How to justify an expected monthly payment when performing a cash flow impairment analysis

As part of Sageworks’ ongoing video series addressing some of the challenging issues and questions regarding allowance for loan and lease losses calculations, Sageworks consulting staff explain how to justify an expected monthly payment when using the cash flow impairment method to perform your FAS 114 calculations.

One of the most common mistakes we see institutions make when performing their allowance for loan and lease losses (ALLL) calculation is thinking that the monthly payment from a loan’s amortization schedule is the same as a loan’s expected monthly payment when performing the FAS 114 cash flow impairment analysis. These are indeed two different things.

That monthly payment for the amortization schedule represents the best-case scenario. If you’re performing this cash flow impairment analysis, more than likely this loan is already in its troubled debt restructuring (TDR) stage. In other words, you have had some trouble with this loan, so the full payment under the amortization schedule is unlikely. Instead, the expected monthly payment needs to be exactly that: what you can expect. That means you need to be able to defend the expected monthly payment you use to generate the cash flow schedule.

The incurred methodology currently used to calculate the ALLL is a backward-looking approach. Look at the last set of payments made over the previous 12 months and take the average of that. You can defend it, and you can justify it, and examiners will be pleased regarding how you came up with your expected monthly payment.

To learn more about the three different valuation methods used when performing your FAS 114 calculations, download the whitepaper, titled: How to Calculate Your FAS 114.