Posts

ACL Model Validation
What You Need to Know 
Part I

By: Peter Warmenhoven, Consultant

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The ASU and its subsequent amendments (collectively referred to as ASC Topic 326) became effective for all entities beginning in 2023.  ASC Topic 326 instituted the Current Expected Credit Loss (“CECL”) methodology for estimating Allowances for Credit Losses (ACL) and eliminated the previous incurred loss allowance methodology used by financial institutions for decades.

Now that your institution has implemented the Current Expected Credit Loss method of estimating its Allowance for Credit Losses, what remains to be done?  What will regulatory agencies look for in terms of evaluating your institution’s CECL compliance?  Moreover, what should you do to prepare for your first regulatory exam since implementing CECL?

Whether your ACL model and process was developed within your institution or by a third-party vendor, have your process reviewed independently for conceptual soundness and compliance with the ASC Topic 326 standard.

As stated in the Interagency Policy Statement on Allowances for Credit Losses (revised April 2023):

“After analyzing ACLs, management should periodically validate the loss estimation process, and any changes to the process, to confirm that the process remains appropriate for the institution’s size, complexity, and risk profile. The validation process should include procedures for review by a party with appropriate knowledge, technical expertise, and experience who is independent of the institution’s credit approval and ACL estimation processes. A party who is independent of these processes could be from internal audit staff, a risk management unit of the institution independent of management supervising these processes, or a contracted third-party.” Find it here.

How will the supervisory agencies evaluate your institution’s ACL estimation process under CECL?

Examiners will first review and evaluate your institution’s ACL Policy for conformance to the standard and supervisory guidance.  Make sure your ACL policy is reviewed and properly approved by your board of directors at least annually.  Also, keep in mind that ASC Topic 326 fundamentally involves management’s estimate of expected credit losses, requiring significant management judgment.  Accordingly, the new standard provides significant flexibility in the method or approach used to estimate credit losses.  As part of their supervisory activities, however, examiners are expected to “assess the appropriateness of management’s loss estimation processes and the appropriateness of the institution’s ACL balances.”  Throughout the Interagency Policy Statement referenced above, the terms “appropriate,” “reasonable,” “supportable” and “documentation” occur a myriad of times with respect to examiners’ assessment of management’s assumptions, methods and process, and the overall ACL.  For each quarterly ACL estimate, be prepared to share with examiners the written rationale supporting management’s estimation process, including the assumptions, forecasts, and qualitative adjustments used.

Throughout 2023 and 2024, our team has worked with a number of clients to validate their approach and offer further guidance on the ongoing ACL process. As most community-based financial institutions approach the first anniversary of this “new” accounting treatment, many may not have experienced a regulatory review since its implementation, lacking regulatory insights to the new ACL process.  Conducting an ACL Validation will help identify areas for improvement either preemptively or in preparation for regulatory feedback.

To download a copy, please click here.

The Enduring Relevance: Exploring the Timelessness of the 5 C’s of Credit 

By: Kevin Graff

As we begin a new year, the financial landscape is evolving at an unprecedented pace. Despite the whirlwind of technological advancements and the ever-changing dynamics of the banking industry, there exists a set of principles that stand the test of time—The 5 C’s of Credit. In this blog, we delve into the enduring relevance of these timeless principles and their fundamental role in navigating the complexities of the financial realm. 

Timeless, as defined by Merriam-Webster, is not restricted to a certain time or date. The concept of timelessness can be applied to many factors involved in commercial lending. While technological advancements in credit underwriting can make complex and difficult financial analysis seem easy, the basic tenets of commercial lending remain steadfast. These central principles included within Character, Capacity, Collateral, Conditions, and Capital provide the foundation for nearly every lending decision.  

Character: The Foundation of Trust 
The first of the 5 C’s, Character, remains the bedrock of sound lending practices. In an era dominated by algorithms and data analytics, the assessment of an individual’s integrity, honesty, and reputation remains unparalleled. The timeless nature of character evaluation ensures that trust, a currency more valuable than ever, continues to be a cornerstone in lending decisions.  

Capacity: Navigating Financial Waters 
Capacity, the second C, addresses the borrower’s ability to repay a loan. Despite the advent of sophisticated financial models, the ability to understand and analyze an individual or business’s capacity to meet financial obligations remains a linchpin in prudent lending. This timeless principle involves both art and science as borrowers face a continuously evolving economic landscape, proving its relevance in diverse financial scenarios.  

Collateral: A Tangible Safety Net 
Collateral, the third C, provides a tangible safety net for lenders. While technological innovations have introduced new ways of assessing collateral value, the fundamental principle of understanding the various nuances of pledged assets remains steadfast. The ability to understand how collateral may be impacted by changing market conditions ensures that this timeless principle remains effective in mitigating risk.  

…

The Enduring Relevance: Exploring the Timelessness of the 5 C’s of CreditRead More »

Can you believe it? Five years have passed since we embarked on this incredible journey, and we couldn’t have done it without you. We are thrilled to celebrate our 5th year in business, and we want to take a moment to express our heartfelt gratitude for your support. This milestone not only represents our achievement but the trust and loyalty you’ve shown us throughout this adventure. 

 Our success story is incomplete without the remarkable people who have supported us from day one  — our customers. We want to extend our deepest gratitude to each one of you.  You are the reason we are here today, and we promise to keep exceeding your expectations.  

 And to our team – we want to extend our heartfelt appreciation to our consultants who have been a driving force in our success. experience, hard work, and dedication has allowed us to expand into five states across the Upper Midwest, serve over 50 financial institutions, review over 2,300 credit relationships, and almost $14 billion in total portfolio commitments.   

 As we celebrate this milestone, we’re not just looking back; we are also looking forward to the exciting journey ahead of us. We value your feedback, and we remain motivated to keep improving.  

 Our 5th-year anniversary is not just about our accomplishments; it’s a celebration of the relationships we’ve built and the community that surrounds us. Thank you for choosing us as your trusted partner, and here’s to many more years of growth, success, and shared moments. We look forward to continuing this next chapter with you! 

Reviewing real estate appraisals and evaluations can seem a mundane but required task in the commercial lending process.  The commercial appraisal and evaluation (valuation) review process[i] within community-based financial institutions includes internally prepared reviews, third-party prepared reviews, or some combination of the two.  Often, the internally prepared review is completed by less experienced financial institution staff as a part of their training process, while some institutions have a dedicated appraisal and review department.  Loan officers may also perceive the review as a necessary evil rather than a risk management function.  The significance of the appraisal or evaluation review should be considered as a part of the pre-funding due diligence and risk management process, however pedestrian the process may seem.

Valuation reviews are a standard and vital part of a loan file review for commercial real estate lending transactions.  Recently our loan review activities identified two situations where the compliance review completed by the financial institution did not identify material flaws with the information included in the appraisal.   Both circumstances originated with a flawed appraisal engagement letter which did not appropriately identify the subject property.  The reviews of these valuations did not detect the mismatch between the appraised property and the property identified in the credit approval pledged to secure the transaction.  The result of the deficient appraisal review led to lending decisions using market values that did not represent the collateral pledged.

[i] The Uniform Standards of Professional Appraisal Practice (USPAP) 2010-2011 edition defines an appraisal review as the act or process of developing and communicating an opinion about the quality of another appraiser’s work that was performed as part of an appraisal, appraisal review, or appraisal consulting assignment. In addition, Section 1473(e) of the Dodd-Frank Act amended Section 1110 of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 to require the federal financial regulatory agencies, Federal Housing Finance Agency (FHFA), and Consumer Financial Protection Bureau (CFPB) to issue appraisal review standards.

To read this full article, click here.

The Not-So-Typical Repo Man: A Conversation with Jeremy Vang with Recovery Solutions 

Recently, Kevin Graff, President of Integrity Loan Review sat down with Jeremy Vang of Recovery Solutions.   Recovery Solutions is a fully insured and bonded nationwide commercial repossession and remarketing agency specializing in commercial-grade repossessions. Recovery Solutions specializes in ag equipment, yellow iron, trucks and trailers, coach busses, cranes, tow trucks, forestry, mining, industrial machines, medical equipment, luxury RVs, and motor homes.

Thanks for sitting down with me, Jeremy. Would you mind telling me a little bit about how you started Recovery Solutions? 

My wife Jessica and I formed Recovery Solutions together in 2015 and we rebranded, strictly focusing on commercial-grade repossessions after 20 years in the auto repossession side of the recovery industry. We noticed that the auto repossession industry was saturated with repo agencies that specialized in consumer vehicles, and nobody was really specializing in commercial-grade equipment repossessions, so we took the ball and ran with it. Recovery Solutions serves lenders of all sizes, ranging from small community banks and credit unions to small-mid-and large ticket leasing and equipment finance companies, attorneys and law firms, and truck and equipment dealers. Because I was able to form Recovery Solutions together with my wife, we are also classified as a woman-owned business.

If there is one thing that separates Recovery Solutions from our competitors and nationwide commercial forwarding companies, it’s the fact that we care about the overall well-being of our lenders and our lenders’ customers, our understanding of brand awareness and reputational risks, and our ability to repossess assets placed with reduced risk to the lender.

You mentioned that you specialize in commercial-grade equipment, do you have a specialty with a specific asset class? How does pricing work for the different asset classes for your business?

We truly specialize in all facets of commercial-grade recovery. We are most versed in ag and construction equipment, trucks and trailers, coach and shuttle busses, limousines, cranes, tow-trucks, forestry, mining, industrial machines, medical equipment, luxury RVs, and motor homes. We’ve even repossessed nail and tanning salons, restaurant equipment, and arcades, and conducted a full-on business closure of a 5-acre truck stop and restaurant once.

With commercial grade repossessions, pricing is typically broken down into weight classes. For instance, if a lender is dealing with mining or installed industrial machines, we try to quote these out to the best of our ability on a case-by-case basis as there will almost always be breakdown and deinstall costs. The one thing that separates consumer and commercial repossessions is this, no commercial repossession is ever the same and it’s hard to put an exact dollar amount on how much it’s going to cost a lender to repossess, deinstall, and transport a 1.5M Tube Laser for instance. The logistics that come with commercial repossessions can be very overwhelming.

To read this full interview, click here.