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Video: How to justify and support your qualitative factors – Part II

May 2, 2014
Read Time: 0 min

Justifying and documenting qualitative and environmental factors in the allowance calculation is a common challenge for banks and credit unions. More than 50 percent of the bankers during a recent webinar pointed to qualitative and environmental factors as their biggest allowance for loan and lease losses challenge. In part I of the video series, we discussed the external-looking factors. In this part, we will identify best practices and supporting documents that can be used to justify and document some of your internal-looking qualitative factors.

From the video

In the previous video, we covered supporting and documenting the three external factors within the nine qualitative factors mentioned in the 2006 Interagency Policy statement. This video covers three internal factors:

1. Changes in the nature and volume of the portfolio in terms of loans.
2. Changes in the volume and severity of past due loans and other similar conditions.
3. The existence and effect of any concentrations of credit in the portfolio.

Now there may very likely already be reports that institutions are running for reporting purposes that are going to cover these latter two areas. Many institutions that we work with are already running concentration reports that are going to show concentrations of credit, changes in past dues and aging of past dues in the loan portfolio. Those are clearly easy reports to use to document your qualitative adjustments. If those things change over time, you are able to show that and try to consistently apply changes to your loss rates based on the changes in those trends.

The other factor can be a little bit more difficult in terms of changes in the nature and volume of the portfolio in terms of loans. Now the volume of the portfolio might be the easy part because clearly we can show what the portfolio was in a previous period and what the total portfolio is in the next period. Terms of loans can be a little bit more challenging, but if there’s been any change in the type of loans the institution is making or in overall credit standards, you are going to want to document those for your adjustments. Eventually those types of changes will flow through to other reports. As you make new loans or maybe change terms of loans or credit standards, eventually that’s going to have some impact on your concentrations as well as on the overall past due situation for the loan portfolio. So, again, picking the metrics that you want to use and showing them consistently over time is critical to having a clearly documented and supportable allowance calculation.

Sageworks ALLL allows bankers to directly access and upload supporting documents and automate a scoring matrix to ensure directional consistency within their allowance process.

By Tim McPeak, senior risk management consultant at Sageworks

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