The ALLL Today – pooled impaired challenges

With the 2016 release of the Financial Accounting Standards
Board’s (FASB) guidance on the CECL model, banking professionals and
consultants have been theorizing about the impact the standard will have on
current bank processes. While it is important for these banking professionals
to be prepared, consultants are stressing the importance of tackling today’s
allowance challenges too. 

One of the challenges impacting financial institutions under
current GAAP is the evaluation of pooled impaired loans. While data management,
q-factors and segmentation are important as institutions transition to CECL,
effectively evaluating and justifying impaired loans is crucial as institutions
meet compliance today. 

Pooled Impaired Challenges:

–       Often impractical to individually
review all loans considered impaired by definition

–       Common to see policy threshold on
exposure amount

                  – Materiality threshold
for small balance loans

                  – Loans above threshold individually
analyzed for specific reserves

–       Pooling small impaired loans may make
practical sense, but:

                  – Some confusion over
current GAAP

                  – Collect in one impaired
pool, or pool of origin?

                  – What loss rate methodology would/should be applied?

Guidance on pooling impaired loans:

According to ASC 310-10-35-21, “…some impaired loans may have
risk characteristics in common with other impaired loans. A creditor may
aggregate those loans and may use historical statistics, such as average
recovery period and average amount recovered, along with a composite effective
interest rate as a means of measuring impairment of those loans.”

Pooled Impaired Solutions:

What does this guidance tell us?

            – ASC 310-10-35 does allow for pooling

            – Must have risk characteristics
in common (beyond impairment status)

            – OCC indicates pooling
is appropriate if the ‘smaller’ loans were modified and are now considered TDRs

            – Otherwise, any pooled loans subject to ASC 450-20

What loss rate would apply?

            – Per ASC 310-10-35, average recovery rates and periods
can be used as a basis for rates
(composite interest rate as discount rate for cash flow valuations)

            – Otherwise, pool of
origin historical loss rates may apply (under ASC 450-20)

To learn more about the ALLL challenges today, watch this
on-demand webinar: Understanding the ALLL Today before CECL.