Why should institutions have a comprehensive ALLL?
In a recent webinar on How to Justify a Change in Your ALLL, Sageworks consulting staff explained why institutions should have a comprehensive ALLL and the benefits of comprehensive calculation.
From the video:
In comprehensive calculation essentially you want to be performing the most comprehensive, robust, detailed calculation that you can be. Some of that means moving to more sophisticated analysis. For de novo institutions that may mean moving from using peer groups to using your own historical loss rate after your de novo status ends, or as it’s working on ending. In some situations you’re not going to have your own losses for all your segments of FAS 5 pools, some you will. You may be able to begin using your own loss rate for those pools – the ones you have losses in – and still using peer groups in the others, and you can slowly tailor away from that. They’re looking for more sophisticated analysis.
The same goes for historical loss rate. If you’re just using the aggregate loss rate, moving to more comprehensive analysis would be using a migration analysis. What migration analysis really exposes is the true credit weakness and credit exposure in your loan portfolio. It is not just one certain segment, for example it is not just CNI. Migration analysis requires you to further sub-segment your portfolio. If you sub-segment, in this case risk rate or risk level, you then have a loss rate assigned to each one of those sub-segments, getting a true indication of the risk that exists. What is showing in the comparison is that on the left we see the current structure, migration analysis. We see the weighting was a 163 pass, 57 special mention and 30 in sub-standards. Those loss rates are applied and we get roughly 32. We have our historical at 250 not sub-segmented, we have a loss rate applied, we get a certain loss. However if we look on the right, let’s say the credit risk adjusts to more of pass or less of sub-standard. When that gets reapplied, our loss that we have to put aside – or our ALLL that we have to put aside – is reduced. But if you’re just using historical, there’s no change. Historical loss rate does not adjust for any shake up in the true credit risk being exposed in your portfolio. That’s very important, that’s the exact reason you would want to look at a more comprehensive analysis to see the true credit risk being exposed.
For more in-depth information on ALLL calculations, download the e-Book: The Complete Guide to the ALLL.
