ALLL: Do Big Banks Know Something that Community Banks Don't?

8/28/2020 - By Josh Strickland, CPA

The world we know looks much different now than it did a few months ago. Businesses, including community banks, are working hard to adapt to the new environment as quickly as possible. Community banks are fighting many headwinds, the remote working environment, squeezed net interest margin, and deferral of loan payments to name a few. One thing most community banks may not have addressed is the need to increase their Allowance for Loan and Lease Losses (ALLL) for COVID-19 related risk.

When we look at the average level of the ALLL in the country’s largest banks, we see that they have increased the ALLL levels significantly during the 1st half of 2020, while banks less than $1 billion in assets have made minimal adjustments to their ALLL. The average ALLL for the 25 largest banks (excluding credit card-based banks) has increased from an average of 1.12% of loans on December 31, 2019, to 2.38% of loans on June 30, 2020. The adoption of the Current and Expected Credit Losses (CECL) methodology did contribute to this increase, but only by 33 basis points. Removing the effect of the adoption of CECL, the average ALLL at the country’s largest banks has increased 93 basis points (or 83%) since December 31, 2019. On the other end of the spectrum, the level of reserves in community banks less than $1 billion had actually decreased to 1.29% of loans on June 30, 2020, as compared to 1.31% of loans on December 31, 2019.

The general consensus is that there is currently more uncertainty (which translates to more risk) in loan portfolios than there was at the end of 2019. However, there has been a lag in community banks identifying and quantifying this risk. There are currently a lot of borrowers that have requested payment deferrals and we will most likely not have a quantifiable impact of these deferrals and other COVID-19 related issues until at least early 2021.

We believe it would be a prudent practice for community banks to begin evaluating the condition of their loan portfolios for potential COVID-19 impacts and begin adjusting the ALLL as necessary. This could include an evaluation of various items in the loan portfolio such as the number of payment deferrals granted along with the composition of their portfolio to determine if they have any concentrations in areas that are more impacted than others by COVID-19, such as hospitality and restaurants. Another recommended practice would be to have loan officers stay in contact with customers that were granted payment deferrals to check in with them and discuss the current situation so the bank can assess the likelihood the loan goes back to normal performance once the deferral period is over. As many of the loans will likely not be showing as past due or impaired due to the payment deferrals granted, we generally are expecting to see increases in the qualitative factors used in the calculation of the ALLL and that by year-end ALLL levels will be higher than reported in the 2nd quarter.

If you would like to discuss ALLL further, please contact a member of our banking team.

About the Author | Josh Strickland, CPA
Joshua is a Senior Manager in the Audit & Assurance Services Department of Saltmarsh, Cleaveland & Gund. He is also a part of the firm’s Financial Institution Advisory Group, with particular experience providing audit and consulting services to the firm’s financial institution clients. Josh has been with Saltmarsh since 2010.