AFI-UNS
Comment Letter No. 50
Thom Conus
106 E. Cleveland
Monett MO 65708
4L7-235-2435
E-Mail: thomc@mo-net.com
November 6,20L3
Technical Director,
Financial Accounting Standards Board
401 Menitt 7
PO Box 5116
Norwalk, CT 06856- 5116
RE:
File Reference No. 2012-260
Proposed Accounting Standards Update, Financial Instruments-Credit Losses
(Subtopic 825-15)
Dear Sir/Madam:
My name is Thom Conus and I am a Senior Vice-President of a rural community bank. This
commentary reflects an expression of my opinions only and does not by inference represent the
views of the bank. I would like to thank you for allowing commentary regarding the proposed
accounting standards for credit loss analysis and reporting. I am in agreement with the Independent Community Banker's Association stand on this proposed process and my community bank
is a small, relationship based institution that serves the local community through customized
lending that is tailored to specific customer needs. We also agree that the proposed approaches
to credit loss forecasting, with reliance on complex modeling techniques and front loading impact on loan loss reserve provisioning, is simply the wrong direction to take for predicting future
credit losses.
Summary and Questions for Respondents
Why Is the FASB Issuing This Proposed Accounting Standards Update?
I entered the lending industry when accountant tools were a Big Chief tablet and a number 2
pencil. Delinquency was measured by recency of payment rather than by number of past due
payments. Loan loss was recognized only when a loan was deemed to have absolutely no chance
of receiving further payment of any kind. At some point, in the era of the Industrial Revolution
of the late 1800's, a community bank loan officer created a methodology for measuring loan loss
reserve requirements that has endured through the ages up to the present time. Although I have
no empirical evidence to confirm my belief, I would venture to say thatamajority of all community banks under the size of $300 million continue to successfully utilize some form of that mutually acceptable (i.e. by regulators, accountants, auditors, senior management, directors and
stock holders) methodology today. Here is that process: Loan Loss Reserve is equal to 50% of
loan balances rated Doubtful; plus judgmental selection of 5 to20oh of loan balances rated SubStandard; plus .25oh of all loan balances secured by l-4 family residences; and, 1.00% of all remaining loan balances (less specifically classified loans; less deposit secured loans and less govemment guaranteed -SBA/USDA- loans).
AFI-UNS
Comment Letter No. 50
Why is the FASB issuing this proposed accounting standards update? Because they have been
doing so without success about every other year from the time of the loan officer's first creation
of a perfect loan loss reserve calculation methodology! If they continue throwing enough rocks,
they will eventually hit their target!
Scope
Question
for All
Respondents
Question 1: Do you agree with the scope of financial assets that are included in this proposed
Update? If not, which other financial assets do you believe should be included or excluded?
whv?
Response:
Prior to the enactment of banking deregulation in the early 1980's, stockbrokers
sold stocks and securities, savings and loan companies made mortgage loans, insurance companies sold insurance and banks protected deposits. Today, we are all providing "financial services" and stockbrokers are called investment bankers, mortgage brokers are called mortgage bankers and original real bankers are now called commercial bankers. Now, financial assets are extremely complex and as varied as the individuals and businesses selling them. Yes, I believe the
scope of affected financial assets is proper, but to imply that the accounting standards for financial assets of the mega Deutsche Bank of Frankfurt, Germany, should be the same as the loan
loss reserve analysis for a $50 million dollar bank in Humansville, Missouri is beyond belief.
Recognition and Measurement
Questions
for
Users
Question 2: The proposed amendments would remove the initial recognition threshold that currently exists in U.S. GAAP and, instead, view credit losses as an issue of "measurement" as opposed to an issue of "recognition" because the credit losses relate to cash flows that are already
recognized on the balance sheet. Do you believe that removing the initial recognition threshold
that currently exists in U.S. GAAP so that credit losses are recognized earlier provides more decision-useful information?
Response:
Yes, in part, I do, but not with the methodologies that are proposed. For instance,
in the initial analysis of a proposed new credit advance, any perceived loss potential would be
mitigated at the outset by the addition of collateral, added guarantors andlor added guarantors
etc. In other words, how would you measure loss recognition at this period of
time? The current accounting standards of ASC-450 (FASB 5) and ASC-310 (FASB I 14) provide instructions to arrive at the proper solution. The correct interpretation should include both
incurred AND expected losses! By combining, historical, migration, trend and fair value considand collateral,
erations, an unquestionable credit loss analysis can be achieved.
After the issuance of the 1993 Interagency Statement of Regulatory Policy, I reviewed the above
practice as it related to our bank and created a system to further define our course ofaction to
AFI-UNS
Comment Letter No. 50
better arrive at a more accurate calculation of loan loss reserve (see Loan Loss Reserve Allocation Analysis Summary attached).
First, as related to the traditional procedure, I believed that the fixed L00o/o and .25Yo allocation
of loans was too generic and lacked precise specificity. After review of several procedures, I
found that using a 5 year historical record of actual loan loss amounts by loan category created
the most logical reserve multiplier for "expected loss" allotment of the entire loan portfolio (see
Methodology #l attached). It demonstrated that .25 % was too low for real estate loans and that
1.00% was way too high for all other loans. This became a component of my strategy to satisfy
ASC-450 (FAS 5) (group of loans) requirements. However, to further fine tune this model I developed a mechanism (see Methodology #2 attached) to provide a means to react to ongoing circumstances both under control and beyond the control of the bank by using financial trend analysis of loan payment delinquency, loan review grading trends, economic issues such as the unemployment rate, rate risk and loan concentration risks. This "trend" analysis was further refined
after the release of the 2006 Interagency Policy Statement.
Finally, I retained the specific judgmental (incurred loss) allocation of the "Classified Loan"
watch-list. I also added a "Classified Loan Migration Analysis" (see Methodology #3 attached)
to support the ASC-310 (FAS 114) evaluation of individual loans. This was effected by following a loan from its first classification for three years to see if it migrated to collected or charged
off status. The loss ratio factor for each loan classification category (Monitor, Sub-Standard,
Doubtful) was then applied to the total of each category of current classified loans to further
modify the "expected" loan loss reserve allocation.
In 2006, as a result of new Interagency Policy Statement regarding loan impairment, the specific
"Classified Loan" watch list was replaced with a new classified loan worksheet (incurred loss
analysis) devised to conform with the new guidelines for "fair value" accounting of loan impairment status in the reserve calculations (see the Loan Loss Reserve Worksheet attached). This
new worksheet eliminated any further'Judgmental" allocation to the loan loss reserve.
Question 3: As a result of the proposed amendments, the net amortized cost on the balance sheet
(that is, net of the allowance for expected credit losses) would reflect the present value of future
cash flows expected to be collected, discounted at the effective interest rate. Do you agree that
the net amortized cost (which reflects the present value of cash flows expected to be collected)
results in more decision-useful information than currently exists under U.S. GAAP?
Response:
Yes, I agree that the net amortized cost on the balance sheet is decision-useful information but only as it currently exists under U.S. GAAP. The definition of net amortized cost
should reflect the present value of future cash flows scheduled to be collected, discounted by the
final allocation for loan loss reserye as arrived at by incurred and expected loss assessments.
Question 4: The Board has twice considered credit loss models that would permit an entity not
to recognize certain expected credit losses. In the January 2011 Supplementary Document, the
t
AFI-UNS
Comment Letter No. 50
Board considered a model that would permit an entity not to recognize some credit losses expected to occur beyond the foreseeable future. In the recent discussions on the three-bucket impairment model, the Board considered a model that would permit an entity only to recognize lifetime credit losses for loss events expected to occur within a 12-month horizon. Instead, the proposed amendments would require that at each reporting date an entity recognize an allowance for
all expected credit losses. Do you believe that recognizing all expected credit losses provides
more decision-useful information than recognizing only some of the expected credit losses? If
not, how would you determine which expected credit losses should not be recognized (for example,12 months or similar foreseeable future horizon, initial recognition threshold, and so forth)?
Response:
What a vague question! Loan loss reserve surveillance is an ongoing process that
must be adjusted at each reporting period. Of course the entire loan loss reserve allocation must
be recognized on the balance sheet as a component of net present value of future cash flows anticipated to be collected regardless of whether it is derived from either "expected" or "incurred"
assessments. I have attached our current loan loss reserve analysis report to demonstrate assessments of our "originated" loan portfolio which is in compliance with current regulatory rules.
Question 5: The proposed amendments would require that an estimate of expected credit losses
be based on relevant information about past events, including historical loss experience with similar assets, current conditions, and reasonable and supportable forecasts that affect the expected
collectibility of the financial assets' remaining contractual cash flows. Do you believe that expected credit losses based on this information provide decision-useful information?
Response:
See Question 2 Response - Yes it provides decision-useful information BUT
ONLY when combined with "incurred" loss analysis.
Question 6: For purchased credit-impaired financial assets, the proposed amendments would
require that the discount embedded in the purchase price that is attributable to expected credit
losses at the date of acquisition not be amortized into and recognized as interest income over the
life of the asset. To achieve this result, upon acquisition the initial estimate of expected credit
losses would be recognized as an adjustment that increases the cost basis of the asset. Apart from
this requirement, purchased credit-impaired assets would follow the same approach as nonpurchased-credit-impaired assets. That is, the allowance for credit losses would always be based
on management's current estimate of the contractual cash flows that the entity does not expect to
collect. Changes in the allowance for expected credit losses (favorable or unfavorable) would be
recognized immediately for both purchased credit-impaired assets and non-purchased-creditimpaired assets as bad-debt expense rather than yield. Do you believe that using the same approach to recognize changes in the credit impairment allowance for purchased credit-impaired
assets and non-purchased credit-impaired assets provides decision-useful information? Do you
believe that this is an improvement from the current model used for purchased credit-impaired
assets?
Response: (Let's start with the premise that good loans almost always
stay good and bad
loans almost always go bad! Community banks don't originate bad loans as was demonstrated in
AFI-UNS
Comment Letter No. 50
the "foreclosure" crisis!) This question is trying to compare apples (purchased credirimpaired
financial assets with oranges (originated credit-impaired financial assets). Except for the purchase price discount and credit score averages, there really can be no other measurement for "expected" asset loss allocation for purchased credit-impaired assets. After purchase, loss allocation
is affected by "market" value (incurred loss or gain) that is priced based on popularity of securitylinvestment type and by rating agencies monitoring rate risk and quality risk. Originated cre-
dit-impaired asset losses can, as demonstrated elsewhere in this commentary, be measured by
incurred and expected loss methods. In addition, originated credit assets are initiated by similar
rules, policies and procedures and approved by similar originators, underwriters, management
and regulators. Not so with the hodge-podge of purchased credit-impaired asset packages.
Therefore, the scope of data for furnishing decision-useful information from originated creditimpaired asset loss forecasting is very much varied from that used to assign a loss allocation for
purchased credit-impaired asset loss expectancy.
Question 8: The proposed amendments would require that an entity place a financial asset on
nonaccrual status when it is not probable that the entity will receive substantially all of the principal or substantially all of the interest. In such circumstances, the entity would be required to
apply either the cost-recovery method or the cash-basis method, as described in paragraph 825l5-25-10. Do you believe that this approach provides decision-useful information?
Response:
Does this represent any kind of change over current practice?
Questions
for All
Respondents
Question 16: Under existing U.S. GAAP, the accounting by a creditor for a modification to an
existing debt instrument depends on whether the modification qualifies as a troubled debt restructuring. As described in paragraphs BC45-BC47 of the basis for conclusions, the Board continues to believe that the economic concession granted by a creditor in a troubled debt restructuring reflects the creditor's effort to maximize its recovery of the original contractual cash flows in
a debt instrument. As a result, unlike certain other modifications that do not qualify as troubled
debt restructurings, the Board views the modified debt instrument that follows a troubled debt
restructuring as a continuation of the original debt instrument. Do you believe that the distinction
between troubled debt restructurings and non-troubled debt restructurings continues to be relevant? Why or why not?
Response: A troubled debt restructuring is in reality
a credit risk mitigated asset that
will
be
monitored in the same process as non-troubled debt instruments. If impairment continues after
will be classified for special monitoring, a loss allowance
should be maintained and accounted for accordingly and the relevance of TDR versus non-TDR
after consummation ought to be the same.
the restructuring, the financial asset
AFI-UNS
Comment Letter No. 50
Disclosures
Questions
for
Users
Question 17: Do you believe the disclosure proposals in this proposed Update would provide
decision-useful information? If not, what disclosures do you believe should (or should not) be
required and why?
What a question! Are you referring to decision-useful information for a CEO to use for management purposes or an investment manager to use for advising clients? What is decision-useful for
a bank credit analyst and what is decision-useful for a regulator? Can one complex model fulf,rll
the proper disclosure for loans, securities and trade receivables or should each category, by necessity, require its own unique disclosure format? No, I do not believe that the suggested universal disclosure proposals will provide useful information. In the bank loan department, the measurement is primarily for originated financial assets analyzed by internal methods. In the bank
investment department the measurement is primarily for purchased financial assets rated externally by public rating agencies. Each of these asset classes, although similar in outward appearances, is distinctively different and requires a separate form of quality/impairment loss determination. Likewise, with originated assets, the bank knows the value of the underlying collateral
and understands the potential loss calculation; with purchased assets, the bank has only the rating
agencies loss risk analysis to support a rating and no real understanding of the borrowers or the
collateral value that support those financial assets.
There must be a better decision-useful disclosure methodology designed for each of the above
categories. The proposed standard is a starting place but will require several more years of trial
and error manipulations to arrive at a final conclusive decision-useful course of action.
Again, thank you for allowing user input into this complex area of credit loss measurement and
disclosure. If you have any questions regarding the attached methodology, please do not hesitate
to contact me at thomcr,i=?mo-net.com or 417-235-2435.
Sincerely,
Thom Conus
Att:
L.
2.
3.
4.
Loan Loss Reserve Analysis
Methodology #L- Measures expected loss based on historical analysis
Methodology #2 - Expected loss modifiers for Methodology # I analysis
Methodology #3 - Incurred loss forecast modifier based on migration analysis
Loan Loss Reserve Worksheet - measures incurred loss forecast
AFI-UNS
Comment Letter No. 50
Allowance
for
Loan Loss Reserve
ASC-310 t\'r', ASC-450
Analysis
Bank
March 31,20XX
Quarterly Update
ALLRO311
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AFI-UNS
Comment Letter No. 50
1. Concept Summary
2. Methodology #1- Required Reserve - By Loan Category
Historical Experience Analysis
3. Methodology #2 - Financial Trend lndicators and
Observable Data
4. Methodology #3 - Classified Loan Migration Analysis
(Used to support the Specific Watch List Allocation
5. Loan Loss Reserve Worksheet
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AFI-UNS
Comment Letter No. 50
Loan Loss Reserve Allocation Analysis Summary
Methodology # 1 (FAS 5) - Required Reserve (Historical)
559,142.00
Methodology # 2 (FAS 5) - Trend lndicators & Observable Data
390,531.14
Methodology # 3 (FAS 5) - Reserve Adjustment (Migration Factor)
338,960.46
(FAS 114) - Specific 'Classified Loan' Loss Reserve Worksheet
TOTAL LOAN LOSS RESERVE ALLOGATION:
16,727.00
$
1,305,360.59
Note: ASC-450 (FAS 5) is the allocation of loss reserve for a qroup of loans with similar risk characteristics.
ASC-310 (FAS 114) is the allocation of loss reserve based on our evaluation of individual loans. Worksheets
attached include Historical Experience Analysis by Loan Categories, Financial Trend lndicators and Observable
Data, Classified Loan Migration Analysis, the Concentration of Credit Report and the Loan Loss Reserve
Worksheet.
ALLRO3l-1
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AFI-UNS
Comment Letter No. 50
Loan Loss Reserve Analysis
Methodology # 1
Allocation by Loan Portfolio Category based on Five Year Historical Loss Experience
Category
$ 37,364
$14
5 Year Total Average Loans:
5 Year Category Average Loss:
$
$
Category Average Loss Factor:
Commercial
$
13,098
Net Loan Loss $
355
$
$
13,560
s42
15,258
278
$
$
$
8,794
$ee
$
$
9,165
(3)
$
13,563
$
9,873
$
$
22
1,001
$.
$i
10,127
$
9,196
31
$
1
$
9,431
ALLRO311
497
$
9;431
,, 3A
30
$
$
2,862
tz
0.5871%
Five Year Loan
Loss Factor
$
0.3181o/o
$
2,444
0.5871o/o
0.5958%
Methodology
Allocation
$ 237,323
3.2234%
TOTAL Required Reserve:
*Actual
..,,,.
437
39,834
8,710
8,401
$
$' ;"' ,,,13i816,3
0.3181o/o
Category Average Loan Loss Factor:
$
12,192
$
$
5 Year Total Average Loans:
5 Year CategoryAverage Loan Loss:
Real Estate
Commercial
Agriculture
Personal
10
$
$
3.22343%
Category Average Loss Factor:
Actua! Net
Loans (000's)*
268
13,708
$
5 Year Total Average Loans:
5 Year Category Average Loss:
Forecast
268
45,017
$
$
Category Average Loss Factor:
Net Loan Loss
45,017
$
0.59578%
5 Year Total Average Loans:
5 Year Category Average Loss:
Agriculture
$
$
$
$
$
Net Loans = Loans minus "Classfied" minus "Deposit Secured" minus "Government Guaranteed"
CONFIDENTIAL
280,749
26,724
14,346
t
AFI-UNS
Comment Letter No. 50
Loan Loss Reserve Analysis
Methodology # 2
Financial Trend lndicators and Observable Data
#2is
to be used as a fine
mechanism because although methodologys' based on
experience and/or identified problems does provide a fairly reliable indicator for allocation of loan loss
a means must be available to react to other circumstances that are beyond the control of the bank.
1. Delinquency Trends: .1 basis point times delinquency percentage of loans 30 days or more past due. (i.e. 3/31/1 1 30+
delinquency percentage of 5.86% times loans net of secured deposits, government guarantees and classifieds ($60,3OSM)
equals Loan Loss Reserve Allocation of $3S3,386.
2. Local Unemployment Rate: County Rate has risen to a twelve month average 6.79%. Since no significant area layoffs
have occurred, and area increase is primarily a seasonal adjustment, management feels no adjustment for Loan Loss
Reserve Allocation is appropriate at this time.
3. Concentration of Credit Risk: Categories exceeding 25% of Total Outstanding Loans will be reviewed as necessary and
an appropriate reserve will be assigned. Management has reviewed the 35% portfolio concentration of Non-Farm, NonResidential Real Estate Loans and because of overall payment performance and equity positions, that no additional reserye
is required. With regard to the Construction, Multi-family Residential and Non-Owner Occupied Commercial Real Estate
Concentration review, Construction Loans areatl2o/o of Tier 1 Capital; Multi-family is 14.00% and Non-Owner Occupied
CRE is at 65.00%, all well below the 300% thresholds of CRE concentrations described in regulatory guidance.
Management does not believe an additional CRE allocation is justified at this time.
4. Prime Rate Risk: A standard of 12.00oh is established as a neutral factor based on this reviewer's experience with cash
flow analysis and the effect interest rates have on repayment ability. .01 basis points will be added to or subtracted from the
Method # 3 Allocation for each point of bank interest above or below this standard. 3t31111 Bank Prime Rale = 7o/o = minus 0.0005.% adjustment.
5. Loan Review Grading Trends: All loans are graded as per loan policy. Trend analysis will be applied on a two year" & "
quarterly tracking of the portfolio grades and an adjustment to ALLR will be applied. Due to lack of data, no adjustment will
be made for March 31, 20XX.
6. Monitor Notlmpaired Trends: Trend analysis will be applied to this ALLR watchlist category and an adjustment factor will
be applied as deemed necessary. Trend data is insufficient for 3131111, but a base adjustment value of .010% is being
allocated for this category until a trend is established.
7. Sub-Standard Not-lmpaired Trends: Trend analysis will be applied to this ALLR watchlist category and an adjustment
factorwill beappliedasdeemednecessary.
Trenddataisinsufficientfor3l3llll,butabaseadjustmentvalueof .005%is
being allocated for this category until a trend is established.
8. lnflation Rate Risk: When and if management feels that the national inflation rate presents an element of risk to the loan
portfolio, an appropriate allocation will be assigned.
9. Overall state of the economy: Management will consider other factors which may arise from time to time along with any
influence they may have on the loan portfolio and adjust the loss reserye accordingly. Note: Although economic conditions
for our local economy have only been minimally affected, conditions on a national level remain weak and may yet cause
deterioration locally. Therefore, an adjustment based on the National Prime Rate will be applied. WSJ Prime Rate of
0.0325 divided by 100 = 0.000325%.
Forecast:
J - t\l,et loans of $60,305M times 0.005867o = Loan Loss Reserve Allocation of $3s3,386.
2.) - Net loans of $60,305M times 0.0002% = Loan Loss Reserve Allocation of $12,06 1 .
4.) - Adjustment of $60,305M times -0.0005% = Loan Loss Reserve Adjustment of $-30,152
6.) - Total "Monitor Not-lmpaired" loans $2,936M times 0.01% = Loan Loss Reserve Adjustment of $29,359
-1
7.) - Total "Sub-Standard Not-lmpaired" loans $1,256M times 0.005% = Loan Loss Reserve Adjustment of $6,279
9.) - Net loans of $60,305M times 0.000325% = Loan Loss Reserve Allocation of $19,599.
Total Method # 2 Loan Loss Reserve Allocation of
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1.14
AFI-UNS
Comment Letter No. 50
Loan Loss Reserve Analysis
Methodology # 3 - Classified Loan Migration Analysis
Three Year Loss Experience Calculation
Total Doubtful Loss
$
Total Sub-Standard Loss
$ 1 ,169,838
Total Monitor Loss:
$-
Migration Experience
Doubtful Loss Ratio:
Substandard Loss Ratio:
Monitor Loss Ratio:
7,e26
2.53o/o
26.38%
0.00%
Example:
LLR Worksheet Monitor Total $2,935,861 times Loss Ratio Factor 0 % = $0 Loss Reserve Allocation.
11 LLR Worksheet Sub-Standard Total $1,255,716 times Loss Ratio Factor 26.38 Yo = $331,304 Loss Reserve Allocation.
1/1 1
1
1 LLR Worksheet Doubtful Total $302.404 times Loss Ratio Factor 2.53oh = $7,657 Loss Reserve Allocation.
Total Classified Loan
Loss Reserve Allocation =
AMOUNT FIRST CLASSIFIED
DATE
TOTAL: $ 4,015,612
3t31t2011 Trio
3t31t2011 Aaron
3t31t2011 John
313112011 Kevin
3t31t2011
3t31t2011
12t31t2010
12t31t2010
12t31t2010
David
Solar
Larry
Cutter
ALLRO311
4.433,954
$
8,979
$
4,482
$
$
$
394,973
60,644
123,664
$
24,677
$
2,011
61,678
2,985
556,873
1,876,463
$
$
Ron
71,720
1213112010 William
12t31t2010 Jeff
12t3112010 Tom
12t31t2010 Nicholas
913012010 Cass
9t30t2010 John
6t30t2010 Kevin
6/30/2010 Jon
$
$
$
$
120,590
$
49,966
419,931
10,368
CONFIDENTIAL
$
313,032
$
302,404
$
AFI-UNS
Comment Letter No. 50
Loan Loss Reserve Analysis
Methodology # 3 - Classified Loan Migration Analysis
Three Year Loss Experience Calculation
6/30/2010 Mark
3t31t2010 GTC
23,431
$
1,340,000
313112010 Jeff
10,852
54,763
313112010 M Charles
17,636
313112010 Charles
1213112009 Malt
1213112009 Jetf
1213112009 Edward
8,978
2,800
46,361
1213112009 Roger
19,912
351,097
1213112009 Jerold
101,723
'1213112009 Jared
7,926
2,136
$
$
9/30/2008
9/30/2008
6/30/2008
6/30/2008
6/30/2008
ALLRO311
32,630
5,000
74,896
Doug
313112009 Kenneth
1213112008 Homer
1213112008 Larry
1213112008 Don
$
7,926
2,136
7,635
Ryan
3/31/2009 Land
3/31/2009 Oral
$
4,656
252,126
5,087
913012009 Ashley
Donald
DRP
Guy
659
24,391
23,334
9/30/2009 Cass
9/30/2009 John
9/30/2009 Tammy
6/30/2009
6/30/2009
6/30/2009
6/30/2009
6/30/2009
17,637
630
1,769,938
810
294,206
$
889,796
$
183,667
120,000
35,696
79,449
2,072
Randall
Roy
Farron
James
Jesse
5,086
8,1 65
7,476
2,618
CONFIDENTIAL
2,618
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Comment Letter No. 50
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Comment Letter No. 50
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Comment Letter No. 50
LLR03 11-worksh eet
CONFIDENTIAL