1 ALLL Questions What is the relationship between the loan classifications of Substandard, Doubtful, and Loss and the identification of loan impairment?

2 ALLL Questions Under FAS 114, an individually reviewed, collateral dependent loan that is found to be impaired should not have an allowance if the fair value of the collateral less cost to sell exceeds the recorded investment in the loan. Under FAS 114, an individually reviewed, collateral dependent loan that is found to be impaired should not have an allowance if the fair value of the collateral less cost to sell exceeds the recorded investment in the loan. Shouldn’t there be at least some amount of allowance for this loan regardless of the amount of collateral protection? Shouldn’t there be at least some amount of allowance for this loan regardless of the amount of collateral protection?

3 ALLL Questions If a loan is individually reviewed and found not to be impaired, it is supposed to be included in a pool of loans with similar characteristics that is evaluated for impairment under FAS 5. If a loan is individually reviewed and found not to be impaired, it is supposed to be included in a pool of loans with similar characteristics that is evaluated for impairment under FAS 5. Why is the loan included in a pool after it has already been determined not to be impaired and not to need an allowance under FAS 114? Why is the loan included in a pool after it has already been determined not to be impaired and not to need an allowance under FAS 114?

4 ALLL Questions A bank correctly applies FAS 114 and FAS 5 and its ALLL analysis is well documented. The total amount of the FAS 114 and FAS 5 allowances is significantly lower than the ALLL on the bank’s books. A bank correctly applies FAS 114 and FAS 5 and its ALLL analysis is well documented. The total amount of the FAS 114 and FAS 5 allowances is significantly lower than the ALLL on the bank’s books. Should Examiners tell the bank that the ALLL on its books is not adequately documented or should they tell the bank the ALLL is excessive and should be reduced? Should Examiners tell the bank that the ALLL on its books is not adequately documented or should they tell the bank the ALLL is excessive and should be reduced?

5 ALLL Questions A bank has loan administration problems that indicate that the amount of past-due loans is understated. It will take the bank some time to determine the amount of the understatement and obtain more accurate data. A bank has loan administration problems that indicate that the amount of past-due loans is understated. It will take the bank some time to determine the amount of the understatement and obtain more accurate data. Should examiners recommend that the bank increase its ALLL or should this be part of the capital analysis? Should examiners recommend that the bank increase its ALLL or should this be part of the capital analysis?

6 ALLL Questions A bank has had no net charge-offs for several years. How should the bank take this historical loss experience, or lack thereof, into account in calculating its ALLL?

7 ALLL Checklist Are effective loan review/credit grading systems in place? Are effective loan review/credit grading systems in place? Are loans deemed uncollectible promptly charged off? Are loans deemed uncollectible promptly charged off? Are policies and procedures in place that describe how the loan portfolio is segmented? Are policies and procedures in place that describe how the loan portfolio is segmented? Does the ALLL evaluation include an analysis of impairment for individual loans under FAS 114? Does the ALLL evaluation include an analysis of impairment for individual loans under FAS 114? Are individual FAS 114 impairment determinations and measurements of impairment well documented and supported? Are individual FAS 114 impairment determinations and measurements of impairment well documented and supported?

8 ALLL Checklist (Cont.) Does the ALLL evaluation include an analysis of impairment for pools of loans under FAS 5? Does the ALLL evaluation include an analysis of impairment for pools of loans under FAS 5? Are FAS 5 loss rates reasonable, well supported, and incorporate historical loss experience and other factors? Are FAS 5 loss rates reasonable, well supported, and incorporate historical loss experience and other factors? Is the ALLL analysis performed by management and reviewed by the Board at least quarterly? Is the ALLL analysis performed by management and reviewed by the Board at least quarterly? Does the reported ALLL level on the balance sheet differ significantly from the most recent quarterly calculation? Does the reported ALLL level on the balance sheet differ significantly from the most recent quarterly calculation?

9 Deadly Sins of the ALLL Impaired loans are not segregated from pools of loans Impaired loans are not segregated from pools of loans Impaired loans are double counted in the ALLL calculation Impaired loans are double counted in the ALLL calculation Recorded ALLL materially greater or less than bank’s calculation Recorded ALLL materially greater or less than bank’s calculation Percentages mentioned in the 1993 Interagency Policy Statement (FIL 89-93) for Substandard (15%) and Doubtful (50%) loans are used without substantiation Percentages mentioned in the 1993 Interagency Policy Statement (FIL 89-93) for Substandard (15%) and Doubtful (50%) loans are used without substantiation Provisions for loan and lease losses are based on budgeted amounts rather than on an analysis of the loan portfolio Provisions for loan and lease losses are based on budgeted amounts rather than on an analysis of the loan portfolio Unfunded commitments and unused lines of credit included in the ALLL calculation Unfunded commitments and unused lines of credit included in the ALLL calculation ALLL is determined based on target and/or peer statistics (e.g. ALLL to Total Loans) ALLL is determined based on target and/or peer statistics (e.g. ALLL to Total Loans) ORE allowances are included in the ALLL ORE allowances are included in the ALLL

10 Worksheet for Estimating Credit Losses Estimated Credit Loss Amount Category Recorded Investment HighLow $$$ Allowance for Estimated Loan Losses I Individually identified I Individually identified No impairment identified No impairment identified NANA II Large groups of smaller-balance homogeneous loans collectively evaluated for impairment II Large groups of smaller-balance homogeneous loans collectively evaluated for impairment Credit card Credit card Residential mortgage Residential mortgage Consumer Consumer Other Other III Other large groups of loan containing unidentified, impaired loans III Other large groups of loan containing unidentified, impaired loans IV Loans measured at fair value or at the lower cost or fair value IV Loans measured at fair value or at the lower cost or fair value NANA Total allowance for estimated loan losses Liability for Losses on Credit Instruments and Other Credit Exposures Standby letters of credit Standby letters of credit Commitments Commitments Loans sold with recourse Loans sold with recourse Loans on guarantees Loans on guarantees Other Other Total liability for credit instruments and other credit exposures AICPA Audit and Accounting Guide ALLL Example