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Will your bank’s qualitative factors stand against loan losses?

Jun 25, 2020
By: Michael D. Carlson
Financial Services

As stay-at-home orders are gradually lifted and the economy slowly reopens, many bankers are asking themselves, “How much do I need in my allowance?” Fortunately, banks have not experienced widespread loans losses during this pandemic, now going on over three months. Yet there is a feeling of uneasiness; we know the losses are there — it is just a matter of time until they rear their ugly head. 

With many banks now looking ahead to the end of the second quarter, we have seen a rise in questions regarding the allowance calculation and its mechanics. Since historical losses have been low or nonexistent, coupled with low levels of impaired loans (maybe a slight increase in TDRs), how do you justify an increase in the reserve? The answer: your qualitative factors. 

Today, your bank’s qualitative factors are more important than ever. Q factors allow you to reserve at an appropriate level when the total of your historical loss rates and specific loan impairments would be deemed insufficient. As detailed in the FDIC’s FIL-105-2006, Interagency Policy Statement on the Allowance for Loan and Lease Losses, nine qualitative factors that banks should evaluate in connection with their allowance calculation are identified. 

In today’s world of COVID-19, two qualitative factors stand out:

  • Changes in international, national, regional and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments
  • Changes in the volume and severity of past-due loans, the volume of nonaccrual loans and the volume and severity of adversely classified or graded loans

As bankers prepare their June allowance calculations, these two factors should garner extra attention. Ensure the factors are moving in a manner that is directionally consistent with data points. Consider revisiting your external data points too. Are they current? Are they measurable? Economic indicators such as the unemployment rate and the Federal Reserve’s beige book provide a great start. 

By effectively leveraging and understanding your bank’s nine qualitative factors, you should be well on your way to answering one of the toughest questions in banking: “How much do I need in my reserves?”


Michael D. Carlson , CPA, CGMA
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