Our goal is to demystify the issue of the Allowance for Loan and Lease Losses (“ALLL”), both as to the inherent technical factors and with respect to the current status as discussions continue within the regulatory agencies, the accounting profession and, in consequence, in bank boardrooms.

The ALLL is now thought to be THE critical factor on the bank balance sheet because (i) the volatility of our economic environment makes reserve analysis much tougher than it was before 2007 and (ii) the regulatory agencies are looking hard at CAPITAL, and the ALLL is a major factor in determining capital adequacy.

The first rule is – have a methodology.  The second is – don’t pioneer; create one that is similar (not the same necessarily) to others already in use and approved, or regulators and auditors will torture you with questions.  The third is – make sure that the methodology reflects current regulatory guidelines as well as the risk profile of your loan portfolio.

• Capital Partners Group (“CPG”) will first review your Loan Policy and related procedures, the current ALLL documents, the current loan rating system, the results of the most recent internal loan review (including comments on individual loans and exceptions), a selected sampling of larger relationships, the initial results of the most recent FDIC exam and any other documents which we feel are relevant.
• CPG will review the Bank’s segmentation, with an emphasis on owner occupied and non-owner occupied Commercial Real Estate (CRE).
• CPG will construct an experience-based worksheet to document the general reserve for the homogenous pool of loans.  We will use a simple experienced-based model or a model based on Probability of Default (PD) and Loss Given Default (LGD), whichever is appropriate and preferred by the client. We will weight the data as is appropriate to reflect the most valid loss experience.
• CPG will review all of the impaired loans identified by the Bank, with the emphasis on (i) the reason for impairment, (ii) the method used to calculate the reserve allowance in compliance with SFAS-114 and (iii) the adequacy of the documentation supporting the resultant reserve allowance.
• CPG will list the industry-standard qualitative factors and will ensure that they apply to the Bank’s loan portfolio.  We will then suggest individual qualitative reserve amounts as applicable, which will be tracked as to migration quarter-to-quarter on the Board Report.
• Once all of these steps have been completed, CPG will advise the Bank on the issue of the Unallocated Reserve.

• ALLL Methodology memorandum compliant with regulatory guidelines and best practices.
• ALLL quarterly Board report template with worksheets.
• Worksheet templates documenting each component of the ALLL reserve calculation.  This will include a model for the SFAS-114 impairment reserve analysis.
• Any other template, model or document that the Bank may reasonably request to complete the scope of this engagement.
• NOTE: the CPG consultants who deliver this engagement will be available to the Bank by telephone for subsequent consultation at no charge to the Bank within reasonable limits.. 

The ALLL Methodology must reflect sound business practices as well as the rules that have been handed down by the regulators and the accounting profession, because anything else will reflect neither sound business judgment nor compliance. 

We must all accept the fact that change is inevitable.  We must also understand that, in the case of the ALLL, change is often driven by actual events that uncover deficiencies or by expected future events that may uncover deficiencies.

At Capital Partners Consulting Group our focus is to keep those two thoughts in mind as we help you with your ALLL Methodology.