Dorsey Baskin | Managing Partner | Grant Thornton
Brooks Brady | SVP ALLL | Zions Bancorporation
Because they are more subjective than other aspects of the ALLL estimation, qualitative and environmental adjustment factors can be the most problematic. Essentially the role of the “Q” factor is to adjust the historical rate of loss for current conditions. Messrs. Baskin and Brady provided insights that should help bankers remove some of the subjectivity of applying Q factors.
Q factors are recognized in regulatory guidance, but only in terms of a list or examples of factors. Guidance does not suggest that adjustments be considered every quarter for all Q factors. Because historical charge-off rates are lagging indicators, the longer look-back period a bank uses, the more Q factors will help determine an estimate reflecting current conditions.
Example Q factors include:
- Changes in lending policies and procedures
- Changes in economic and business conditions (local may be preferred over national for smaller banks)
- Changes in nature and volume of loans or terms
- Changes in lending management and staff
- Changes in volume or severity of past dues, in quality of institution’s loan review system, value of collateral for collateral-dependent loans, concentrations of credit or levels of such concentrations
Q factors should relate as closely as possible to the circumstances and conditions of the specific bank, including its customer base, economic environment, underwriting, and other bank-specific conditions.
Other key considerations related to the use of Q factors:
- A Q factor adjustment isn’t required simply because it is included in regulatory examples, nor if the issue is already addressed in other aspects of the estimation methodology. However, banks need to provide evidence that each of the regulatory Q factors is considered, even when historic loss rates are not adjusted.
- The factor might have implications for future loan losses, but shouldn’t be used if it the event hasn’t yet occurred as of the reporting date.
- A factor should be supported.
- Factors can result in downward as well as upward adjustments.
- Like other aspects of determining the ALLL, Q factor adjustments must be well documented. Factors need to be supported by tangible evidence rather than simply a statement of judgment. Mr. Brady provided some highlights of how Zions Bancorp supports the qualitative portion of its allowance:
- Identify the maximum differences between historic losses and estimated losses, and use these differences to support a range of estimated losses.
- Using well-supported metrics, select a point in the range for each Q factor.
- Document how the bank determined each point in the range, and use the metrics consistently each quarter.