Loan level valuation

1. Loan Fair Value Overview for Banks
market, liquidity & credit risk measurement and validation solutions for banks
Fred Poorman Jr., CFA, Managing Principal
fpoorman@bankriskadvisors.com
1

2. Objectives of Best Practices Loan Fair Value
analytics
 Financial reporting
 Quarterly and annual Fair Value Disclosures
 Step 2 Goodwill impairment analysis
 Best practices analytics for ALM analysis
 Calculation of internal economic capital and/or economic value of equity
 Comprehension of value creation & value change drivers
 Loan pricing
 Congruence between loan pricing and loan valuation
 Comprehension of market value-based pricing
 Another tool for pricing and transfer pricing
 ALLL analytics
 Congruence in analytics for loan value and ALLL analytics
 M&A analysis
 Pre- & post- M&A analysis of loan values and Goodwill
2

3. Approach to Loan Fair Value analytics
 Use ALM model(s) to produce accurate loan Fair Values
 Reliable, repeatable, documented ALM modeling and valuation
processes
 Accurate =
 Granular, loan level or clearly delineated homogenous pools
 Benchmark to market values/factors, whenever practicable
– Market curve= LIBOR/Swaps (Bloomberg USSW or c23
screens)
– Credit spreads based on mapping
– Liquidity spreads based on market data and mapping
 Signed off by external audit firms
3

4. Approach to Loan Fair Value analytics
 Loan Fair Values to be congruent with FASB/IFRS Standards
 Hierarchy of Level 1, 2, 3 (old SFAS 157)
 Congruence between Jan 2011 release and old SFAS 115:
 Trading, or mark through Income
 AFS, or mark through OCU
 HTM, or amortized cost
4

5. Mapping Overview
 Map internal loans to external (market) factors for level 2
disclosure approach
 Loan level mapping requirements for granular, loan level
best practices approach
 Commercial: Internal risk grade; 1-10
 Residential: Appraisal, LTV, FICO data
 Consumer: FICO
5

6. Mapping Example: Commercial Loans
 Map internal loan grades to external (market) grades
 Commercial mapping uses internal loan grades
 Internal ratings are mapped to S&P/Moody’s equivalents
 Works best if PD is part of internal rating
 Use peer/benchmark banks
 Mapping considerations
 Internal
 Loan policy
 Loss history/ALLL analysis
 External
 S&P/Moody’s histories
 RMA eStatement studies (uses Moody’s for benchmarks)
 Basel II/III
 FED E2 release
 Benchmark banks from proprietary database
6

7. Issues & Resolutions
 Issue: Loan level data may not be available from current
core systems/extracts
 Resolution: Use current extracts along with BI or other internal data to
create supportable weighted average spreads at the ALM model line
level.
 Issue: Uncertainty about mapping process
 Resolution: Bank Risk Advisors can assist with mapping. Consultants
backgrounds include market, liquidity, and credit risk backgrounds.
 Issue: Uncertainty about reliable 3rd party sources of spreads
 Resolution: Bank Risk Advisors updates benchmark spreads monthly
and/or quarterly, depending on loan types. Posted to SharePoint site
free of charge for clients.
7