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Revised Interagency PolicyStatement on theAllowance for Loan and LeaseLosses (ALLL)

Industry Day

October 2008

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Revised ALLL Policy StatementRevised ALLL Policy Statement

Issued 12/13/06 by FFIEC memberagencies

Replaces 1993 Interagency PolicyStatement on the ALLL

Issued 12/13/06 by FFIEC memberagencies

Replaces 1993 Interagency PolicyStatement on the ALLL

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Why Revise the 1993 Policy?Why Revise the 1993 Policy?

Ensure consistency with GAAP

Issued before FAS 114 took effect Reflect evolution in ALLL accounting

practices

Ensure consistency with more recent

supervisory guidance 2001 Policy Statement on ALLL

Methodologies and Documentation

(which remains in effect)

Ensure consistency with GAAP

Issued before FAS 114 took effect Reflect evolution in ALLL accounting

practices

Ensure consistency with more recent

supervisory guidance 2001 Policy Statement on ALLL

Methodologies and Documentation

(which remains in effect)

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Revised ALLL Policy StatementRevised ALLL Policy Statement

Reiterates key concepts and requirements in

GAAP and existing supervisory guidance

ALLL process involves a high degree of managementjudgment, is inevitably imprecise, and results in a range

of estimated losses

Consider all significant factors affecting collectibility

Prudent, conservative, but not excessive ALLLs that fallwithin an acceptable range are appropriate (no longeradequate) based on best estimate per AICPA auditguide

Reiterates key concepts and requirements in

GAAP and existing supervisory guidance

ALLL process involves a high degree of managementjudgment, is inevitably imprecise, and results in a range

of estimated losses

Consider all significant factors affecting collectibility

Prudent, conservative, but not excessive ALLLs that fallwithin an acceptable range are appropriate (no longeradequate) based on best estimate per AICPA auditguide

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Management Should Develop and maintain effective loan review

system and credit grading system

Adopt and adhere to written ALLL policies

and procedures appropriate to institutions sizeand nature, scope, and risk of its lending

Develop, maintain, and document acomprehensive, systematic, and consistentlyapplied ALLL process

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Management Should...

Determine ALLL each quarter in accordance

with GAAP, its policies and procedures, itsbest judgment, and supervisory guidance

Promptly charge off loans confirmed to be

uncollectible

Periodically validate its ALLL methodology

(look here to support for factors similar to

IRR Statement)

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The Board of Directors Should

Review and approve ALLL policies and

procedures

Review assessments of soundness of loan

review system

Review amount estimated and reported forALLL and PLLL

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GAAP GuidanceGAAP Guidance

FASB Statement 5,FASB Statement 5, Accounting forAccounting forContingenciesContingencies

FASB Statement 114,FASB Statement 114, Accounting byAccounting byCreditors for Impairment of a LoanCreditors for Impairment of a Loan

FASB Emerging Issues Task Force Topic DFASB Emerging Issues Task Force Topic D--

80 on application of FAS 5 and FAS 11480 on application of FAS 5 and FAS 114

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Components of the ALLLComponents of the ALLL

FAS 114 component for loans individuallyFAS 114 component for loans individuallyevaluated and found to be impairedevaluated and found to be impaired

FAS 5 component for groups of loans withFAS 5 component for groups of loans withsimilar risk characteristics (incurred, notsimilar risk characteristics (incurred, not

expected losses)expected losses)

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FAS 114FAS 114 Accounting by Creditors forAccounting by Creditors for

Impairment of a LoanImpairment of a Loan

Apply normal loan review procedures to identify loans to beApply normal loan review procedures to identify loans to be

individually evaluated for impairmentindividually evaluated for impairment

Does not apply to large groups of smaller balanceDoes not apply to large groups of smaller balancehomogeneous loans collectively evaluated for impairmenthomogeneous loans collectively evaluated for impairment

Loan is impaired when, based on current information andLoan is impaired when, based on current information andevents, it is probable that creditor will be unable to collect aevents, it is probable that creditor will be unable to collect allllamounts due (principal and interest) according to loanamounts due (principal and interest) according to loansscontractual termscontractual terms

Independent of adverse classification (i.e. a nonaccrual loan isIndependent of adverse classification (i.e. a nonaccrual loan islikely impaired, but not necessarily Substandard, Doubtful, orlikely impaired, but not necessarily Substandard, Doubtful, orLoss)Loss)

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FAS 114FAS 114 Accounting by Creditors forAccounting by Creditors for

Impairment of a LoanImpairment of a Loan If individually evaluated loan is impaired, measureIf individually evaluated loan is impaired, measure

impairment based on one of three methodsimpairment based on one of three methods

Present value of expected future cash flowsPresent value of expected future cash flows

Fair value of collateral if loan is collateral dependentFair value of collateral if loan is collateral dependent

(required for such a loan)(required for such a loan)

LoanLoans observable market prices observable market price

If amount of impairment is zero for an impaired loan,If amount of impairment is zero for an impaired loan,

it will have no allowance (i.e. no FAS 5 pool)it will have no allowance (i.e. no FAS 5 pool)

If individually evaluated loan is not impaired, includeIf individually evaluated loan is not impaired, include

in a group of loans evaluated under FAS 5in a group of loans evaluated under FAS 5

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FAS 5 Accounting for Contingencies

Starting point is to determine historical loss rate (orrange of loss rates) for each group of loans with similar

risk characteristics based on institutions own loss

experience for that group

Historical net charge-off rates generally used

Exceptions - De novo institutions, new loan

products

Consider qualitative or environmental factors likely to

cause estimated credit losses to differ from historical

loss experience (primary or sole support when little or

no institution loss history)

Easiest to segment portfolio using Call Report grouping

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Qualitative or Environmental Factors Changes in lending policies and procedures, underwriting

standards, and collection practices

Changes in economic and business conditions http://www2.fdic.gov/recon/index.asp

Changes in volume and severity of past due and adverselyclassified loans and in nonaccrual volume

Changes in nature, volume, and terms of loans

Changes in lending management and loan review

Effect of concentrations and changes in levels

Changes in underlying collateral values (only addition since1993)
http://www2.fdic.gov/recon/index.asphttp://www2.fdic.gov/recon/index.asp

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Reflect overall effect of qualitative factors on aloan group as adjustments that increase or

decrease groups historical loss rate

Alternatively, reflect effect of qualitative factors

through separate standalone adjustments within

FAS 5 component of the ALLL

Evaluating effect requires significant judgment

because data to determine precise impact offactors may not be reasonably available or

directly applicable

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Maintain supporting documentation for

historical loss rate developed for each

group of loans

To support qualitative adjustments,

maintain reasonable documentationexplaining how adjustments reflect current

information, events, and conditions

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Changes in the ALLLChanges in the ALLL

Should be directionally consistent with changes inShould be directionally consistent with changes in

the factors, taken as a whole, that evidence creditthe factors, taken as a whole, that evidence creditlosseslosses

If declining credit quality trends relevant to theIf declining credit quality trends relevant to theportfolio are evident, ALLL as a percentage of loansportfolio are evident, ALLL as a percentage of loans

should generally increaseshould generally increase

If improving credit quality trends are evident, ALLL as aIf improving credit quality trends are evident, ALLL as a

percentage of loans should generally decreasepercentage of loans should generally decrease

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InstitutionInstitution--Specific FocusSpecific Focus

Ratio analysis helpful as a supplementalRatio analysis helpful as a supplemental

tool for evaluating overall reasonablenesstool for evaluating overall reasonablenessof ALLLof ALLL

Not a sufficient basis for determiningNot a sufficient basis for determiningappropriate amount of ALLLappropriate amount of ALLL

Appropriate ALLL is an institutionAppropriate ALLL is an institution--specificspecificamount determined based onamount determined based on

comprehensive analysis of the portfoliocomprehensive analysis of the portfolio

and factors affecting collectibilityand factors affecting collectibility

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InstitutionInstitution--Specific FocusSpecific Focus

Inappropriate for institution to adjust aInappropriate for institution to adjust a

properly computed and supported ALLLproperly computed and supported ALLLfor sole purpose of reporting an ALLLfor sole purpose of reporting an ALLLthat corresponds to peer group median,that corresponds to peer group median,target ratio (standard percentage), ortarget ratio (standard percentage), orbudgeted amountbudgeted amount

Address concerns about high levels ofAddress concerns about high levels ofrisk or possible future events byrisk or possible future events bymaintaining higher equity capital, notmaintaining higher equity capital, notby arbitrarily increasing ALLLby arbitrarily increasing ALLL

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Off Balance Sheet ExposureOff Balance Sheet Exposure

Unused loan commitments, standby letters ofUnused loan commitments, standby letters ofcredit, guarantees, and recourse liabilities fromcredit, guarantees, and recourse liabilities fromloan salesloan sales Estimated credit losses should be evaluated similarlyEstimated credit losses should be evaluated similarly

to loan loss exposureto loan loss exposure

Institution should maintain an allowance for theseInstitution should maintain an allowance for theseexposures if FAS 5 conditions are metexposures if FAS 5 conditions are met

Should consider funding probabilityShould consider funding probability

Report such an allowance as anReport such an allowance as another liability,other liability,notnotpart of the ALLLpart of the ALLL

Once funded, move fromOnce funded, move fromother liabilityother liabilityto ALLLto ALLL

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Examiners Should Assess

Credit quality of loan portfolio, considering all significantfactors affecting collectibility, including value of collateral

Effectiveness of board oversight

Quality of loan review system

Appropriateness of ALLL policies, procedures,methodology, and documentation

Appropriateness of reported ALLL

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Examiners Should Generally accept managements estimates and not seek to adjust the

ALLL when management has:

Maintained effective loan review systems and controls for timely

problem identification

Analyzed all significant factors affecting collectibility of portfolio in

a reasonable manner

Established an acceptable ALLL evaluation process that meetsGAAP requirements

Incorporated reasonable and properly supported assumptions,valuations, and judgments

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Examiners Should

Recommend corrective action for inappropriate ALLL level and/or

deficient process in the Report of Examination

Reverse Provision

Suspend Recurring Provisions Strengthen Documentation

Cite any departures from GAAP and contraventions of revised ALLLpolicy statement and 2001 policy statement on methodologies and

documentation (one exam pass if no criticism at last exam)

NOT use 1993 Policy Statement benchmarks as standard for evaluatingan institutions ALLL methodology (15/50/100).

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Questions?Questions?

Documents

Alll Oct 2008