Jul 19 2011

The Allowance for Loan Losses: Critical Issues for Credit Union Leaders

Report  
Number  
243

This report illuminates the ground on which credit unions calculate their particular allowance. The author unpacks the various accounting standards at play and matches them with the expectations of CFOs and credit union examiners alike.

    Michael J. Sacher, CPA
    Sacher Consulting
    Report Number 243

    Executive Summary

    The Washington Mutual (WaMu) collapse of 2009 stands as the nation’s largest-ever bank failure. Economic, strategic, and market challenges all coalesced against the thrift at the end, but the more immediate cause of its failure was an insurmountable mismatch on its balance sheet: bad loans overwhelmed the bank’s ability to stay solvent. WaMu’s allowance for loan losses (ALL) was not big enough.

    Today’s financial landscape is littered with the bones of banks and credit unions alike done in by bad loans. But credit losses are a story as old as banking itself: Financial institutions suffer, and some collapse, when borrowers cannot (or will not) repay their loans. Regulations and accounting standards are enacted with the best intent to control and measure credit losses. But marketplace volatility exhibited by devaluation of collateral and negative earnings has focused increased scrutiny of the ALL. Add to the mix complex accounting requirements heretofore not applicable to most credit unions and the result has been confusion, disagreement, and contention over the ALL.

    What is the research about?

    This report illuminates the ground on which credit unions calculate their particular allowance. The author unpacks varies accounting standards at play and matches them with the expectations of CFOs and credit union examiners alike. The result is a useful document that can be used as both a template and a reference for finance managers, supervisory committee members, and boards of directors walking the fine line between "too much" and "not enough" ALL. In some cases the fate of the credit union depends on that line. 

    What are the credit union implications?

    This analysis of credit unions’ ALL deals directly with a pressing current problem: What is the right way to reserve for credit losses? The issue is made more challenging because it is not just a management issue but a regulatory issue in which reasonable people with differing perspectives often disagree. And for CFOs to disagree with examiners, even respectfully, requires a firm basis in the relevant accounting principles

    The ALL is just one of many accounting variables that a credit union should manage well. But its importance has been reinforced during the Great Recession. This timely, tactical report will help your credit union manage it better.