How Much Should You Segment Your ASC 450-20 (FAS 5) Pools?
Jan 21, 2015
Proper segmentation of an institution's portfolio will yield many benefits. For one, institutions can gain more insight into sub-segmented performance when they have a granular view of their portfolio. In addition, more sophisticated loss methodologies such as migration analysis require segmentation of the portfolio and can strengthen an institution's overall ALLL. Overall, institutions should examine the size of their portfolio and arrive at a degree of segmentation that both provides a granular view of their pools while maintaining statistical relevance in the size of their pools.
In terms of your FAS5 Segmentation, there is no really one-size-fits-all way to segment the portfolio. You want it to be granular enough that you are showing loans with similar characteristics in the pools. In the current market it is very common to see institutions actually getting more granular. A common example would be looking in the residential pools or even in the commercial real estate pools and breaking out owner versus non owner occupied. That being said, there is definitely risk about getting too narrow or too granular. The risk with that is that the smaller or more granular you get with your pools, the smaller those balances become.
First, that makes for a very cumbersome calculation in terms of the number of calculations you make and pools you evaluate. Second, you may lose the statistical significance at that small granular level. So, it really is institution specific, but there is a sweet spot to find – a set up where you are granular enough to where you are not going overboard and having too many pools.
I wish there was just one answer I could give you, but the reality is that it is going to vary quite a bit from institution to institution. Again, the main thing to look for is pools that are specific but not too narrow or focused in terms of the loan balances of those segments.