The ALLL today – segmentation challenges

With the 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.

Proper loan pool segmentation will be a critical step in
effectively implementing an expected loss model. However, proper segmentation
is a challenge that financial institutions face when working toward
compliance under current GAAP.

“Loan pool segmentation is a current challenge bankers face
and one they will continue to face as they transition to an expected loss model.
It is a balancing act; specifically, making sure that the pools’ loans have similar
characteristics while also having granularity and being statistically
significant,” said Sageworks Director of Consulting Aaron Lenhart.

Segmentation Challenges:

• ·        
  Fewer, large pools – lacking granularity and
  diluted loss rates for loan types with unique characteristics
• ·        
  Too many pools – weakening statistical validity
  and individual charge-offs/recoveries can have a disproportionate effect on
  loss rate calculations
• ·        
  Sub-segmentation not being considered often
  enough

Segmentation Solutions:

• ·        
  Consider Federal Call Codes as a starting point –
  improves consistency and can break-out additional segments/sub-pools as needed
• ·        
  Use additional segmentation to reflect risk as
  appropriate – risk rating/grade, days past due buckets, and FICO band
• ·        
  Loans with unique characteristics should be
  broken out – promotional lending programs, shared national credits, indirect
  and asset based lending and discontinued lines of business

While there is not a single correct way to segment the
portfolio, these tips can be used to produce the granularity preferred with
today’s ALLL as well as the ALLL under CECL.

To learn more about the ALLL challenges bankers are facing today, watch this ondemand webinar: Understanding the ALLL Today before CECL.