February, 2012 - Sageworks' risk management consultants documented the process that financial institutions typically follow when calculating the allowance for loan and lease losses or ALLL in the institution. This is a quarterly process but may be completed monthly if the complexity or performance of the bank's portfolio merits closer attention. Calculating the allowance is often a responsibility of an institution's CFO or someone familiar with the reserve amount and provisions. The exact ALLL calculation that a financial institution uses can oftentimes be a point of scrutiny during federal exams; examiners focus on the ALLL in order to ensure the institution has appropriately set aside a reserve or allowance that accounts for the risk in the institution's portfolio.
As the infographic shows, an institution’s portfolio is separated into FAS 5 (ASC 450-20) and FAS 114 (ASC 310-10-35). FAS 5 loans are analyzed by assembling homogenous risk pools and then assessing the risk within the pools. FAS 114 loans, loans that are considered impaired, are analyzed individually. The risk within each group of loans is used to calculate how much reserve the institution must keep on hand. Then that required reserve is compared to the current ALLL reserve to determine if an additional provision is needed. Any change in the ALLL must be documented as well as the allowance for loan and lease losses methodology.
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Raleigh, NC-based Sageworks is a financial information company. Sageworks’ data and applications are used by thousands of accounting firms and financial institutions across North America. The company has been named to the Inc. 500 list of the fastest growing privately held companies in the U.S. and to the Deloitte Technology Fast 500.