Reporting & Presenting
Calculating the allowance for loan and lease losses (ALLL) is one part of a larger process. Once equipped with the results, financial professionals must relay that information to various stakeholders, including the Board of Directors, examiners and auditors.
Certain presentations must follow regulatory guidelines. For instance, banks must provide disclosure reports to their regulatory agencies. These reports detail how the institution develops its allowance for credit and losses, as well as how it manages credit risk.
Other reporting components may not be required, per se, but are ubiquitously practiced. Bank executives are almost always tasked with presenting the ALLL results to the Board, whose feedback may require additional changes to their methodology or practices.
Outside of presenting to stakeholders, Institutions that focus on the results of the ALLL calculation can derive insight into portfolio performance by analyzing individual FAS 5 (ASC 450-20) pools. They can also develop trends into these pools for greater defensibility of their qualitative factors, among other things.
Reporting & Presenting
Peer Group Comparisons for the ALLL
For this ALLL benchmarks to be significant, however, requires the institution to have a valid and comparable peer group from which the benchmark allowance to total loans is calculated. In a recent Abrigo User Group, Abrigo consultants and attendees discussed meaningful peer groups as they related to portfolio management.
As a result of ASU 2010-20, all banks that have audited financial statements must provide disclosure reports to their examiners. The main objective of disclosure reporting is increased transparency to financial statement users about institutions’ allowance for credit losses and the credit quality of their financing receivables.
Included in the 2006 Interagency Guidance was a statement that “Policies should require periodic validation of the methodology.” It is typically recommended that these model validations take place annually to ensure the methodology complies with Interagency Guidance/GAAP, and that it is appropriate for the portfolio.
Justifying a Change
Though a consistently applied ALLL does not typically result in a drastic change, certain improvements may merit inconsistencies. If an institution moves to a more sophisticated model (e.g. migration analysis over historical loss rates), some inconsistency from the prior period may arise, but should be acceptable in the eyes of examiners if the methodology is transparent and well-documented.
Backtesting for Reporting
Backtesting is an exercise that compares the actual outcome with model forecasts during a defined period. It can be considered a form of outcome analysis to monitor model performance and determine if adjustments or revisions are needed over time.
Auditors vs. Examiners
The mixed interest comes into play when we consider that institutions can release reserves directly into income. Auditors of banks may wish to see high profitability to appease shareholders, whereas examiners may wish to see a more conservative view of the institution’s ALLL.
Presenting to Auditors
Similar to presenting ALLL results to examiners, documentation is of the utmost importance in defending your ALLL methodology to auditors. Because the role of an auditor includes protecting shareholders, you must be able to transparently explain your methodology at the time of an audit and provide the proper documentation to ensure that your ALLL calculation is both objective and in line with guidance.
Presenting to Examiners
When presenting the ALLL results to examiners, it is imperative that financial professionals include the proper documentation. Any and all assumptions must be documented, and the examiner should be able to view the input of the methodology and how the financial institution arrived at its final number.
Presenting to Board
When presenting ALLL results to the board, financial professionals do not need as much documentation as is necessary for examiners. Rather, they should keep the presentation concise, objective and focus on the big picture.