Objectives, Scope, and Methodology

Our objectives were to determine whether loan loss reserve methodologies used by insured depository institutions resulted in reserve amounts that were justified by supporting analysis and comparable among institutions and accounting standards provided by FASB and regulatory guidance provided by OCC, FRB, FDIC, and OTS were sufficient to promote fair and consistent financial reporting of loan loss reserves among depository institutions. Loan Loss Reserves Were Incomparable and Included Large Unjustified Amounts

The 12 depository institutions we reviewed used markedly different methods to establish their loan loss reserves, which resulted in incomparable reserves, and, in most cases, significant portions of their reserves were not justified by supporting analyses. Loan loss reserves that cannot be compared or that misrepresent risks in loan portfolios impede investors, creditors, depositors, regulators, and other users of financial reports from understanding the true financial condition of depository institutions. All of the institutions used historical losses to establish reserves for loans that were not individually assessed. Thus, significant amounts of the reserves of most of the institutions were based on historical losses. However, because the methods used to determine and apply these historical losses varied widely the resultant reserve amounts were not comparable among the institutions. The build-up of the supplemental reserve not only masks the improvement in the condition of the loan portfolio during years 1 through 3, but also enables the institution to conceal the significant increase in loss exposure which occurs during years 4 and 5.
Why GAO Did This Study

GAO reviewed the methods that federally insured depository institutions used to establish loan loss reserves, focusing on whether: (1) the reserve amounts were justified by supporting analysis and comparable among institutions; and (2) accounting standards and regulatory guidance were sufficient to promote fair and consistent financial reporting of loan loss reserves among depository institutions.

What GAO Found

GAO found that: (1) case studies showed that the depository institutions maintained significant amounts of unsupported loan loss reserves, particularly large supplemental reserves that were not linked to loss exposure; (2) most of the institutions' loan loss reserves were not justified by supporting analysis and were not comparable among institutions; (3) the institutions' reserving methods varied greatly regarding the use of individual loan assessment results, determination and use of historical loss experience, and the inclusion of supplemental reserves; (4) financial report users could not compare the adequacy of the institutions' reserves or judge the quality of their loan portfolios; (5) unjustified supplemental reserves could cushion changes in the condition of the loan portfolio and mask the institutions' true financial status, which in turn could impede regulators' oversight; and (6) there was no regulatory guidance for establishing loan loss reserves, which gave the institutions excessive flexibility in how they calculated their loss reserves.