The benefits of segmentation within the Allowance for Loan and Lease Loss calculation are many. Institutions can gain more insight into sub-segmented performance, conduct more sophisticated loss methodologies such as migration analysis and can make better-informed lending decisions over time. However, as the old adage goes, there certainly can be “too much of a good thing,” and a tipping point exists in which institutions run the risk of over-segmentation.
As stated in the Comptroller’s Handbook, “Effective management of the loan portfolio and the credit function is fundamental to a bank’s safety and soundness.” The ability to adequately meet ALLL, stress testing and other risk management requirements relies upon sound segmentation practices.
The Comptroller’s Handbook also states that an institution must understand “the portfolio’s product mix, industry and geographic concentrations, average risk ratings and other aggregate characteristics.” In other words, management must have a way to accurately assess risk on both a portfolio level and within the various components of their portfolio in order to both be in compliance and to steer portfolio objectives, risk tolerances and strategic planning.Thus the question presents itself – “How much should an institution segment its FAS 5 (ASC 450-20) pools?” As is the case with many interpretations of guidance, the answer to this quandary is “it depends.”