1. 1 Allowance For Loan & Lease Losses (ALLL) Overview

2. 2 Introduction

3. 3 Objectives Analyze the Allowance for Loan and Lease Losses (ALLL). Analyze the Allowance for Loan and Lease Losses (ALLL). Analyze a bank’s ALLL methodology and determine whether it is appropriate and falls within the Accounting and Regulatory framework. Analyze a bank’s ALLL methodology and determine whether it is appropriate and falls within the Accounting and Regulatory framework.

4. 4 Topics for Discussion Nature and Purpose of ALLL Nature and Purpose of ALLL Board and Management responsibilities Board and Management responsibilities Loan review and credit grading systems Loan review and credit grading systems Accounting (GAAP) guidance Accounting (GAAP) guidance Regulatory guidance Regulatory guidance ALLL Questions ALLL Questions ALLL Checklist ALLL Checklist Deadly Sins of ALLL analysis Deadly Sins of ALLL analysis Examples Examples

5. 5 Nature & Purpose of ALLL Valuation allowance against total loans on balance sheet that represents amount considered to be appropriate to cover estimated losses in the current loan portfolio. Valuation allowance against total loans on balance sheet that represents amount considered to be appropriate to cover estimated losses in the current loan portfolio. ALLL components: ALLL components: FAS 114 Component (Individual Loan Impairment) +FAS 5 Component (Collective Loan Impairment) =ALLL Level

6. 6 Board & Management Responsibilities Maintain ALLL at level appropriate to absorb charge-offs of incurred loan losses. Maintain ALLL at level appropriate to absorb charge-offs of incurred loan losses. Evaluate ALLL at least quarterly. Evaluate ALLL at least quarterly. Maintain effective loan review/credit grading systems. Maintain effective loan review/credit grading systems. Ensure prompt charge-off of loans deemed uncollectible. Ensure prompt charge-off of loans deemed uncollectible. Ensure ALLL analysis is comprehensive, adequately documented, and follows GAAP/regulatory guidance. Ensure ALLL analysis is comprehensive, adequately documented, and follows GAAP/regulatory guidance. Source: Risk Management Manual of Examination Policies

7. 7 Loan Review System Independent of lending function Independent of lending function Minimum criteria: Minimum criteria: - Credit quality - Underwriting and administration practices - File documentation - Adherence to the bank’s loan policy - Accuracy of assigned loan grades Written policy guidance Written policy guidance Source: Risk Management Manual of Examination Policies

8. 8 Loan Review System (Cont.) Policy items to consider: Qualifications/independence of loan review personnel Qualifications/independence of loan review personnel Frequency, scope, and depth of reviews Frequency, scope, and depth of reviews Review and follow-up of findings and recommendations Review and follow-up of findings and recommendations Workpaper and report distribution Workpaper and report distribution Source: Risk Management Manual of Examination Policies

9. 9 Credit Grading System Elements of effective credit grading system: Written description for each loan grade Written description for each loan grade Loan grades assigned at inception of loan Loan grades assigned at inception of loan Periodic independent review of assigned loan grades Periodic independent review of assigned loan grades Procedures to adjust loan grades Procedures to adjust loan grades Source: Risk Management Manual of Examination Policies

10. 10 Loan Charge-off Criteria Loans should be charged off when they are considered uncollectible and of such little value that continuance as a bankable asset is not warranted. Loans should be charged off when they are considered uncollectible and of such little value that continuance as a bankable asset is not warranted. Definition consistent with Regulatory “Loss” classification. Definition consistent with Regulatory “Loss” classification.