- Determining which loans should be evaluated under FAS 114 (ASC 310-10-35) versus under the Pooled Loans.
Many financial institutions will start by using the criteria of separating out into FAS 114 (ASC 310-10-35) any loans that are risk rated Substandard or worse on the institution’s risk rating system. One of the challenges inherent in this approach is that it is dependent on the institution having an effective risk rating methodology that is current and reflective of the level of risk on its loans. Bruce Vance from Advanced Bank Solutions says: “The primary challenge is the proper risk rating of loans, especially the identification of impaired loans… banking regulators are keenly focused on this area.”
To ensure the institution is not missing any loans that need to be evaluated individually, it should consider also looking at:
- All loans that have been labeled as a Troubled Debt Restructure (TDR). Most, if not all, of these loans should be evaluated under FAS 114 (ASC 310-10-35).
- All loans that are considered to be in non-accrual. The bank still may have some threshold (by dollar volume), but they will want to ensure that the appropriate loans in this category are being evaluated under FAS 114 (ASC 310-10-35), in case some of these are not picked up by the risk rating criteria.
- Loans that are at a certain level of delinquency (i.e., Days Currently Past Due > 90, or loans that have reached certain delinquency levels a set number of times).
One other potential pitfall of identifying loans for impairment is erring on the side of being too conservative. Vincent Van Nevel of Professional Bank Services, Inc. points out: “One of the biggest traps banks can fall into in the FAS 114 analysis is calculating impairment on loans that are really not impaired… For example, many banks are just being conservative and calculating potential ‘exposure’ on all substandard rated credits. Many of these credits may still be paying or modestly past due, but are not yet past due enough (90 days) to be considered impaired, nor are they truly collateral dependent. Once the regulators see the bank has an impairment calculated, they will require it to be nonaccrual and possibly a partial charge off.” The bank needs to ensure it is using its risk rating system effectively and looking beyond it to other metrics like non-accrual status during this process.