A Young & Associates, Inc. Publication
January 2015 Vol. 28, No. 4
New Regulations on
Capital Planning and Contingency
By: Gary J. Young, CEO
The Office of the Comptroller of the Currency has issued guidance for evaluating
capital adequacy and capital contingency. This letter closely corresponds with the
manner in which the FDIC and Federal Reserve assess capital adequacy according
to information in their examiner’s handbook. The concept is that banks (1) assess
capital adequacy in relation to their unique overall risks, and (2) plan for maintaining appropriate capital levels in all economic environments. A bank should maintain
a sufficient level of capital based on the associated risk at the bank and within the
economic environment comprised within the bank’s market. We have heard from our
clients that regulators are focusing on this much more than in the past.
Inside This Issue:
Capital Market Commentary - 2015
Forecast and 2014 in Review........3
The 8 Critical Components of
Basel III............................................5
Interest Rate Risk - Supervisory
Insights – Winter 2014....................7
Executive Search and Recruitment
Services...........................................8
Mirror, Mirror, On the Wall.............8
Young & Associates, Inc.
Welcomes Jerry Sutherin as
Senior Consultant.........................10
Proposed FASB Change to CECL
Model – Begin to Prepare............10
Young & Associates, Inc. agrees that this approach is appropriate and is in the best
interest of community banking. Of course, the real issue is how the regulation will
be implemented in the field. It is our recommendation that community banks take
a proactive position in developing a methodology for determining capital adequacy
and developing a capital contingency. It is our opinion that a bank is in a better position when the regulator reacts to a plan than when the regulator demands or even
requests that a plan be developed.
This article outlines the methodology that Young & Associates recommends in
meeting this guidance.
Step 1 – Develop a Base Case
A five-year projection of asset generation and capital formation (earnings less dividends) would be used to project the future tier-1 leverage ratio and risk-based capital
ratios. This is the Base Case scenario. Within this scenario, minimum capital adequacy
standards will be established. At this point, there will be no additional capital for risk.
As an example, for the tier-1 leverage ratio, the bank might establish a 5.0 percent
minimum plus a 1.5 percent additional for unknown risk. This approach would be
similar to the Basel III calculation. This would establish a 6.5 percent leverage ratio
minimum. This example is for the leverage ratio only. A separate calculation would
be needed to examine risk-based capital.
Step 2 – Identify and Evaluate Risk
In this step, the focus will be in identifying and evaluating:
ƒ ƒ Credit risk
ƒ ƒ Operational risk
ƒ ƒ Interest rate risk
Off-Site SAFE Act Review............13
ƒ ƒ Liquidity risk
BankTrends.............................. 14
ƒ ƒ Strategic risk
Pandemic Policy...........................14
Basel III Estimator................... 14
Capital Planning System.............14
ƒ ƒ Reputation risk
ƒ ƒ Price risk
ƒ ƒ Compliance risk
The risk would be assigned a level (i.e., extreme, high, moderate, low) and a trend
 (continued on next page)
Vol. 28, No. 4
Page 2
(i.e., decreasing, stable, or increasing). Based on these assignments additional capital
may be added to the base. In the analysis of risk, you should examine the current position as well as potential risk in a stressed environment. You should also look closely
at regulatory examinations, audit reports, and observation of current systems. Consider assigning additional capital for each position within the risk levels. It is acceptable and advisable that differing risk areas would have differing impacts on capital
need. As an example, credit risk might have a greater capital contribution than price
risk. Let’s assume that an additional 1.25 percent in capital is required based on the
bank’s risk profile. This is similar to the use of Qualitative Factors in the Allowance
for Loans and Lease Losses. Added to the 6.5 percent from above, the new capital
adequacy level based on risk would be 7.75 percent.
It is possible that your directors would want the leverage ratio to exceed 7.75 percent. Let’s assume that percentage is 9.0 percent. While directors want 9.0 percent,
those directors could also state that based on the bank's risk compared with others,
7.75 percent is the measure for regulatory capital adequacy.
“ . . .as we all know,
plans don’t work
perfectly. Therefore,
it is critical to stress
all assumptions in
the development of
the Base Case and in
the identification and
evaluation of risk.”
Step 3 – Stress Capital After Lending Stress
Both the FDIC and the OCC have suggested models for banks to stress capital
based on stress from loan losses by loan classification. Young & Associates strongly
recommends that the appropriate model should be included in your bank’s planning
process. The goal is for the model to indicate that the bank could survive a significant stress. This will also help in formulating your capital contingency which is discussed as Step 4.
Step 4 – Perform Contingency Planning for Stressed Events
If development of the Base Case and identification of risk is perfect with no internal or external errors, there would be no need for a contingency plan. However, as we
all know, plans don’t work perfectly. Therefore, it is critical to stress all assumptions
in the development of the Base Case and in the identification and evaluation of risk.
The stress or worst-case scenario in these areas will determine the amount of capital
needed to be raised. The analysis would then examine all realistic possibilities for
increasing capital including, but not limited to:
ƒ ƒ Reducing assets from the Base Case
ƒ ƒ Asset diversification (impacts risk-based capital)
ƒ ƒ All profitability enhancement measures
ƒ ƒ Dividend reduction, if applicable
ƒ ƒ Branch sale, if applicable
ƒ ƒ Downstream cash from holding company
ƒ ƒ Capital raise from existing shareholders
ƒ ƒ Capital raise from new shareholders
ƒ ƒ Additional holding company debt
ƒ ƒ Sale of the bank
A brief word for mutual companies that are now regulated by the OCC: Many of the
capital raising opportunities do not exist for a mutual. We would suggest that this is
an additional risk for these banks. We would suggest that an additional 0.5 percent or
so of additional capital is necessary for mutual banks compared with stock banks.
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Step 5 – Develop a Capital Planning and Contingency Policy
All of the preceding will be placed in policy and would include:
ƒ ƒ Assignment of roles and responsibilities
ƒ ƒ Process for monitoring risk tolerance levels, capital adequacy, and status of capital planning
ƒ ƒ Key planning assumptions and methodologies, as well as limitations and
uncertainties
ƒ ƒ Risk exposures and concentrations that could impair or influence capital
 (continued on next page)
ƒ ƒ Measures that will be taken based on differing stress events
ƒ ƒ Actions that will be taken based on stress testing
Vol. 28, No. 4
Page 3
Young & Associates has already begun working with banks to develop capital
adequacy standards, a capital contingency, and the related policies. In addition, we
have developed a product that will help you complete this risk assessment on your
own in as little as one day. You can find this product on www.younginc.com, or you
can call our office. If you have any questions about this article or would like to discuss having Young & Associates assist your bank, please call Gary J. Young, CEO,
at 330.283.4121, or send an e-mail to gyoung@younginc.com. 
Capital Market Commentary
2015 Forecast and 2014 in Review
By: Stephen Clinton, President, Capital Market Securities, Inc.
Market Update
The general stock market continued its upward climb in the third quarter of 2014.
The Dow moved up 1.29% in the quarter while the broader Nasdaq Index moved up
1.93%. Bank pricing, however, moved in the opposite direction. The Nasdaq Bank
Index fell 4.76% in the third quarter. The principal contributors to the rising market
appear to be continuing improvement in economic conditions. We believe that the
decline in bank pricing is mostly related to concerns over near-term bank profitability. The net interest margins of banks are being pressured by the low interest rate
environment. The profit gains banks have achieved from releasing loan loss reserves
appear to be nearing an end. Loan growth has been difficult for banks to achieve for a
number of reasons. Finally, the benefits of cost-cutting programs undertaken by many
banks have been realized and further cost cuts may be harder to achieve.
Among the economic factors we are monitoring are:
ƒ ƒ Economic Growth. The U.S. economy posted its strongest growth in 11 years during the third quarter. GNP grew at a seasonally adjusted annual rate of 5%. However, with most of the world struggling economically, we expect that U.S. economic
growth in 2015 will be hard pressed to continue its strong pace.
ƒ ƒ Housing. Yearly growth in home prices continued to moderate early in the fourth
quarter, suggesting that the housing market may be settling into a more gradual
sustainable recovery. Prices increased 4.6% in the 12-month period ending in October, according to the Case-Shiller home-price report. That is significantly lower
than the 10% plus gains recorded earlier.
ƒ ƒ Oil Prices. Last year we noted that in 2013, the U.S. surpassed Russia as the
world's largest energy producer. While this was a sign of the U.S. moving toward energy independence, the increase in oil production has helped create an
oil glut that has sent oil prices plunging. In early 2015, the price fell below
$50 a barrel. The falling oil prices has driven gas prices to below $2 a gallon
and is projected to save U.S. consumers $125 billion, according to Goldman
Sachs economists in a recent research report. We do not foresee oil prices remaining at these levels and expect oil producers to reach some accord to control oil supplies.
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ƒ ƒ Auto Sales. Sales of cars and light trucks in the U.S. totaled an estimated 16.5
million in 2014, and based on December’s sales and industry expectations
the pace could reach 17 million in 2015, a level not seen in 12 years. As the
auto industry remains a dominant component of the U.S. economy, auto sales
strength is a positive sign for 2015.
ƒ ƒ Imports/Exports. Last year, we noted some optimism regarding growing U.S.
exports. Our ability to reduce the trade gap in 2014 was impacted as U.S. exports fell, a sign of how a stronger dollar and slower growth overseas weakened
demand for American-made goods. We do not expect the deficit to improve
substantially in 2015.
 (continued on next page)
Vol. 28, No. 4
Page 4
ƒ ƒ Job Growth. The economy continues to reflect job growth with 2014 expected
to be the best year of job creation in 15 years. While the Republicans and the
Democrats disagree on many issues, fostering job growth is at the top of both
parties’ agendas. This should bode well for continued job creation in 2015.
ƒ ƒ Consumers. Consumer spending, bolstered by lower gas prices, increasing
personal income, and improved consumer confidence, has been strong since
the weak numbers recorded due to the harsh winter that impacted 2014’s first
quarter numbers. Since two-thirds of GNP is made up in consumer spending,
continued consumer confidence will be a key economic component for 2015.
ƒ ƒ Government. The fall elections will bring a new dynamic to Washington. Republicans now control both houses of Congress. A lame duck White House will
be hard pressed to enact legislative initiatives and soon the focus will turn to
the next presidential election.
ƒ ƒ Fed. Federal Reserve Chair Janet Yellen expects the economy to improve
enough in 2015 to justify raising interest rates and to begin to normalize monetary policy. She further added that the Fed will be “patient in doing so.” We
anticipate modest rising rates in the second half of 2015.
ƒ ƒ Inflation. Inflation remains in check. The most recent index of consumer prices
was reported below the Fed’s 2% target for the 31st consecutive month. The
lack of inflation concerns provides flexibility for the Fed to continue its accommodative policies well into 2015. With slower economic growth anticipated,
in conjunction with lower energy costs, we do not anticipate inflation worries
to be a concern for 2015.
Market Update
The stock market recorded continued improvement in 2014. The Dow reached
a record high above 18,000 near the end of the year. The Dow Jones Industrial
Index rose 7.52% in 2014 compared to the Nasdaq Composite Index’s increase
of 13.40%.
Short-term interest rates ended 2014 with the 3-month T-Bill at 0.04%. Longer-term interest rates decreased in 2014. The 10-Year T-Note ended the year
at 2.17% compared to 3.04% at December 31, 2013.
Market pricing for the banking sector improved modestly in 2014. The Nasdaq Banking Index posted an increase of 2.84%. Although banks have experienced positive pricing trends since late 2011, bank prices remain nearly 25%
below their highs recorded in late 2006.
Merger and Acquisition Activity
As we predicted last year, bank merger activity increased in 2014. The number
of deals increased approximately 25%. Pricing on bank sales improved modestly in
2014, recording a median price to book multiple of 135% and a price to earnings
multiple of 19.9. We expect the merger activity to accelerate in 2015 as merger pricing multiples continue to climb.
Interesting Tidbits
As has been our custom from time to time, we like to pass along various items that
we have seen that you might enjoy reading. These include:
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+
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ƒ ƒ The OCC recently released a report that reviewed loans recently closed. The report found that lenders continued to loosen underwriting standards for the third
consecutive year across all types of loans but especially commercial lending. The
report further notes that the largest banks have eased underwriting standards the
most. It was noted in the report that pricing was the most common method by
which lenders loosened their standards.
ƒ ƒ It was reported that Fannie and Freddie reported profits totaling $6 billion in the
third quarter which will be paid to the U.S. Treasury. Dividends paid to the government now total $225.5 billion compared to $187.4 billion that the GSEs drew
down from the government.
ƒ ƒ The Small Business Administration reported its 7(a) loan program reached another
milestone in 2014. In fiscal year 2014 (ended September), the SBA approved $19.2
billion in loans, a 7.4% increase from the previous year.
 (continued on next page)
Vol. 28, No. 4
Page 5
ƒ ƒ In December, the Treasury Department sold its remaining stake in Ally Financial.
This was the Treasury’s last major ownership position from the TARP program (it
still owns positions in approximately thirty-five community banks). The net gain
from the TARP program was approximately $15 billion.
ƒ ƒ In June, the European Central Bank introduced negative interest rates on deposits it held. The central bank in Denmark has also used negative interest rates. The
Swiss central bank followed suit in early 2015.
ƒ ƒ There are over 2 million (full-time equivalent) employees working for FDIC financial institutions.
Capital Market Services
Young & Associates, Inc. has a successful track record of working
with our bank clients in the development and implementation of capital
strategies. Through our affiliate, Capital Market Securities, Inc., we have
assisted clients in a variety of capital market transactions. For more information on our capital market services, please contact Stephen Clinton
at 1.800.376.8662. 
The 8 Critical Components of Basel III
By: Gary J. Young, CEO
Basel III became effective on January 1, 2015, and you will use these changes
at the time you file the March 2015 call report. There are numerous parts of Basel
III that will effect some community banks and many more regional banks, but I
believe there are 8 critical components that every community banker needs to understand. While Basel III will not have a significant impact on most community
banks, it will on some, and others will need to know the impact of changes.
The following are my 8 critical components:
1. Basel III effects risk-based capital only. There is no impact on the tier-1
leverage ratio, which most bankers and regulators follow more closely than riskbased capital. There is a new capital definition, CET1, which is capital equity
tier-1 and includes stock, surplus, undivided profit, and current income. But, the
denominator of this ratio is risk-weighted assets. CET1 is not the tier-1 leverage
ratio which is divided by average assets.
2. Prompt Corrective Action capital amounts do not change. Well Capitalized is a 5.0% tier-1 leverage ratio, a 6.5% CET1, 8% tier-1 risk-based capital,
and 10% total risk-based capital. Adequately Capitalized is 4.0% tier-1 leverage, 4.5% CET1, 6% tier-1 risk-based capital, and 8% total risk-based capital.
The Capital Conservation Buffer is added to the Adequately Capitalized ratios in
which the denominator is risk-weighted assets. In other words, there is no Capital
Conservation Buffer for the tier-1 leverage ratio. Remember point 1 – Basel III
only impacts risk-based capital ratios.
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3. Capital Conservation Buffer. This is designed to conserve capital by
restricting dividends and bonus payments in those banks getting close to Adequately Capitalized. There is a phase-in period. When fully implemented at the
beginning of 2019, a bank must maintain a level of capital equal to 2.5% above
Adequately Capitalized. The table on the following page provides additional
information on the phase-in and capital amounts needed, as well as potential
dividend restrictions.
If the last 4 quarters of net income minus dividends or distributions is negative,
and if the bank failed to meet the capital conservation buffer in the last quarter,
no discretionary bonus payments are permitted. This is obviously a critical factor to follow.
 (continued on next page)
2015
2016
2017
2018
2019
Minimum Before Capital Conservation
Vol. 28, No. 4
Page 6
Common Equity Tier-1
4.5%
4.5%
4.5%
4.5%
4.5%
Tier-1 Capital Ratio
6.0%
6.0%
6.0%
6.0%
6.0%
Total Capital
8.0%
8.0%
8.0%
8.0%
8.0%
0.000%
0.625%
1.250%
1.875%
2.500%
7.000%
Capital Conservation
Minimum After Capital Conservation
Common Equity Tier-1
4.500%
5.125%
5.750%
6.375%
Tier-1 Capital Ratio
6.000%
6.625%
7.250%
7.875%
8.500%
Total Capital
8.000%
8.625%
9.250%
9.875%
10.500%
*Denominator is risk-weighted assets.
4. Highly Volatile Commercial Real Estate (HVCRE). This is an acquisition,
development, and construction (ADC) loan. Automatically excluded from HVCRE
are 1-4 family residential property, the purchase or development of agriculture
land, or projects that qualify as community development projects. If not excluded
above, the loan could still be excluded if the loan is below the maximum supervisory LTV for that category of loan and the borrower has contributed, in cash
or cash equivalent, 15% of the appraised completed value. If not excluded, the
loan is an HVCRE loan with a risk weight of 150%. When the loan moves into
permanent financing, it generally will not remain an HVCRE loan. This pertains
to all loans in the portfolio, not just loans booked after January 1, 2015. You are
encouraged to document everything. There is nothing illegal about making an
HVCRE loan. But, since it has more risk, the risk-weighting is higher.
5. Non-Performing Loans. Non-performing loans have an increased risk
weight of 50%. Therefore, 1-4 family real estate loans that are 90+ days delinquent or in non-accrual have a 100% risk weight, while all other loans have a
150% risk weight. If the loan is guaranteed by the Federal Home Loan Bank, another bank, Farmer Mac, etc., there is no increased risk weight.
6. Unfunded Commitments. Unfunded commitments have some major changes. The Capital Conversion Factor for the unfunded commitment of a loan with an
original maturity of one year or less is 20%. For loans over one year, the Capital
Conversion Factor is 50%. If the loan can be unconditionally cancelled by the
bank, there is a 0% Capital Conversion Factor.
7. MSA and DTA. There is a 10% of common equity limit, and a 15% aggregate limit on mortgage servicing rights, deferred tax assets, and investments
in banks that are not consolidated. The amount below the common equity limit
receives a 250% risk weight. The amount above the common equity limit is deducted from common equity tier-1.
8. Unrealized Gains or Losses. If the bank does not opt-out, unrealized gains
or losses will not be removed from capital. Most community banks will want to
opt-out. The AOCI opt-out must be made on the bank’s first call report filed after January 1, 2015.
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To help answer and alleviate fears, Young & Associates, Inc. has developed an
easy-to-use program that will estimate capital under the new Basel III rules and
compare that information to the bank's capital at the September 30, 2014 and future call reports. To complete this, we partnered with BankTrends to develop the
Basel III Estimator, which will provide a close estimate of your bank's Basel III
calculations with little or no input from you. The cost of a one-year subscription
is $300. To see a sample of how the Basel III Estimator works and looks, follow
https://www.bank-trends.com/Reports/BaselIIIYoung/. If you would like to purchase the model, click upgrade for your detailed information.
I am very proud of this product and hope you find it useful. If you would like
to speak with me about this article, please call my cell at 330.283.4121, or e-mail
me at gyoung@younginc.com. 
Interest Rate Risk
Vol. 28, No. 4
Page 7
Supervisory Insights – Winter 2014
By: Gary J. Young, CEO
Young & Associates has been alerting our clients, and all community banks
through the 90-Day Note, that interest rate risk is a serious concern for some
banks. In recent months, regulators have issued concerns about the growth of
non-maturity accounts and the potential shift to certificates when rates increase.
Regulators have also issued concerns about the lengthening of assets to gain yield.
In a past 90-Day Note article, I examined UBPR data and came to the same conclusion. There is interest rate risk at banks that could have both short-term and
long-term impact on profitability.
The FDIC has raised the level of concern. In Supervisory Insights – Winter
2014, the entire 44-page document is devoted to interest rate risk. This is an
excellent article that discusses:
ƒ ƒ Effective Governance of IRR
ƒ ƒ Developing Key Assumptions
ƒ ƒ Developing In-House Independent Review
ƒ ƒ What to Expect During an Interest-Rate Risk Review
ƒ ƒ Recent Supervisory Guidance
I view the Supervisory Insights - Winter 2014 as a regulator WARNING.
In effect it is saying that if your bank has problems in the future, we warned
you. No bank nor banker wants to be in that position. There are a few steps
that I would suggest you review to determine what action your bank needs
to take, if any.
To read Supervisory Insights – Winter 2014, click HERE to access a PDF. Review your Interest Rate Risk Policy carefully. Are you following it? Does your
ALCO follow each of the steps listed in the policy?
1. Review the mix of non-maturity deposits to all other deposits. Compare the
pre-recession mix to the current mix. In almost all cases, there has been a shift
to non-maturity deposits during this low interest rate environment. Does your
model consider that as interest rates rise and the rate differential in these accounts widens, some non-maturity deposits will shift to certificates?
2. Compare your asset maturities pre-recession to current asset maturities. Have
you lengthened your maturities?
3. Review every assumption within your interest rate risk model. There are many
bankers that have maintained default assumptions without considering if they
are accurate. Even if an assumption change has been made, is it still appropriate in this environment?
4. Are your decay rates and betas appropriate? Do you have support for these
assumptions?
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5. An independent review is very important. Supervisory Insights – Winter 2014
walks you through how you can develop all this in-house. Some banks certainly have the potential for doing this, but not all. Regardless of whether this
is in-house or you engage a competent third party, this needs to be done.
6. If you need assistance, call us; or call another competent consulting group
that can assist you in preparing for the growing interest rate risk.
If you would like to discuss interest rate risk, please send me an e-mail at
gyoung@younginc.com or call me 330.283.4121. You can also contact Martina
Dowidchuk at 800.525.9775 or mdowidchuk@younginc.com. 
Vol. 28, No. 4
Page 8
Executive Search
and Recruitment Services
Experiencing Difficulty Finding the Right Candidate
To Meet Your Staffing Needs?
If your bank is finding it hard to identify and screen candidates to meet your
staffing needs, consider Young & Associates, Inc. While we are qualified to help
with all levels of staffing within your organization, we have routinely been called
upon to help staff the following positions: President/CEO, Chief Financial Officer, Lending Officer, and Compliance Officer.
Specialists in the Banking Industry: Unlike many traditional search firms
that do not specialize in staffing banking positions, Young & Associates, Inc. is
very knowledgeable about the skills necessary to be successful in your banking
environment. In addition, we will utilize our experts internally through the prescreening and interviewing process to verify skills, experience, etc.
Search Goal/Objective: Our objective throughout the search will be to provide your bank with 2-3 highly-skilled, thoroughly-screened, and motivated
candidates to fill your opening(s).
Multiple Options: Our Executive Search Services provide a number of options, from resume generation to full placement, depending upon your needs.
Thorough and Effective: We will help you ensure the “right” candidate is
sourced and referred to you by carefully and thoroughly prescreening and interviewing, verifying employment/work history, and obtaining 2-3 professional
and/or character references.
Extensive Database: Through our long history working with banks, we have
developed an extensive network of contacts and resumes of individuals interested in furthering their career(s). In addition, we can employ direct sourcing
to banks and other financial institutions, as well as print and/or internet advertising to generate additional qualified candidates.
Timeline: Once we begin the search and receive your commitment to staff
your opening, we will work quickly and efficiently to staff your needs. Most
searches can be completed in thirty to ninety days.
We truly value the opportunity to provide you with this highly specialized
service. For additional information on our Executive Search Services, contact
Sharon Jeffries at 330.678.0524 or sjeffries@younginc.com. 
Mirror, Mirror, On the Wall
By: John Fahrendorf, Executive Vice President, Western Division
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I know – you’re wondering what that title has to do with community banking.
Over the last number of months, at every regulatory conference that we’ve attended, one of the regulatory panelists has either verbatim or similarly said, “look
around the room – how many of you will be at this meeting five or ten years from
now?” They then proceeded to talk about the increasing importance of succession
planning and building your bench strength now; all while faced with the obvious
aging of both “C officers” and board directorship, and combined with the increasing competition for tomorrow’s leaders by other non-bank financial services. They
referred to not just succession planning in the traditional sense, but also to the
importance of building and enhancing the management pipeline and talent pool
to ensure a solid future for you, your bank, and your shareholders.
Human Capital Banking
At Young & Associates we have been extremely passionate about community
banking for over 35 years and have been consistently talking about the heightened
importance of this issue as an ongoing process, not merely an event or something that will be addressed at some future date. That’s part of the reason that,
 (continued on next page)
Vol. 28, No. 4
Page 9
a couple of years ago, we chose to partner with The Findley Group to form Human Capital Banking. Ok, you’re saying, “what’s Human Capital Banking?” Let
me first tell you what it’s not. It’s not just succession planning (management and
board). It’s not just performance management. And, it’s not about just spending
money on training.
Human Capital Banking is a seven-step process, as follows:
1. Aligning your bank's vision, mission, and strategies
2. Defining your bank's core values
3. Assessing your bank’s talent and then building an action plan
4. Hiring the right people
5. Aligning employee performance to your bank’s vision and values
6. Creating managerial and employee development plans in order to meet your
vision
7. Rewarding and recognizing the right things, or simply put, walking the walk.
Human Capital Banking is defined, in one sentence, as a process and culture
for developing, maintaining, and maximizing the Human Capital within your
bank in order to ensure your long-term success and relevance as a premier performing bank.
“Human Capital
Banking is . . a
process and culture
for developing,
maintaining, and
maximizing the Human
Capital within your
bank to ensure your
long-term success and
relevance as a premier
perfoming bank.”
Over the past number of months, we’ve seen a number of articles (Robert Morris & Associates, Bank Director, McKinsey & Company, etc.) about the current
or emerging “talent crisis” or “war for talent,” and how that war for talent would
separate the winners from the losers. The common thread in all those articles
speaks to the continued aging of the baby boomer pool, and the critical need to
consistently develop the emerging “talent pool.” Compounding that challenge,
based on a Compdata Surveys study, is the finding that the banking and finance
industry has the second-highest employee turnover rate, second only to the hospitality industry.
The other key component of Human Capital Banking is converting the view
of “spending money on training” and making it a real and measureable “return
on investment” that consistently results in a payback that significantly exceeds
the investment. As bankers, we are particularly attentive to costs and appropriately are on a never ending quest to drive down our costs. We all focus on our
efficiency ratio and traditionally devote our energies to one side of that equation.
Almost sixty years ago, Peter Drucker was one of the first “gurus” to espouse
that our people should be viewed and treated as assets, not merely liabilities to
be eliminated. Another of my favorite authors, James C. Collins (Good to Great:
Why some Companies Make the Leap...and Others Don't), had many insightful
thoughts, a couple of which, in particular, are worth repeating and are relevant
to Human Capital: 1) "A company should limit its growth based on its ability to
attract enough of the right people,” and 2) "Great vision without great people is
irrelevant.”
With Human Capital Banking, we can assist you in remaining not just relevant,
but also help enable you to stand out from the crowd and either continue to or
achieve premiere performance.
35+
So, “mirror, mirror on the wall?" I’d like all of you, next time you’re looking
in the mirror, to take a few minutes and give some serious thought as to whether
you’re truly doing all that you can do to ensure that you are maximizing your most
important resources, Human Capital resources, as all truly great leaders do. 
John Fahrendorf
YEARS
1978 - 2015
younginc.com
1.800.525.9775
602.383.3603
www.humancapitalbanking.com
jfahrendorf@younginc.com.
Vol. 28, No. 4
Page 10
Young & Associates, Inc. Welcomes
Jerry Sutherin as Senior Consultant
We are pleased to announce that Jerry Sutherin has joined Young & Associates
in the Lending and Loan Review Division. With over 28 years in the financial
services industry, Jerry provides community banks throughout the region and the
U.S. with third-party loan review, lending policies and procedures, loan portfolio
due diligence, and ALLL review services. Prior to joining Young & Associates,
Jerry worked in varying capacities ranging from supervising an Asset Quality/
Loan Review function at a large regional bank, to managing a $2.5 billion loan
portfolio responsible for loan performance, credit quality, and departmental efficiency. Jerry has earned a National Loan Review Certification from the Bank
Administration Institute, and graduated with Honors from the Stonier Graduate
School of Banking, as well as other post-graduate degrees, including a Bachelors
of Business Administration Finance degree from Kent State University and a Masters of Business Administration (MBA) from the University of Steubenville. He
can be reached at 1.800.525.9775 and jsutherin@younginc.com. 
Proposed FASB Change to CECL Model –
Begin to Prepare
By: S. Wayne Linder, Senior Consultant
“Most financial
institutions already
have acceptable
processes in place
for determining
specific reserves for
individually reviewed
loans under ASC 310.
Today’s challenge is for
defending the ASC 450
reserve calculations for
the homogenous pools
of loans.”
35+
YEARS
1978 - 2015
younginc.com
1.800.525.9775
The Financial Accounting Standards Board (FASB) has proposed accounting
standards that would require all community banks to revise how they account
for their Allowance for Loan and Lease Losses (ALLL), as well as a proposed
allowance for debt securities losses (these categories plus reserves for losses on
unfunded lending commitments are often referred to in the aggregate as the Allowance for Credit Losses). It would replace the current “incurred loss” model
with an “expected loss” model referred to as CECL or Current Expected Credit
Loss model.
Why is FASB proposing changes to the allowance for credit losses? They say
that there is a lack of forward-looking information in loss estimates. The update
seeks to facilitate more timely recognition of likely losses by expanding the timeframe for determining loss estimates from the current GAAP standard of potential
inherent losses existing as of the date of the analysis, i.e., analysis of the present
time period to present and future or life-of-loan time periods.
The CECL model would require financial institutions to factor probable future
credit losses into their methodology with loss forecasts based on a financial institution’s own estimates of future loss probabilities and continual updates to reflect
changing economic conditions and loan risk characteristics. The new proposal
necessitates a reliance on “reasonable and supportable” forecasts about future
economic and other conditions, whereas the current inherent loss model is supposed to rely on only information known as of the date of the analysis.
Financial regulators support this change and, in fact, have already implemented many of the processes through the issuance of regulatory guidance statement
suggesting that financial institutions should be utilizing these processes today.
Financial regulators continue to stress the need for greater portfolio segmentation based on loan characteristic, stress testing of significant portfolio segments,
determination of credit risk indicators specific to your market and loan portfolio,
correlation of economic conditions and collateral values to credit risk indicators,
and the trending of movements in these correlations over the economic cycle.
Most financial institutions already have acceptable processes in place for determining specific reserves for individually reviewed loans under ASC 310. Today’s
challenge is for defending the ASC 450 reserve calculations for the homogenous
pools of loans. (Approximately 20% received feedback from regulators or CPA
firm requesting additional loan segmentation, supporting documentation, or more
in-depth commentary.)
 (continued on next page)
This includes:
Vol. 28, No. 4
Page 11
1. Appropriate segmentation of the pools. Regulators want to see more in-depth
segmentation.
2. Determine a historical loss rate for each sub-segment pool.
3. Defense of qualitative factor adjustments:
a. Correlation
of economic conditions and collateral values to credit risk
indicators
b. Q-factor value adjustment process and justification of adjustment amount
This will not change under the proposed CECL model. Added to this list
will be:
4. Forecasting future lifetime loss probabilities by sub-sectors within the
portfolio
5. Duration – life-of-loan determination by sub-sectors within the portfolio
Preparing For Changes
There are several steps institutions can take now to prepare for the proposed changes:
Create a Data System Warehouse
CECL requires establishment of a process to gather and project forward-looking information and forecasts that are to be considered in the estimation of credit
losses. This will likely necessitate gathering, computing, and storing of many more
data points of information. The first step will be to enhance data capture on your
core system. The second step will be the storage of this data in a manner that
will allow easy access and usability.
Data collection needs to be of the type that can be correlated to loan losses.
This data should:
ƒ ƒ Span a sufficiently long time period – at least one full economic cycle
ƒ ƒ Include a risk rating of all individual loans, including consumer and residential
mortgages
ƒ ƒ Include the capture of more individual loan characteristics – better loan
segmentation
ƒ ƒ Codes for various credit risk indicators – product code, collateral type, underwriting exceptions by type, renewals, delinquency, etc.
ƒ ƒ Collateral values – change over different phases on economic cycle
ƒ ƒ Individual loan duration – the average life of a loan in a segment of the portfolio
ƒ ƒ Include information on defaulted loans – loss given default throughout an entire
economic cycle
35
+
YEARS
1978 - 2015
younginc.com
1.800.525.9775
ƒ ƒ Include predictive macroeconomic variables – the performance and behavior of
the economy as a whole. This includes national, regional, and local performance
indicators, such as unemployment rates and price indexes, to understand how the
whole economy functions.
Currently most community financial institutions lack sufficient data for effectively forecasting or inputting data into a third-party vendor models. If you
do not have these new data elements, you will likely have to rely on peer data,
which could prove costly if your reserve rate is lower than average.
The more portfolio data collected, the more precisely financial institutions can
calculate expected losses. More data will also enable financial institutions to better defend the calculation to examiners and auditors.
Design and Implement an Effective Credit Risk Indicator Program
Management should establish “risk or loss drivers that should be considered
 (continued on next page)
Vol. 28, No. 4
Page 12
when evaluating inherent risk that may drive losses in a loan portfolio.” (Qualitative Factors and the Allowance for Loan and Lease Losses in Community Banks,
by Sharon Wells, Examiner, and Trevor Gaskins, CPA, Assistant Examiner, Federal Reserve Bank of Philadelphia’s SRC Insights, Fourth Quarter 2010). Select
credit risk drivers for each of the nine Q-factors.
1. Determine the best measures for credit risk. Work with management in designing indicators; limit measures to those that are most representative.
2. Determine data availability.
3. Develop measures. Balance the objective historic data as a measure of future
risk with the more predictive but more subjective before the event (future)
measures of risk. Before the event measures have the most value to provide
insight into future issues. Understand risk indicators versus performance
measures.
4. Use escalation criteria or trigger points. This is a requirement of regulators
for risk management programs board oversight.
5. Approach indicators as a work in progress. Experience will help refine measures to those most valuable to any one risk or process.
Examiners expect qualitative adjustments to mirror the improvement and decline of both internal and external drivers of credit risk. This is referred to as directional consistency. (Interagency Policy Statement on the “Allowance for Loan
and Lease Losses,” dated December 2006)
Scrubbing of Data for Accuracy
Portfolio segmentation is one of the key elements to a sufficient ALLL methodology and may be even more important when estimating lifetime rather than
inherent losses. The ability to segment the loan portfolio adequately is often based
on the adequacy and accuracy of loan coding.
Segmenting by FDIC Call Code is often not granular enough. This breakdown
can be viewed by many auditors and examiners as inadequate because these
broad buckets are unable to account for the varying levels of risk within each of
the loan segments. The financial regulators have suggested over the past several
years that financial institutions should segment the above mentioned portfolio
segments into smaller homogenous pools with similar risk attributes and risk
characteristics in order to better identify levels of risk in the loan portfolio as a
whole. For example, the financial institution needs to have the ability to identify
by codes: HVCRE (High Volatility CRE) as a sub-category of CRE, end of draw
period HELOC loans, IORR (Investor Owned Residential Real Estate) loans, and
future regulatory higher risk lending activities.
Enhancement of Establishing Loan Loss Rates
There are two significant points to address under this topic. First, management
will need to establish and maintain supporting documentation used to develop the
historical loss rate for each pool of loans under the more in-depth segmentation
as addressed earlier in this article.
35
+
YEARS
1978 - 2015
younginc.com
1.800.525.9775
Second, the expected loss estimate for CECL should be a point-in-time (PIT)
versus through-the cycle (TTC) method. PIT estimates attempt to measure the
level of risk as of the estimation date, taking into account the prevailing credit
environment, whereas TTC estimates attempt to measure the level of risk assuming mid-cyclical economic conditions. Unlike the unexpected losses capital exists to absorb, the losses to be absorbed by the allowance are expected to occur
in the ordinary course of business.
Conclusion
Financial institutions should not passively wait for the approved proposal,
only to react to the finalized changes. Rather, institutions should begin considering the possible changes and taking a proactive approach towards improving
their processes and data gathering and warehousing to accommodate changes
required by CECL.
 (continued on next page)
Vol. 28, No. 4
Page 13
The use of peer group data may be questioned by the financial regulators for
input into any credit loss model. Each financial institution needs to have a risk
management system and process in place that adequately identifies and measures
the financial institution’s own credit risk position.
“We want all banks, including community banks, to maintain strong capital
and to take advantage of the analytical tools that can help them prepare for an
uncertain future. We also want them to focus on having risk management capabilities commensurate with their size and complexity.” (Remarks by Thomas J.
Curry, Comptroller of the Currency, before the ABA Risk Management Forum,
Orlando, Florida, April 10, 2014)
For more information on this article, contact Wayne Linder, Senior Consultant, at swlinder@younginc.com, or Tommy Troyer, Consultant and Loan Review
Manager, at ttroyer@younginc.com. 
Off-Site SAFE Act Review
The CFPB's Regulation G (SAFE Act) specifically requires an annual
audit for compliance. While this review can be done anytime during
the year, the best time is right after the annual renewal period
(November 1 through December 31).
In order to assist financial institutions with this requirement, Young &
Associates, Inc. has developed a SAFE Act Review that can be done
completely off site, which increases efficiency and reduces expenses.
The review includes a formal report.
As part of the review, you will be asked to provide your SAFE Act
information to us electronically - and we take it from there.
Pricing: Pricing is all inclusive, and is based on the number of Mortgage
Loan Originators (MLOs) that your institution has.
35
+
YEARS
1978 - 2015
younginc.com
1.800.525.9775
• Up to 10 MLOs - $700
• Each additional MLO - $30 each
For more information, contact Karen Clower today at
1.800.525.9775 or kclower@younginc.com to learn more
about this simple, turn-key system to perform your annual
SAFE Act Review.
Vol. 28, No. 4
Page 14
PRODUCTS
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For more information and pricing, contact us at
bank-trends@younginc.com or 1.800.525.9775.
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This may be used as a stand alone policy or incorporated into
your Business Continuity Policy. Contains guidance from
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sample Pandemic Plan.
Basel III Estimator - $300/Year
Designed to help community bankers to understand the impact
Basel III will have on their bank's capital adequacy. Data is provided
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Customize Results: Provide additional inputs to reflect your
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Comprehensive tool that allows you to assess capital adequacy in
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plan for maintaining appropriate capital levels in all economic
environments.
Allows you to:
Develop a Base Case Scenario in which minimum capital
adequacy standards are established.
Identify and Evaluate Risk for your bank. Parameters in this
analysis have been field-tested in our work with banks over
the years and closely resemble adequacy standards established
in consent orders.
Stress Test Capital by loan classification (as recommended
by the FDIC and OCC)
Perform Contingency Planning for stressed events. All
assumptions are stressed to determine the amount of capital
needed and possibilities for increasing capital are examined.
Generate Your Capital Plan in as Little as 1 Day! Data
from the Excel spreadsheets can be easily transfered directly
into a Word document that can be customized to fit the unique
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System Requirements: Microsoft® Excel 2007 and Word 2007
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For more information concerning any of these articles or products, visit us at www.younginc.com or call 1.800.525.9775 and mention offer #551.
This publication is designed to provide accurate and authoritative information concerning the subject matter covered. In publishing this newsletter, neither the author nor the publisher is engaged in rendering legal, accounting, or other professional advice. If legal, accounting, or other expert assistance
is required, the services of a professional competent in the area of concern should be sought.
Copyright © 2015 By Young & Associates, Inc.