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“IMPAIRED” AND
“IMPAIRMENT”:
IS THERE A DIFFERENCE?
Garrett MorrisDirector of Consulting
Sageworks
PRESENTED BY
Emily BoganSr. Risk Management Consultant
Sageworks
About the Webinar
+ Ask questions throughout the session using the GoToWebinar control panel
+ The slides and the recording will be sent out to attendees after today’s session
About Sageworks
+ Financial information company that provides credit and risk management solutions to financial institutions
+ Data and applications used by thousands of financial institutions and accounting firms across North America
+ Awards
+ Named to Inc. 500 list of fastest growing privately held companies in the U.S.
+ Named to Deloitte’s Technology Fast 500
+ NC Tech Awards: Excellence in Customer Service
Today’s Speakers
Garrett MorrisDirector of Consulting
Sageworks
Emily BoganSr. Risk Management Consultant
Sageworks
Learning Objectives
+ Define the two terms, Impaired and Impairment
+ Determine how to identify an impaired loan
+ How to calculate impairment – 3 valuation methods
+ Examples of valuation methods
+ Review common misconception
+ Documentation requirements
+ Questions
Poll
What is ASC 310-10-35?
+ ASC 310-10-35 is a source of guidance on accounting for impaired loans and impairment calculations in a loan portfolio under GAAP
+ Formerly called FAS 114
+ “Impaired” Definition
+ “A loan is impaired when, based on current information, it is
probable that the institution will be unable to collect all amounts
due according to the contractual terms of the loan agreement”
“Impaired” in Practice
+ Substandard loans
+ TDR loans
+ Nonaccrual loans
+ Loans > 90 days past due
+ Tiered for asset size?
More About ASC 310-10-35
+ Applies to all loans except:
+ Large groups of smaller-balance homogeneous loans that are
collectively evaluated for impairment (such as credit card,
residential mortgage, etc.) and which have not been
restructured as troubled debt
+ Loans that are recorded at fair value or at the lower of cost or
fair value (e.g., loans held for sale)
+ Leases
+ Debt securities
“Impairment” Definition
+ If a loan is determined to be impaired, an impairment analysis should be performed to calculate whether a specific reserve is required
+ Guidance requires that “impaired loans…be measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent.”
Valuation Methods
1. Fair Market Value of Collateral
2. Present Value of Future Cash Flow
3. Loan Pricing
Poll
Fair Market Value of Collateral
Appraised collateral value minus discounts and/or liquidation costs = Fair Value/Valuation
amount
The Total Recorded Investment exceeds the valuation amount
Therefore, the difference is the reserve amount
Present Value of Future Cash Flows
Example – No Impairment
Example - Impairment
Example – Impairment w/ Shared Collateral
Documentation Needed for Compliance
+ Document methods and processes:
+ Type of analysis used (FMV of Collateral, PV of Future Cash
Flows) and steps performed to determine which technique is most
appropriate
+ Amount and timing of cash flows
+ Effective interest rate used to discount
+ Basis for determining cash flows
+ Appraisals, valuation assumptions
+ Supporting rationale for adjustments to assumptions
Poll
Common Misconception
+ Many institutions test for impairment to decide if loans belong within ASC 310-10-35
+ If zero impairment is found, loans are moved back within their homogeneous pools under ASC 450-20
+ Widely used within the community bank market, but is not in accordance with guidance
Common Misconception
+ OCC bulletin published in 2006:
“If an institution assesses an individual loan under FAS 114 and
determines that it is impaired, but it measures the amount of
impairment as zero, may it include that loan in a group of loans
collectively assessed under FAS 5 for estimation of the ALLL?”
Answer: No. For a loan that is impaired, no additional loss
recognition is appropriate under FAS 5 even if the measurement of
impairment under FAS 114 results in no allowance. One example
would be when the recorded investment in an impaired loan has
been written down to a level where no allowance is required.”
Review and Document Valuations
+ Loans with zero impairment should be reviewed to ensure valuations were properly assessed
+ Consider adjustments to values:
+ Collateral – Bank-owned property may not sell for full appraised
value
+ Collateral – Increase or include reduction for selling costs (i.e.
realtor commissions, taxes and insurance)
+ Cash Flows – Are expected cash flow values realistic?
+ If zero impairment is determined accurate, include documentation for assumptions and explanations
Key Takeaways
+ Identify impaired loans using common characteristics
+ Use one of three approved valuation methods to calculate impairment
+ If zero impairment is calculated, loans should remain within ASC 310-10-35
+ Ensure loans with zero impairment have been analyzed using appropriate values and the assumptions are well documented
Poll
2015 Risk Management Summit
+ September 23-25 in Chicago
+ ALLL & Stress Testing, Peer Roundtables
+ Banker Appreciation Night on Lake Michigan
+ sageworks.com/summit
Todd Sprang
Principal
CliftonLarsonAllen
Ariste Reno
Partner
KPMG
John Behringer
Partner
McGladrey
Graham Dyer
Senior Manager
Grant Thornton
Contact Information & Questions
Garrett MorrisDirector of Consulting
Sageworks
866.603.7029
LinkedIn Groups+ ALLL Forum for Bankers
+ Commercial Credit Risk Professionals
Websites+ www.sageworksanalyst.com
+ www.ALLL.com
+ Whitepapers, webinars, thought
leadership
Emily BoganSr. Risk Management Consultant
Sageworks
866.603.7029
Appendices
Total Recorded Investment
+ For all three methods, institutions need to take into account all items that should be included in the “total recorded investment” for the loan
+ These items include:
+ Outstanding principal balance
+ Accrued interest
+ Net deferred fees or costs
+ Unamortized premium / discount
Fair Market Value of Collateral
+ Method used for all collateral-dependent loans
+ Calculate reserves by using the loan balance above the collateral’s fair market value (less selling costs)
+ Also consider:
+ Use a current appraisal or make adjustments to older appraisal
+ Consider any cross-collateralization, prior liens and/or loan
guarantees to ensure the appropriate equity value
+ Document assumptions for any selling costs
Present Value of Future Cash Flows
+ Method used for loans still expected to be supported by repayment from the borrower
+ Used for most troubled debt restructures (TDR)
+ Reserve for the present value of all expected payments
+ Be able to justify expected monthly payment
+ Also consider:
+ Use the effective (original) interest rate as a discount rate
+ Set up a month-by-month analysis with the expected
payment discounted appropriately for each month
+ Be wary of the “NPV” function in Excel
Loan Pricing
+ Used infrequently
+ Reserve amount derived from loan’s observable market price
+ Reserve for any portion of the loan balance which exceeds the loan’s market value
Common ASC 310-10-35 Challenges
+ Determining which loans to evaluate under ASC 310-10-35
+ Ensuring loans are not double-counted for reserves
+ Determining the appropriate valuation method
+ Using appropriate values for impairment analysis
+ Knowing when and how to move an ASC 310-10-35 loan back to its appropriate ASC 450-20 pool
