March 1, 2012

Interagency Guidance on ALL Estimation Practices for Junior Lien Loans & Lines of Credit

The federal financial regulatory agencies* issued supervisory guidance on Allowance for Loan and Lease Losses (ALLL) estimation practices associated with loans and lines of credit secured by junior liens on 1-to-4 family residential properties. While the guidance reiterated previously established generally accepted accounting principles and regulatory ALLL supervisory guidance, the agencies have listed certain responsibilities for management that are expected to be performed related to the ALLL estimation process. Specifically, the guidance states management should ensure that sufficient information is gathered to adequately assess the probable loss incurred within the junior lien portfolio. If the financial institution does not own or service the associated senior lien loan, the guidance suggests the institution should use available “tools” to determine the payment status of the senior loans.

The guidance also suggests that institutions with significant holdings of junior lien loans should ensure adequate segmentation within their loan portfolio to appropriately estimate the needed allowance for high-risk segments of the portfolio. Management should understand and analyze expected default risk associated with payment shocks due to rising interest rates for adjustable rate loans and credits converting from interest-only to amortizing loans.

The guidance directs regulatory examiners to assess the appropriateness of the institution’s ALLL methodology and documentation related to junior lien portfolios. If it is concluded that the reported ALLL is not appropriate, or that management’s ALLL evaluation is deficient, examiners are instructed to include this in the report of examination.

To discuss your institution’s ALLL estimation methodology, contact  the expert listed below at PYA, (800) 270-9629.

*Federal Reserve, FDIC,OCC & NCUA

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