If you were fortunate enough to have your ALLL reserve lowered significantly between calculations, it can and will raise red flags with examiners, so during your next review, you will get looked at with greater scrutiny in two areas. The first is related to the qualitative factors, also known as environmental factors. They will look there with greater detail to make sure your trends and your scoring is in line with the data that is supporting your factors. Example: The economic factor is generally supported by the unemployment index. You may use some other rates as well like bankruptcy. But if you use the unemployment index and it drops (i.e., shows an improvement), then your trend or scoring should be in line with an improvement. If your scoring is not in line (maybe it’s just the same or has declined), then examiners are going to poke at you for not being directionally consistent. Regulators are going to do this for each and every one of the qualitative factors, so it’s important that you can defend the trend and scoring you use for the most recent period in which that ALLL reserve dropped significantly.
The second area they’re going to look at with great scrutiny is your FAS 114 cash flow impairment analysis. They are going to be looking for — using their own words — “excessive optimism” in that cash flow impairment analysis. Basically, you need to make sure you can defend how that expected monthly payment was calculated. Those are the two areas that examiners are going to look with in greater detail when your ALLL reserve drops significantly from one calculation to the next.
To learn more about the challenges in the allowance for loan and lease loss process, download the whitepaper titled: “Challenges in the Estimation of the ALLL”.
To learn how to support a decrease in the ALLL, download the whitepaper, “How to Support a Change to the ALLL“