Federal Regulations

Institutions are also encouraged to use ratio analysis as a supplemental tool for evaluating the overall reasonableness of the ALLL. Ratio analysis can be useful in identifying divergent trends (compared with an institution’s peer group and its own historical experience) in the relationship of the ALLL to adversely classified or graded loans, past due and nonaccrual loans, total loans, and historical gross and net charge-offs.

To distribute an interagency advisory (the Advisory) addressing the allowance for loan and lease losses (ALLL) that reiterates key concepts and requirements included in generally accepted accounting principles (GAAP) and existing ALLL supervisory guidance. This Advisory updates a 1993 policy statement issued by the banking agencies that described the responsibilities of the boards of directors and management of banks and savings associations and of examiners regarding the ALLL. This revision replaces the 1993 policy statement and it also applies to credit unions.

For loans within the scope of FAS 114 that are individually evaluated and found to be impaired, the associated ALLL should be based upon one of the three impairment measurement methods specified in FAS 114.

For all other loans, including individually evaluated loans determined not to be impaired under FAS 114, the associated ALLL should be measured under FAS 5 and should provide for all estimated credit losses that have been incurred on groups of loans with similar risk characteristics. 

An institution may choose the appropriate FAS 114 measurement method on a loan-by-loan basis for an individually impaired loan, except for an impaired collateral-dependent loan. The agencies require impairment of a collateral-dependent loan to be measured using the fair value of collateral method. As defined in FAS 114, a loan is collateral dependent if repayment of the loan is expected to be provided solely by the underlying collateral.

Estimates of credit losses should reflect consideration of all significant factors that affect the collectibility of the portfolio as of the evaluation date.

Net Worth Restoration Plan (NWRP.) Management’s written plan detailing the steps the credit union will take to become adequately capitalized by the end of the plan’s term, and remain so for four consecutive quarters. The credit union will submit the plan within the mandated time frames to the appropriate regional director and, if state-chartered, the appropriate state supervisory authority (SSA) (5702.206.) For PCA purposes, the regulation refers to a new credit union’s equivalent of a NWRP as a revised business plan (5702.304(a)(2)).

An institution may choose the appropriate FAS 114 measurement method on a loan-by-loan basis for an individually impaired loan, except for an impaired collateral-dependent loan. The agencies require impairment of a collateral-dependent loan to be measured using the fair value of collateral method. As defined in FAS 114, a loan is collateral dependent if repayment of the loan is expected to be provided solely by the underlying collateral.

Estimates of credit losses should reflect consideration of all significant factors that affect the collectibility of the portfolio as of the evaluation date.