Commission Staff Issues Accounting Bulletin on Selected Loan Loss Allowance Methodology and Documentation Issues

The Office of the Chief
Accountant and the Division of Corporation Finance of the
Securities and Exchange Commission today released Staff
Accounting Bulletin (SAB) No. 102, which provides certain
views of the staff on the development, documentation, and
application of a systematic loan loss allowance methodology.
The Commission previously issued guidance on this topic in
December 1986 through Financial Reporting Release No. 28
(FRR No. 28).  The SAB applies to registrants that are
creditors in loan transactions that, individually or in the
aggregate, have a material effect on the registrant’s
financial statements.

     This SAB was prepared as a result of the March 10, 1999
Joint Interagency Letter to Financial Institutions signed by
the SEC, the Federal Deposit Insurance Corporation, the
Federal Reserve Board, the Office of the Comptroller of the
Currency, and the Office of Thrift Supervision.  In that
Joint Letter, the agencies agreed to provide parallel
guidance on loan loss allowance methodologies and supporting
documentation.  The banking agencies are issuing their
guidance today through the Federal Financial Institutions
Examination Council as interagency guidance, “Policy
Statement on Allowance for Loan and Lease Losses
Methodologies and Documentation for Banks and Savings
Institutions.”

     The staff views in the SAB are based on the premise
underlying FRR No. 28, that loan loss estimates developed
without a disciplined methodology or adequate documentation
can undermine the credibility of an institution’s financial
statements.  Since the issuance of FRR No. 28, the
Commission’s staff has continued to observe, from time to
time, a lack of discipline in the establishment of
allowances for loan losses and situations in which companies
may have weaknesses in their documentation related to loan
loss allowances.  The General Accounting Office has made
similar observations about the loan loss allowance practices
of depository institutions, as it reported in its October
1994 Report to Congressional Committees, Depository
Institutions:  Divergent Loan Loss Methods Undermine
Usefulness of Financial Reports.  The SAB provides guidance
to registrants to assist them in improving both their
systematic methodologies for estimating loan loss allowances
and their supporting documentation.

     This SAB does not change any of the accounting
profession’s existing rules on accounting for loan loss
provisions or allowances.  As agreed in the March 1999 Joint
Letter, the SEC and the federal banking agencies continue to
support and encourage the Accounting Standards Executive
Committee of the American Institute of Certified Public
Accountants in its work of developing additional guidance on
the accounting for loan losses.

     SABs are not rules or interpretations of the
Commission.  Rather, they are interpretations and practices
followed by staff of the Office of the Chief Accountant and
the Division of Corporation Finance in administering the
disclosure requirements of the federal securities laws.

     For further information contact:  Jenifer Minke-Girard
in the Office of the Chief Accountant at (202) 942-4400 or
Donald A.Walker, Jr. in the Division of Corporation Finance
at (202) 942-1799.

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Fact Sheet:  Staff Accounting Bulletin No. 102 - Loan Loss
       Allowance Methodology and Documentation Issues

July 6, 2001

Staff Accounting Bulletin (SAB) No. 102 provides certain
views of the staff on the development, documentation, and
application of a systematic loan loss allowance methodology.
SABs are not rules or interpretations of the Commission.
Rather, they are interpretations and practices followed by
staff of the Office of the Chief Accountant and the Division
of Corporation Finance in administering the disclosure
requirements of the federal securities laws.

Background

In December 1986, the Commission issued Financial Reporting
Release No. 28 (FRR No. 28) to add guidance on Procedural
Discipline in Determining the Allowance and Provision for
Loan Losses to be Reported./1  In FRR No. 28, the Commission
noted that certain registrants had appeared to lack adequate
documentation of procedures for performing detailed reviews
of loan portfolios and for determining amounts of allowances
and provisions for loan losses.  The Commission indicated
that the staff normally would expect to find “that the books
and records of registrants engaged in lending activities
include documentation of: (a) systematic methodology to be
employed each period in determining the amount of loan
losses to be reported, and (b) rationale supporting each
period’s determination that the amounts reported were
adequate.”
     
Since the issuance of FRR No. 28, the Commission’s staff has
continued to observe some cases of insufficient
documentation of allowances for loan losses.  In the
ordinary course of its reviews of filings, the staff has
observed, from time to time, a lack of discipline in the
establishment of allowances for loan losses and situations
in which companies may have weaknesses in their
documentation related to loan loss allowances, both for
individually impaired loans and loans that are impaired on a
pool basis.  The General Accounting Office has made similar
observations about the loan loss allowance practices of
depository institutions, as it reported in its October 1994
Report to Congressional Committees, Depository Institutions:
Divergent Loan Loss Methods Undermine Usefulness of
Financial Reports.

In recognition of these concerns, the Federal Deposit
Insurance Corporation, the Federal Reserve Board, the Office
of the Comptroller of the Currency, the Office of Thrift
Supervision, and the Commission issued a joint letter to
financial institutions on the allowance for loan and lease
losses (ALLL) on March 10, 1999.  In the Joint Letter, the
Agencies announced the establishment of a Joint Working
Group to study ALLL issues and provide improved guidance on
this topic.  The SAB was prepared as a result of the Joint
Letter.  The banking agencies have issued their guidance on
July 6, 2001 through the Federal Financial Institutions
Examination Council as interagency guidance, “Policy
Statement on Allowance for Loan and Lease Losses
Methodologies and Documentation for Banks and Savings
Institutions.”

Summary of Staff Interpretations

The SAB does not change any of the accounting profession’s
existing rules on accounting for loan loss provisions or
allowances.  Rather, the SAB draws upon existing guidance,
in Commission rules and interpretations, generally accepted
accounting principles, and generally accepted auditing
standards, and explains certain views of the staff in
applying existing guidance related to loan loss allowance
methodologies and supporting documentation.  As agreed in
the March 1999 Joint Letter, the SEC and the federal banking
agencies continue to support and encourage the Accounting
Standards Executive Committee of the American Institute of
Certified Public Accountants in its process of developing
additional guidance on the accounting (as opposed to
documentation) for loan losses.

The staff views in the SAB are organized into the following
topical areas:

  1. A summary of current loan loss allowance guidance under
     generally accepted accounting principles and under
     Commission rules and interpretations;

  2. General factors or elements for registrants to consider
     in developing and documenting their loan loss allowance
     methodologies, including in their written policies and
     procedures;

  3. Staff expectations for measuring and documenting loan
     impairment under Financial Accounting Standards Board (FASB)
     Statement of Financial Accounting Standards No. 114,
     Accounting by Creditors for Impairment of a Loan;

  4. Staff expectations for measuring and documenting loan
     impairment under FASB Statement of Financial Accounting
     Standards No. 5, Accounting for Contingencies;

  5. Staff expectations related to registrants’
     documentation (e.g., summary documentation) of the results
     of their systematic loan loss methodology; and

  6. General guidance to registrants on validating, and
     documenting the validation of, their systematic loan loss
     methodology.

For further information contact:  Jenifer Minke-Girard in
the Office of the Chief Accountant at (202) 942-4400 or
Donald A.Walker, Jr. in the Division of Corporation Finance
at (202) 942-1799.

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1/ See subsection (b) of Section 401.09 of the Commission’s
Codification of Financial Reporting Policies.

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     SAB 102: http://www.sec.gov/interps/account/sab102.htm