The ALLL today – impaired loan challenges
With the 2016 release of the Financial Accounting Standards Board’s (FASB) guidance on the Current Expected Credit Loss (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 individually impaired loans. While data management, q-factors and segmentation are important as institutions transition to CECL, effectively evaluating and justifying the impaired loans is crucial as institutions meet compliance today.
“Levels of impaired loans have steadily declined since 2011 and are down below 1.20% or nearly 50% lower than where they were in 2010,” said Sageworks Director of Consulting Aaron Lenhart. “Despite being at a 7 year low, impaired loans are still a common area of scrutiny for the auditors and regulators.”
Common Impaired Loan Challenges:
For collateral dependent credits, scrutiny is focus around:
– Appraisal details and assumptions
– Selling costs
– Consistency in application of policies
Analysis and judgment are needed to know if the credits are truly collateral dependent.
For present value of cash flows based impairments:
– Ongoing scrutiny of balloon payment assumptions
– Justification of expected payments
– Default assumptions?
Impairment Solutions:
Clear and consistently applied policies around key issues:
– What constitutes collateral dependence?
– Appraisal management process
– Selling/liquidation assumptions
For cash flow based assumptions:
– Possible discounting of contractual payments (probability of default rates)
– Lesser of calculated balloon payment or liquidation value of underlying collateral for terminal value
– For larger credits, credit analysis supporting the coverage of expected debt service
To learn more about obstacles that institutions have to overcome in calculating the ALLL today under incurred loss models, watch this on-demand webinar: Understanding the ALLL Today before CECL.
