The ALLL as a Management Tool

Dorsey Baskin | Managing Partner of Assurance Services Development | Grant Thornton, LLP

Grant Thornton’s Dorsey Baskin has an idea. Noting that banks gather a tremendous amount of high-quality information at a substantial cost in order to calculate their ALLL, he suggests that banks can use that information to improve performance by correlating it to origination sources, underwriting terms, analyzing the profitability of loan products, and evaluating loan officers, branch performance, collateral types and more.

Consider the following types of information that flow into the ALLL estimating process:

  • charge-offs by loan, loan type, risk grade, officer, location
  • risk grades of loans, categories of loans and portfolios
  • collateral valuation information
  • loan portfolio balances by type, risk grade, seasoning
  • recoveries by loan, loan type, risk grade
  • bankruptcies, fraud by loan type/vintage/period
  • national, regional and local economic indicators
  • loss discovery periods
  • loan restructuring nature and frequency

Management can use this information to favorably impact profitability and capital:

  • Reduce charge-offs and the loss accumulation period, allowing a faster reaction to borrower prepayment issues. By collecting more information, more frequently, the bank can shorten the length of time it takes to discover losses.
  • Lower the overall level of the required ALLL by a more comprehensive understanding and subsequent reduction of charge-off rates and loss discovery periods.
  • More appropriately compensate loan officers by linking pay to performance over time. Regulations allow for compensating based on origination of loans, long-term performance of an originator’s loans, meeting performance goals over the life of a portfolio, originating new vs. existing customer loans, and the overall file quality of the originator.
  • By analyzing the historical experience of various types of products, and managing loan products and pricing based on actual results, the bank can improve on new product selection and pricing.