowance process but a lot of times you see the wanted other either the CFO does the violence all by himself or the senior lender does the allowance all by himself but they sometimes it's better if you get to get use a team approach every time you change your qualitative factors make sure you have the corresponding data to support the change so direct as we mentioned directional consistency is key document in your a HR limited to excuse me document in your HIV methodology the financial indicators that drive the changes to your Q factors and we're after the webinar i'm going to send out a job a they kind of four one of the qualitative factors different drivers that you can use to support them and some links to information that you can get okay but I'll just want to say here's my here's my language policy so for changes in tandem past dues and Nanak rules and changes in our problem loans we're going to use the 30 60 to 90 day ratio we're going to use our classified assets ratio we're going to use the non-accrual ratio to support that these are the drivers of that particular Q factor so when I pick it up or when your examiner picks it up they understand what's the rhyme and reason why you've made changes to your qualitative factors use the free information available in internet to support your allowance this information out there again uh there's this there's the st. Louis Fed they have a program called Fred that's very easy to use you can create some really neat graphs that that can really help communicate in document your allowance also use a uniform Bank performance report go into it pay on page six and seven there's your your pass through information as well as your allowance information dig into that and spend some time with that so that when you're examining this it's the same information that your examiner's looking at to assess whether or not your allowance makes sense so it makes sense on the other side for you to understand and be able to communicate and tell the story behind the changes to your allowance 6 use the process of documenting your qualitative factors as an opportunity assess your current economic environment trends in your loan portfolio and risk management practices so it makes good business sense just to spend more time with your qualitative factors it's it's you have an opportunity to look at your local economy but in blue economy you can assess your loan review you can assess their lending staff you opportunity to look at your past dues and look at your concentrations all in one place just by looking at this process and so it just marriage more time in effort to be put into it then then what may you may be using doing at this point in time in seven incorporate the data from your portfolio stress test process into your a triple o documentation so if you currently use these stress testing your loan portfolio and for example if you stress test your commercial real estate portfolio and say well if X percentage of our loans were to have a decrease in their asset value in their collateral value this with the outcome would be use that data to support what you're putting in your allowance and so if your stress testing your portfolio get some additional usage out of that information by incorporating it into your you're a triple L documentation and so these are just some keys I'm we're coming toward that the end of the webinar the presentation portion of it I know we probably have some some good questions here about how you can better document a specific you fact or just on an allowance in general we're getting ready to open it up for questions please feel free to type in your question again my name is anson Cooley and I'm the principal ascendancy bank consulting if you have any questions or have any I want to talk offline my email is here as well as my website and again here's the information about Sageworks some helpful links page works has website is full of information and blog information good information about the HR bilel global cash flow and other credit risk management information again thank you for attending this webinar hopefully you were able to kind of glean some different different useful information about the qualitative factors and how you can better document it again as I mentioned there's a job aid that I'll be sending out to the intend ease that you can use acid as a guide for each one of the qualitative factors how you can just say okay I'm doing my a triple L next month I'm trying to remember what was stated in the webinar that the job be a good supplement for you again thank you and uh Tim you have any questions we do anson thanks yeah we've had some questions them in first question is do you have some specific examples of examiner approved factor documentation I think you touched on that a little bit but maybe you could expand on some of the things you've seen that have been approved so to speak by the examining community well and i'll just be even and as a blunt if I there's no it when you say examiner pew to factor documentation there are there isn't anything I guess examiner improved I think most individuals on its collar has experience you may have your allowance look at at one exam and you think it's fine and then you have another examination somebody tells you that you need to improve your documentation or something's off with it so there's nothing specific but what I would recommend is set to make sure that it just makes sense in that for example if we're talking about past dues and donna pools then go to uniform bank performance report look at page six and seven and look at your past dues and non accruals and that information on that specific page and use that to support it for your changes in local economic kind of use I've seen unemployment rates I've seen changes in the poem crisis those are things but there's nothing really specific just make sure again as we discuss its management's judgment with the HR you just want to make sure that it makes sense and that it correlates and that is directionally consistent so there isn't any for as far as support there isn't like use this use this in dec for use another indicator use indicators that correlate to the risk in each portfolio another question with significant updated training of credit analysts and underwriters and credit analysis be something you could use as a documentation for the q-factor related experience of staff okay yes but also i would also supplement that with perhaps a recent blown review so this you've maybe you've taken three credit analysts and you sent them to sum up some training maybe some training on a CNI lending and they're doing more and your reviews and also their they've updated their knowledge about specific aspects CNI lending you want to document the training that they've gone but then also I would supplement it with and say well we recently had a loan review and we didn't have we had a lower amount of risk rating changes than we've had in the past related to that particular portfolio so we went to training and subsequent to that we had an exam or a loan review based on that they noted the improvement so therefore we reduced our allocation in that particular pool answer another question I do most institutions develop a range of changes to factors based on changes and factors such as economic factors yes and so but the ranges and here's the and here's the thing where it gets real subjective exact the reasoning behind the ranges for example I what's uh what's up what indicates a moderate change of what indicates the Revere change and what should be the correl ting effect of that severe mada change you want to document that so if for example it's and I'm just visualizing this for your commercial real estate portfolio the Q factor would be pastors and articles arm at once say last quarter you had it severe and so because it you had a severe you allocated point 75 basis points and now you seeing the trend decline in past dues and on accruals and now you feel like it's moderate if you go from 75 250 you put you reduced at 25 basis points but I can't say that that specifically that 25 basis points is the right number or if you go from severe too low you should reduce it 30 basis points that's where the judgment comes in but you want to make sure that you mechanism in a process in place that you're consistent in the increments in which aging your your Q factors and Ike and if somebody I haven't add some examples of so for the person that asked that question if you would like an example of it feel feel free to reach out and shoot me an email can provide you with some examples of those mechanisms answer kind of a higher level question here given the scrutiny over the last three years by regulators have you seen a significant improvement in a triple L methodology for there's still a lot of room to improve there's a lot of room to improve on the documentation side I would definitely say that when you when you it's so sometimes like when I come in and do a triple L consultation I'm not it's not even like a gotcha mode or anything like that it's just a conversation and it's what it really is is you it makes you wonder I just put amount of time that the individual is putting into this a triple L and then the amount of money that the individual responsible of the HR can actually spend like you can click OH in it with the click of a button and adding basis points to a qualitative factor add 150 to 200 thousand dollars or dependent on the institution add a million dollars to your allowance but yet we're only spending a day or two days to make those decisions so when you look at the amount of money involved in enough sect on earnings and you put it in in perspective with the time that we're actually spending documenting and supporting our qualitative factors it doesn't really it doesn't match up and so we are seeing their improvement um specifically with allowance in that institutions are getting better updating their appraisal values more frequently or just understanding how to properly communicate their lives but the qualitative factor it needs it just needs to improve because it it facilitates your documentation facilitates a educated conversation with your examiner because you don't want someone just to come in and say well I think you should have X in this Q factor and they don't have a I guess a document reason to other than the fact that that's what they think if you set the playing field with your documentation and your support then that's what we'll that's what the conversation will revolve around anson thank you for that and thank you for the presentation today we really enjoyed it and found it really insightful we do have several other questions that have come in a lot of them are fairly specific so i think it probably would make more sense to have you follow up after the session so we'll pass those along its and then you should be able to reach out to you too in response to those beyond that thang thanks to everyone for their attendance today we are going to be continuing the series of webinars we should have another one in October please check our website for details on that and thanks very much again for the time have a great day thank you