If you ask a bank or credit union executive what allowance for loan and lease information is most pertinent to their board of directors, the answer is most commonly the ratio of allowance to total loans.
This metric, in this case, serves as a proxy for the institution’s reserve level relative to the portfolio, and it gives its users a sense of how conservative the institution’s reserve might be. For this metric 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 Sageworks User Group, Sageworks consultants and attendees discussed meaningful peer groups as they related to portfolio management. Sageworks ALLL makes available FDIC peer group statistics, and users can customize the group as needed. Some best practices the User Group covered for peer groups include:
1) Comparability: benchmarks will be most useful if the institutions included in the average are comparable in terms of size (assets under management) and geography served. If the institution is familiar with institutions that fit those criteria, the bank can go a step further to exclude institutions that they may know have very different risk appetites or concentrations.
2) Peer Group Size: while it is important to choose a group that is comparable to the institution, there is a balance between comparability and group size. That is, rather than limit a peer group to just a few, very similar institutions, it is recommended to have a larger band of institutions included assuming they still meet comparability criteria. The average group size among User Group attendees was roughly 10-30 institutions although there is no specific target recommended by auditors or regulators. The benefit of a larger peer group is its ability to diminish the role of anomalies among the peer group. Keep in mind, however, that group size at the expense of comparability is a misstep. It would not be wise to select a peer group as “under $1B in assets” within Texas; that selection would provide much too large and heterogeneous of a sample.
3) Refresh Peer Groups: a peer group analysis cannot be a “set it and forget it” process. The banking and credit union industries are active M&A environments, and while a certain institution may have been comparable earlier in the year, it may no longer be a suitable fit. The institution could have grown significantly through acquisitions or maybe was the subject of an acquisition, meaning it no longer produces benchmarks to review. The Sageworks User Group recommended that peer-group compositions are reviewed at least semi-annually to validate ongoing comparability of peer group members and size of the group.
Consultants leading the Sageworks User Group cautioned that changes made to peer groups should not be intended to manipulate benchmarks or the perceived performance of the institution. Rather the intention would be to adjust the peer group only to maintain its relation to the institution.
Once a peer group has been established it can be a source of relevant trends, showing how reserve levels, losses and recoveries are evolving.
For more information, watch this video: When Should You Use Peer Data in the ALLL Calculation