Publications & Resources

January/February 2010
Managing Troubled Assets

 

Disclosures Related to the Allowance for Loan Losses  to Significantly Increase

By Larry Raber and Mike Wengel

One outcome of the credit crisis in the banking sector is that investors are demanding more transparency and enhanced disclosures over the allowance for loan and lease losses (ALLL). By the time you read this, the FASB will have either approved or postponed the exposure draft on ALLL disclosures. Furthermore, the SEC has weighed in on its assessment of bank’s disclosures in this area. Regardless of what the FASB does, we believe that the information discussed below should be considered by management as it develops its documentation to support the adequacy of the ALLL .

As of the date this article was written the FASB is currently deliberating on an exposure draft that would require significant enhanced disclosures about the allowance for credit losses and the credit quality of your loan portfolio. If approved, the statement would become effective with the first interim or annual reporting period ending after Dec. 15, 2009 and would apply to loans held by all public and nonpublic financial institutions.

This exposure draft defines two levels of disaggregation, the portfolio segment and loan class. A portfolio segment is a higher level of aggregation and generally will have more than one class of loans. A portfolio segment is defined as the level at which a creditor develops and documents a systematic methodology for determining its allowance for credit losses. A loan class is defined as a level of information that enables users of its financial statements to evaluate the nature and extent of the exposure to credit risk arising from loans that a creditor holds at the date of the financial statements. Generally speaking, the disclosures will be disaggregated by portfolio segment such as commercial, commercial real estate, consumer and residential loans as an example.

The exposure draft also provides additional implementation guidance to determine the appropriate level of disaggregation of information. There are six major categories of disclosures:

  1. Roll forward schedules of the allowance for credit losses from the beginning of the reporting period to the end of the reporting period on a portfolio segment basis for both the allowance for individually evaluated impaired loans (FAS 114) and the allowance for collectively evaluated impaired loans (FAS 5).

  2. Roll forward schedules on a portfolio segment basis of the loans corresponding to item (1) above from the beginning of the reporting period to the end of the reporting period.

  3. The fair value of loans at the end of the reporting period on a portfolio segment basis.

  4. The credit quality of the loan portfolio at the end of the reporting period by loan class.

  5. The aging of past due loans at the end of the reporting period by loan class.

  6. The nonaccrual and impaired loans at the end of the reporting period by loan class.

As they say “a picture is worth a 1,000 words” and it is very true here as well. To best understand the enhanced disclosures, we suggest obtaining the exposure draft at www.fasb.org and review Appendix A for an example of the tabular disclosure.

In addition the SEC issued a “Dear CFO Letter” in August 2009 to address disclosures in  management’s discussion and analysis (MD&A) regarding the ALLL (see www.sec.gov for a copy of the letter). The letter stated that clear and transparent disclosure is critically important to an investor’s understanding of financial statements and that the current economic environment may require reassessing whether the information upon which accounting decisions were based still remains accurate as well as suggesting reevaluation of MD&A disclosure over higher risk loans, changes in ALLL methodologies and declines in collateral value.

These additional disclosure requirements are significant, not to mention the system and control requirements to support accurate collection of this data. How can you prepare for the onslaught of disclosures? First, embrace the new disclosures internally – this is valuable information that can be used to support the adequacy of the your ALLL by ensuring that critical information is considered and that the ALLL is directionally consistent with the quality of your loan portfolio. Second, identify and develop the systems to accurately accumulate the additional information requirements and establish the internal control over financial reporting necessary to track and document the required information on a disaggregated level. This will take a significant effort and we suggest that you start planning for this as soon as possible. 

Larry Raber and Mike Wengel are assurance partners at Perry-Smith, a regional accounting firm that specializes in the financial services industry with over 60 financial institution clients primarily located in California. They can be reached at 916-441-1000 or larryr@perry-smith.com or mikew@perry-smith.com.

Unauthorized reproduction of all or part of this material without the express written consent of the author is strictly prohibited. All rights reserved.