Methodological consistency in ALLL calculations
For years, subjectivity has been at the forefront of ALLL calculations; however this does not always sit well with examiners, who look for “directional consistency” and well supported documentation that shows a consistent methodology over time. The 2006 Interagency Policy Statement details the elements and factors needed for boards of directors, management and bank examiners pertaining to the estimation of the ALLL. Furthermore, it explains that there are nine qualitative factors that should be used when estimating credit losses. Financial institutions are encouraged to use and add to this list of qualitative factors, included below:
- Changes in lending policies and procedures, including changes in underwriting standards and collections, charge-offs and recovery practices
- Changes in international, national, regional and local economic conditions
- Changes in the nature and volume of the portfolio and terms of the loans
- Changes in the experience depth and ability of lending management
- Changes in the volume and severity of past due loans and other similar conditions
- Changes in the quality of the organization’s loan review system
- Changes in the value of underlying collateral for collateral-dependent loans
- The existence and effect of any concentrations of credit and changes in the levels of such concentrations
- The effect of other external factors (i.e. competition, legal and regulatory requirements) on the level of estimated credit losses.
By utilizing an environmental and qualitative factor matrix that ensures consistent methodology from quarter to quarter, banks are able to increase the amount of objectivity, particularly in FAS 5 (ASC 450-20) pools. Chris McKinley, president of Green Cap Financial in Burlington, NC, states: “What we are seeing from regulatory examinations is a drive to have a consistent, proactive process and an understanding of the trend analysis data.” Several banks have started to switch to an ALLL solution to eliminate human error, reduce subjectivity and construct comprehensive and detailed analysis of ALLL provisions.
For more information about prudent data collection for the ALLL, disclosure reporting and how to bring consistency in methodology, download the whitepaper ALLL: 3 Ways to Prepare for Year-End.
