A Focus on Allowance at the 2015 AICPA Bank Conference

Last week at the 40^th annual AICPA “National Conference on Banks & Savings Institutions” in Washington, DC, change was on everyone’s mind. The conference coincided with the second Republican primary debate and the even bigger debate about whether the Federal Reserve would raise interest rates for the first time in almost a decade. 

The Republican primary debate delivered on the promise of must-see reality TV, but it was hard to find clarity about what to expect in 2016. And, in what has become an expected practice with the Federal Reserve, they again elected to keep interest rates the same.

It seems sometimes, the more things change the more they stay the same.

The AICPA bank conference covered usual topics including the economy, housing, regulations, risk management and current accounting guidance. One topic, however, loomed larger than all others – accounting for the allowance for loan and lease losses (“allowance”). Like interest rates, the allowance has been a consistent point of contention for the past decade.

The anticipated new accounting standard, Current Expected Credit Loss (CECL) model, was at the heart of the discussion. There was little agreement among regulators and the Financial Accounting Standards Board (FASB) as to when the new accounting standard will be effective. The prevailing thought was no earlier than 2019, and possibly 2020.

The question now becomes what happens between now and then. There’s a high level of concern across all regulatory bodies about the application of the current incurred loss model and the risk that reserves are too low. In fact, current allowance levels are at pre-recession levels, heightening fear among regulators. This attention is squarely directed at how banks are accounting for qualitative factors in their allowance calculation and raises the question about exactly what banks should focus on as they evaluate the strength of their documentation and assessment of these factors.

Understanding the FAS 5 Computation

Dorsey Baskin with Grant Thornton presented on this topic of calculations twice during the conference. The presentation and a respective white paper skillfully highlight the points every banker should be thinking about as they calculate the general (FAS 5) component of their allowance.

Banks are well versed in calculating the historical loss experience regarding charge-offs. It is in quantifying the adjustment factors where they often fall short. The SEC staff and federal bank regulatory agencies have published lists of adjustment factors banks should consider, including:

Mr. Dorsey also discusses the appropriate length of time for considering historical charge-offs, “The optimal length of the historical charge-off accumulation period is typically about the length of the loss discovery period for each category of loans. We believe the historical charge-off accumulation period should be at least as long as needed to allow loans a normal amount of time to slide from performing status to charge-off.  An accumulation period much longer than that is not necessary.” The following diagram illustrates the concept of the loss discovery period.

No doubt, quantifying these considerations and their applicability to your allowance is difficult. Challenge notwithstanding, banks stand to benefit from taking a proactive approach to addressing these concerns in the FAS 5 calculation. The information is critical to effectively navigating the scrutiny of the federal regulatory agencies, SEC, PCAOB and auditors, and for positioning your bank for successful adoption of the looming CECL standard. 

How well is your bank quantifying the various qualitative factors in your allowance calculation? The experienced team at HORNE is here to help. 

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