Bank of America 2012 Annual Report Download - page 107

Bank of America 2012 105
Provision for Credit Losses
The provision for credit losses decreased $5.2 billion to $8.2
billion for 2012 compared to 2011. The provision for credit losses
was $6.7 billion lower than net charge-offs for 2012, resulting in
a reduction in the allowance for credit losses due to improved
portfolio trends and increasing home prices in the consumer real
estate portfolios, lower bankruptcy filings and delinquencies
affecting the Card Services portfolio, and improvement in overall
credit quality within the core commercial portfolio (total
commercial products excluding U.S. small business). Absent
unexpected deterioration in the economy, we expect reductions in
the allowance for credit losses, excluding the valuation allowance
for PCI loans, to continue in the near term, though at a slower pace
than in 2012.
The provision for credit losses for the consumer portfolio
decreased $6.4 billion to $8.0 billion for 2012 compared to 2011.
The improvement was primarily in the consumer real estate loan
portfolios due to improved portfolio trends and an improved home
price outlook in our PCI portfolios. The provision for credit losses
related to the PCI loan portfolios was a provision benefit of $103
million in 2012 as the home price outlook improved, compared to
a provision expense of $2.2 billion in 2011.
The provision for credit losses for the commercial portfolio,
including the unfunded lending commitments, increased $1.1
billion to $197 million in 2012 compared to 2011 due to
stabilization of credit quality, loan growth and a higher volume of
loan resolutions in the prior year, all within the core commercial
portfolio.
Allowance for Credit Losses
Allowance for Loan and Lease Losses
The allowance for loan and lease losses is comprised of two
components. The first component covers nonperforming
commercial loans and TDRs. The second component covers loans
and leases on which there are incurred losses that are not yet
individually identifiable, as well as incurred losses that may not
be represented in the loss forecast models. We evaluate the
adequacy of the allowance for loan and lease losses based on the
total of these two components, each of which is described in more
detail below. The allowance for loan and lease losses excludes
LHFS and loans accounted for under the fair value option as the
fair value reflects a credit risk component.
The first component of the allowance for loan and lease losses
covers both the nonperforming commercial loans and all TDRs
within the consumer and commercial portfolios. These loans are
subject to impairment measurement based on the present value
of projected future cash flows discounted at the loan’s original
effective interest rate, or in certain circumstances, impairment
may also be based upon the collateral value or the loan’s
observable market price if available. Impairment measurement for
the renegotiated credit card, unsecured consumer and small
business TDR portfolios is based on the present value of projected
cash flows discounted using the average portfolio contractual
interest rate, excluding promotionally priced loans, in effect prior
to restructuring. For purposes of computing this specific loss
component of the allowance, larger impaired loans are evaluated
individually and smaller impaired loans are evaluated as a pool
using historical loss experience for the respective product types
and risk ratings of the loans.
The second component of the allowance for loan and lease
losses covers the remaining consumer and commercial loans and
leases that have incurred losses which are not yet individually
identifiable. The allowance for consumer and certain
homogeneous commercial loan and lease products is based on
aggregated portfolio evaluations, generally by product type. Loss
forecast models are utilized that consider a variety of factors
including, but not limited to, historical loss experience, estimated
defaults or foreclosures based on portfolio trends, delinquencies,
economic trends and credit scores. Our consumer real estate loss
forecast model estimates the portion of loans that will default
based on individual loan attributes, the most significant of which
are refreshed LTV or CLTV, and borrower credit score as well as
vintage and geography, all of which are further broken down into
current delinquency status. Additionally, we incorporate the
delinquency status of underlying first-lien loans on our junior-lien
home equity portfolio in our allowance process. Incorporating
refreshed LTV and CLTV into our probability of default allows us to
factor the impact of changes in home prices into our allowance
for loan and lease losses. These loss forecast models are updated
on a quarterly basis to incorporate information reflecting the
current economic environment. As of December 31, 2012, the loss
forecast process resulted in reductions in the allowance for all
major consumer portfolios.
The allowance for commercial loan and lease losses is
established by product type after analyzing historical loss
experience by internal risk rating, current economic conditions,
industry performance trends, geographic and obligor
concentrations within each portfolio and any other pertinent
information. The statistical models for commercial loans are
generally updated annually and utilize our historical database of
actual defaults and other data. The loan risk ratings and
composition of the commercial portfolios used to calculate the
allowance are updated at least quarterly to incorporate the most
recent data reflecting the current economic environment. For risk-
rated commercial loans, we estimate the probability of default and
the LGD based on our historical experience of defaults and credit
losses. Factors considered when assessing the internal risk rating
include the value of the underlying collateral, if applicable, the
industry in which the obligor operates, the obligor’s liquidity and
other financial indicators, and other quantitative and qualitative
factors relevant to the obligor’s credit risk. As of December 31,
2012, updates to the loan risk ratings and portfolio composition
resulted in reductions in the allowance for the commercial real
estate, U.S. commercial and commercial lease financing
portfolios.
Also included within the second component of the allowance
for loan and lease losses are reserves to cover losses that are
incurred but, in our assessment, may not be adequately
represented in the historical loss data used in the loss forecast
models. For example, factors that we consider include, among
others, changes in lending policies and procedures, changes in
economic and business conditions, changes in the nature and size
of the portfolio, changes in the volume and severity of past due
loans and nonaccrual loans and the effect of external factors such
as competition, and legal and regulatory requirements. We also
consider factors that are applicable to unique portfolio segments.
For example, we consider the risk of uncertainty in our loss
forecasting models related to junior-lien home equity loans that
are current, but have first-lien loans that we do not service that
are 30 days or more past due. In addition, we consider the inherent
uncertainty in mathematical models that are built upon historical
data.