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Appeal of Allowance for Loan and Lease Losses Deficiency (First Quarter 2015)

Background

A community bank appealed the supervisory office’s determinations in the most recent report of examination (ROE) to the Ombudsman of the Office of the Comptroller of the Currency (OCC). Specifically, the bank appealed the following:

  • Matter requiring attention for a deficient allowance for loan and lease losses (ALLL) for second quarter 2014.
  • Requirement to refile the call report as of second quarter 2014.
  • Violation of 12 USC 161 for an inaccurate call report as of second quarter 2014 due to an inadequate ALLL.

Discussion

The appeal argued that the supervisory office did not consider the impact of a large problem loan payoff on the second quarter 2014 ALLL calculation when assessing ALLL adequacy. The appeal asserted that while the supervisory office identified errors in the bank’s loan risk ratings, the impact on the ALLL from the loan payoff subsequent to quarter-end but before filing the second quarter call report offset the impact of loans downgraded by the supervisory office.

The appeal also disagreed with supervisory office conclusions that the bank’s increase in certain qualitative factors in the third quarter ALLL calculation reflected conditions present during the previous quarter, and therefore should have been recognized in second quarter 2014. The appeal stated that subsequent to filing the call report, the bank’s new senior management team increased qualitative factors and the provision for loan loss expense to more accurately reflect newly identified risks associated with underwriting practices. The bank contended that these inputs were estimates and that generally accepted accounting principles require such changes to be accounted for on a prospective basis.

Conclusion

The Ombudsman conducted a comprehensive review of the information submitted by the bank and the supervisory office. The Ombudsman concurred with the bank that the balance of the ALLL was adequate as of second quarter 2014 and no refiling of the call report was required, that the matter requiring attention for a deficient ALLL was not appropriate, and that the bank did not violate 12 USC 161.

The following published communications were used as standards for the analysis:

  • OCC Bulletin 2001-37, “Policy Statement on Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions: ALLL Methodologies and Documentation,” July 20, 2001.
  • OCC Bulletin 2006-47, “Allowance for Loan and Lease Losses (ALLL): Guidance and Frequently Asked Questions (FAQs) on the ALLL,” December 13, 2006.
  • Federal Financial Institutions Examination Council’s Consolidated Reports of Condition and Income Instructions.
  • ASC section 250, “Accounting Changes and Error Corrections”, section 855, “Subsequent Events” and section 450, “Contingencies.”

The Ombudsman determined that loan downgrades by examiners during the third quarter required adjustments to the bank’s second quarter ALLL calculation in accordance with guidance for accounting errors under ASC 250. A material error under ASC 250 discovered after financial statements issuance requires correction by restating the previous-period financial statements. A large substandard loan paid shortly after second quarter-end but before call report issuance is a subsequent event under ASC 855, guidance explained in the general instructions section of the call report instructions. In this case, the subsequent event under ASC 855 should have been recognized in the second quarter financial statements. After adjusting for the accounting errors and subsequent event described above, the Ombudsman determined that the net impact of the adjustments resulted in a required ALLL balance within the bank’s calculated range. The overall impact of the recalculated ALLL was immaterial to the bank’s financial statements as of second quarter 2014.

The Ombudsman determined that the bank adjusted qualitative factors and the ALLL level has been directionally consistent. The bank’s detailed review of credit information during the third quarter of 2014 revealed newly identified underwriting concerns, and the bank appropriately increased the ALLL balance during the third quarter. The Ombudsman determined that management appropriately supported this additional amount, consistent with the “Interagency Policy Statement on the Allowance for Loan and Lease Losses,” communicated in OCC Bulletin 2006-47, which states, in part, “Determining the appropriate level for the ALLL is inevitably imprecise and requires a high degree of management judgment. Management’s analysis should reflect a prudent, conservative, but not excessive ALLL that falls within an acceptable range of estimated credit losses.”