Allowance for loan and lease losses

With the increased regulatory scrutiny and challenges of documenting and defending the estimation, many companies find themselves overwhelmed by the process of estimating and documenting the allowance for loan and lease losses (ALLL) every month or quarter.

Some financial institutions continue to struggle to establish a systematic and consistent ALLL estimation due to demands of regulators, external auditors, and the board.

One of the challenges surrounding the determination of the allowance estimation is the manual labor-intensive nature of the process, which is often prone to error. Staying abreast of new accounting standards and regulatory demands, which may or may not coincide, also presents a challenge. The additional reporting and disclosure requirements, and increased scrutiny on the assumptions used to determine the allowance, can be time consuming and place additional strain on limited resources. There also is increased scrutiny surrounding the assumptions used to determine the general allowance, as well as the specific allowance, allocations for impaired loans. Challenges such as these require a systematic and structured approach to evaluating inherent losses. Efforts to streamline the process and better document the financial institution’s assumptions are beneficial in defending the estimation of the allowance.

Increased disclosures surrounding the allowance are meant to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables. Entities are required to provide a rollforward schedule of the allowance from the beginning of the reporting period to the end of the period showing charge-offs and recoveries on a portfolio segment basis. The nonaccrual status of financing receivables and impaired financing receivables should also be shown by class of receivables. An aging of past due financing receivables should be disclosed by segment, as well as troubled debt restructurings. For examples on disclosure requirements, please see FASB update 2010-20 – Receivables (Topic 310).

In reviewing selected financial statement disclosures that incorporate the increased ALLL requirements, the following fundamental disclosures were generally provided:

  • A rollforward schedule of the allowance for loan loss showing charge-offs and recoveries by segment type along with the percent of portfolio total to the total allowance, and percent of portfolio total to the total loans. 
  • Aging of delinquent loans in total by 30, 60, and 90+ day categories or broken out by segment.
  • Non-accrual loans by segment, which included the percentage of non-accrual to the portfolio total and the segment non-accrual amount as a percent of the total non-accrual loans.
  • Accruing loans past 90 days by segment and restructured loans (accruing) by segment. 
  • Non-performing assets by segment type. Some included a rollforward schedule of non-performing commercial assets.

Baker Tilly Insights

The importance of clear and comprehensive disclosure concerning the ALLL and the loan portfolio will continue to be high. Especially as the economic recovery remains slow, real estate values remain depressed, and limited new loan demand continues. As more companies refine and expand their disclosures concerning the performance of the loan portfolio and the sufficiency of the ALLL, the burden will increase for all similar institutions. Greater transparency will give rise to a higher level of conservatism in establishing the ALLL. Financial statement users will be provided with much more meaningful information about the adequacy of the ALLL and the specific risks that may give rise to measurable additional or reduced provision for losses in future periods.