Western Independent Banker - January/February 2008 - (Page 20)

Bridging the GAAP How can privately held banks properly calculate and support an ALLL that meets both GAAP and regulatory requirements? loan underwriting). Impaired means that based on current information and events, it is probable that a bank will be unable to collect all amounts due. Probable means likely to happen. Further, the magnitude of the probable loss must be reasonably estimated. FASB 5 also states (paragraph 22) that once a loss has been determined probable and subject to estimate, the loss can be applied to individual loans or in relation to groups of similar types of loans, even though the particular loans that are uncollectible may not be identifiable. So, with this in mind, banks need to document both their FASB 114 and FASB 5 criteria and methodology. Here are some suggestions. First identify the list of specific loans in the loan portfolio that might be potentially impaired using the FASB 114 criteria. Ascertain which of the three impairment measurement methods is most applicable. The three are: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; or (2) if saleable, the loans’ observable market price; or (3) if the loan is collateral dependent, the fair value of the collateral. Then establish specific quantifiable valuation amounts for “each” impaired loan. The amount of the valuation must be supported by adequate documentation. The sort of documentation would depend on which of the three impairment measurement methods is used. For example, for collateral-dependent loans for which the bank must use the fair value of collateral method, the bank should document: (1) how fair value was determined including the use of appraisals, valuation assumptions, and calculations; (2) the supporting rationale for adjustments to appraised values, if any; (3) the determination of costs to sell, if applicable; and (4) appraisal quality and the expertise and independence of the appraiser. www.wib.org Western Independent Banker New Rules in Effect for 2007 On Dec. 13, 2006, the joint regulatory agencies issued an interagency policy statement (IPA) on the allowance for loan and lease losses (ALLL). Its issuance appears to have settled a three-decades-old debate between accountants and regulators as to the true definition, purpose and method of calculating the ALLL. At long last, the regulatory agencies stated that the purpose of the ALLL is not to serve as a “Multi-Risk Capital Cushion,” and that it is not designed to absorb all of the risks in a bank’s loan portfolio. Banks that have high levels of risk in the loan portfolio or are uncertain about the effect of possible future events on the collectability of the loans should address these concerns by maintaining higher equity capital and not by arbitrarily increasing the ALLL in excess of amounts supported under GAAP. Regulators and accountants finally agree that collection risk is the purpose of the ALLL and that capital adequacy should cover all other sorts of risks inherent in the loan portfolio. 20 The new IPA requires bankers not only to support the magnitude of the ALLL with hard (FASB 5 & FASB 114) rule-oriented data, but also separately develop and document information that proves that their capital structure can withstand any potential generic portfolio risks, such as industry concentration (i.e. commercial real estate loans). Calculating the ALLL—GAAP Rules Prevail Generally Accepted Accounting Principles (GAAP), particularly as set forth in FASB 5 & FASB 114, are the cornerstones of a bank’s ALLL calculation. An appropriate ALLL covers: (a) under FASB 114—estimated credit losses on individually evaluated loans that are determined to be impaired; and (b) under FASB 5—estimated credit losses inherent in the remainder of the loan portfolio. Banks must strictly apply these rules to the risk of loans becoming, or having already become, less than 100 percent collectible, e.g. impaired (including any interest or fees set forth in the original http://www.wib.org

Table of Contents for the Digital Edition of Western Independent Banker - January/February 2008

Western Independent Banker - January/February 2008
Contents
A Message from the President
Compliance Administration
Four Realities of Data Security Policy, Enforcement
Managing Internet Banking Risks
Understanding Data Breach Notification Laws
The Effect of Business Continuity Management on Compliance Programs
Bridging the GAAP
Top 10 Compliance Fitness Steps for De Novo Banks
Common OFAC Errors and How to Avoid Them
The Intersection of Equal Credit Opportunity and Sub-Prime Loans
Location-Based Tax Credits for Banks
Protect Your Bank and Your Customers
WIB Calendar
Welcome New Members
Index to Advertisers
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Western Independent Banker - January/February 2008

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