On August 3, the Federal Deposit Insurance Corporation (FDIC) released a Financial Institution Letter entitled “Allowances for Loan and Lease Losses in the Current Economic Environment: Loans Secured by Junior Liens on 1-4 Family Residential Properties” to FDIC-supervised institutions.
The Letter states that, at least quarterly, banks must analyze the collectability of their loans held for investment and maintain an allowance for loan and lease losses (ALLL) at a level that is appropriate and determined in accordance with generally accepted accounting principles (GAAP). According to the Letter, an appropriate ALLL covers estimated credit losses on individually evaluated loans that are determined to be impaired and on groups of loans with similar risk characteristics that are collectively evaluated for impairment. With respect to estimating credit losses on each group of loans with similar risk characteristics under applicable Financial Accounting Standards, however, banks should consider their “historical loss experience on the group, adjusted for changes in trends, conditions, and other relevant factors that affect repayment of the loans in the group as of the ALLL evaluation date.”
In its conclusion, the Letter states that the FDIC “recognizes that determining the appropriate level for the ALLL for each group of loans with similar risk characteristics” under existing financial accounting guidance is “inevitably imprecise and requires a high degree of management judgment.” The Letter continues, stating that “delaying the recognition of estimated credit losses on junior lien loans secured by 1-4 family residential properties by failing to properly consider the effect of more senior liens on the collectability of an institution’s existing junior lien loans is an inappropriate application of GAAP.”
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