CECL: ONE YEAR LATER

ArticlesSubmitted by Adam Davis, June 13, 2017 One year ago, on June 16, 2016, the Financial Accounting Standards Board issued ASU No. 2016-13 “Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments”, which introduced the current expected credit loss methodology for establishing allowances for credit losses.  In the banking industry we have come to know this now by “CECL”.  As a banker, you may be on your way to developing a plan or you may be like many and wondering when and how you should start. We here at ProBank Austin wanted to provide a quick recap of CECL for those that are still in the planning stages and our thoughts on steps to be taking now to be prepared for implementation.  If you have further questions or would like to discuss your institution’s plan for CECL, we are available to help. As always, it is the purpose of ProBank Austin to make formidable tasks more manageable for you and your staff.   Definition of a Public Business Entity (PBE), Per ASU No. 2013-12 A public business entity is a business entity meeting any one of the criteria below. Neither a not-for-profit entity nor an employee benefit plan is a business entity. (a) It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing). (b) It is required by the Securities Exchange Act of 1934 (the Act), as...

The Board’s Vital Role in Lending

ArticlesSubmitted by Vince Van Nevel, June 27, 2017   We have all heard this mantra time and again. “The board is responsible for safely directing the business and affairs of the institution in the best interest of shareholders, customers, the community, and in accord with the law.” Heaven forbid, should these four interests diverge, the path should be chosen that is in the best interest of shareholders. The interests of shareholders and regulators are not always aligned. In the worst case scenario, the FDIC as Receiver succeeds to all rights and privileges of a failed bank, including claims against former directors and officers, and sues officers and directors for “gross negligence,” usually related to loan underwriting and approval. This article spells out five key requirements and regulatory expectations for the board to implement in carrying out its duties and vital role in lending. First, it is clear that the FDIC and other regulators expect boards to provide a clear governance framework that incorporates sound: Objectives; Policies; and Risk Limits. Equally important, the Board should monitor the extent to which officers and employees comply with this framework. Second, if directors are involved in approving loans, they must attend and participate in board and assigned committee meetings regularly to fulfill their responsibilities. This is critical to sound corporate governance. Why? Because almost every state has set standards of conduct for corporate and/or financial institution directors that require directors to discharge their duties in good faith, with prudent care and in a manner the director reasonably believes to be in the best interest of the corporation. These standards are harder to meet...

The Changing Role of the Compensation Committee of the Board of Directors in Community Banks

ArticlesSubmitted by Jon Doukas, April 12, 2016 Introduction. Traditionally, most executive compensation decisions have been handled at the December meeting of the board of directors, and these decisions were based on limited information and the board’s subjective judgment. However, executive compensation has become more complex. The passage of the FDIC Improvement Act of 1991 (FDICIA), Dodd-Frank Wall Street Reform Consumer Protection Act of 2010, and Securities and Exchange Commission Regulations, regarding executive pay communications to stockholders, have made compensation procedures and decisions more challenging. Media coverage and stockholder interest have also increased in recent years. The result has been the need to develop a more formalized approach to the institution’ total compensation programs. Current Environment. In addition to regulatory requirements, other changes in compensation activities must be considered in determining an effective approach to the development of an overall compensation plan. The low level of inflation during the past few years and the increased availability of bankers (due to both consolidation and downsizing) have kept annual increases in a range of 2% to 4%. Due to fewer promotional opportunities from restructuring and continuing consolidation, more financial institution employees now remain in their current positions for longer periods of time. This has resulted in more uniform salaries and has impacted an institution’s ability to provide rewards for performance within base salary programs. In turn, more interest has been created in bonus and incentive programs to provide a mechanism to improve profitability and to reward responsible individuals while, at the same time, controlling personnel expenses. A need has been created for developing and administering internal programs that maintain consistency and objectivity...

Working the Appraisal

Articles           – and Playing the Numbers Submitted by Ann Scott, April 4, 2016 If loan underwriting and cash flow analysis are the main course of a loan, appraisals are typically considered a part of the appetizer. Actually, they’re the burgundy to the beef, the Alfredo to the fettuccine, the mint to the julep. It’s up to the appraisal reviewer to take a close look at the numbers. Do the rents used by the appraiser match the most recent Tax Return or FYE numbers? What about the expenses? Did the appraiser use a “market percentage” or the actual expenses indicated by the financial information? And what about all of those numbers? One expert appraiser estimates that over 50% of all appraisals have mathematical errors. Most of those will be minor, but some will be critical. Given that, the reviewer needs to review not only the narrative, but examine and test numbers contained within the appraisal.  Checklists are not sufficient. Given the volume of information contained within an appraisal, errors are not surprising. In one income producing property with a wide variety of retail and medical tenants, a $3 million error was made due to an over estimation of expenses. The appraiser “assumed” all of the leases had identical expense terms after reading a couple of the leases where all expenses were paid by the landlord. As it turned out, only a few “minor” tenants did not pay expenses. The other leases were all NNN and those leases represented nearly 80% of the total square footage. The error resulted in a 30% markdown of the property. The reviewer read all of...

Appraisal Detail

Articles          – Not Just Minutiae Submitted by Ann Scott, March 14, 2016 Appraisals contain a lot of data. The information can be ignored or it can be viewed with an eye towards usefulness. Sometimes the untrained eye will gloss over details that are critical to a loan structure. Following are just a few items that can be critical to a lending decision. Zoning Words to watch for are “grandfathered” or “subject to zoning change.” When subject collateral is grandfathered it typically means the zoning has changed and the current zoning would not allow for the subject to be constructed today if the lot were vacant. This requires further analysis. The lender needs to know what is permissible given the current zoning. Say the subject is a 12 unit apartment building and new residential zoning would limit the number of units to four if the lot were vacant. It’s fairly easy to ascertain that the cash flow from 12 units will probably exceed the cash flow from four units. The lender will need to carefully examine the insurance coverage as a precaution should the improvements be destroyed. If a property is appraised “subject to zoning change,” the appraisal should also include the “as is” value based on its current zoning. Knowing when the zoning change is to occur and documenting the approval of such is critical. A borrower may apply pressure to close a deal prior to a zoning change. Full funding based on the “subject to” value should not happen unless the change has occurred. Access The reviewer should compare the access description and the plat (or aerial photo)...

Risk Management and Strategic Planning

Articles          – A Long Courtship Submitted by Vince Van Nevel on March 10, 2016 Talk about risk management! Our neighborhood men’s group half-jokingly volunteered a friend, recently retired from the Air Force with combat “tours” in the Middle East, for a project some thought was a bit risky, declaring he was a risk taker. He quickly corrected us stating, in the military the whole idea is to identify risks in your mission and then make plans to minimize them while still accomplishing your goal with a highly trained and disciplined team. If the risk assessment presented too much risk they may scrap the mission and/or find alternative strategies to achieve their objective. This approach should sound familiar to bankers right now! Why? Because this same approach is what the examiners will be looking for when they visit your institution. The term “Risk Management” has been discussed in banking circles since the late 1980’s, and began to take root in the early 1990’s. As some of you may recall, the Comptroller of the Currency tested this examination approach in its Southeast District beginning in 1991.  The initial results were chaos and confusion, and gave rise to the OCC’s Ombudsman program. Under the testing phase of this risk-based examination approach, Composite 2 rated banks were being placed under formal agreements! What was the problem? The problem was these test banks had poor risk management as evidenced by the following possible weaknesses: weak loan underwriting practices; poor file documentation; inadequate polices and lack of controls to detect noncompliance; inadequate information in board and management reports; and inadequate ALLL methodology (the ALLL itself...
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