Loan Modifications and Troubled Debt Restructuring – A New Set of Challenges with the Allowance for Loan and Lease Losses (ALLL)
by Geoffrey A Oliver, CPA, CMB
While we are in a credit cycle that is challenging the financial services industry in a number of new and unique ways, questions are also being raised by Audit Committees, external auditors and bank examiners about the Allowance for Loan and Lease Losses (ALLL). Such questions involve critiquing the ALLL methodology for all loan types, assumptions used and the credit process ratings assigned to individual commercial loans. Given the uncertain economic future, the depth of the current recession and the untested performance of loans in the current or near future, auditors and examiners are being critical about the ALLL calculations being made by lenders. Lenders should assume that any previous methodology and assumptions used are not acceptable in today’s market. Allowance amounts related to “current” performing loans are being analyzed more closely than ever as to what the “probability of default” will be. The traditional allowance percentages or the “known loss” concepts are being challenged by the lenders’ auditors and examiners. “Known losses” are being extended out, meaning that anticipated losses 12 to 24 months from now are being considered as “known” by some auditors, especially if the lender does not have data to prove otherwise. Loans in a portfolio are being analyzed by lender/servicers and their auditors/examiners in an aggregate or “box car” approach that treats all loans as similar despite major differences in the underlying characteristics of the borrowers, geographies, real estate values, average versus specific equity levels, cash reserves, employment, etc.
Read the entire paper: New Challenges with the Allowance for Loan and Lease Losses_2-20-09.
