CBA Financial and Lending Audits Questions and Answers — Questions and Answers
Question 1: An auditor is reviewing a bank's Allowance for Credit Losses (ACL) methodology under the Current Expected Credit Losses (CECL) standard. The auditor discovers that the historical loss data used in the model excludes loans from a recently acquired portfolio with a historically higher loss rate. Which of the following audit conclusions is most appropriate?
- The exclusion of relevant historical data may lead to an understatement of the required ACL. (Correct answer)
- The ACL model is acceptable as long as it incorporates reasonable and supportable forecasts.
- The acquired portfolio can be excluded until three years of performance data have been accumulated.
- The bank's qualitative adjustments are sufficient to compensate for any data omissions.
Correct answer: The exclusion of relevant historical data may lead to an understatement of the required ACL.
Under ASC 326 (CECL), the estimate of expected credit losses must be based on all relevant information, including past events and current conditions. Intentionally excluding a portfolio with higher historical losses from the data set used to train the model introduces a bias that will likely result in an ACL that is understated and not representative of the true risk profile of the entire loan portfolio.
Question 2: During an audit of the lending function, a review of loan files reveals several instances where commercial loan officers used their override authority to approve loans that did not meet the bank's established underwriting criteria. What is the auditor's most effective course of action?
- Recommend that loan officer override authority be eliminated entirely.
- Select a sample of the overridden loans to assess the documented justifications and determine if mitigating controls were in place. (Correct answer)
- Conclude that this is an acceptable practice as long as the overrides are within the officers' lending limits.
- Report the issue to the compliance department for a full investigation into potential fair lending violations.
Correct answer: Select a sample of the overridden loans to assess the documented justifications and determine if mitigating controls were in place.
While management overrides are a high-risk area, they may be legitimate in some cases. The auditor's role is to assess the risk and control environment surrounding these exceptions. By selecting a sample, the auditor can evaluate the quality of the justification, determine if mitigating factors were considered (e.g., additional collateral), and assess whether the overrides, in aggregate, represent an unmanaged increase in the portfolio's credit risk. Recommending complete elimination may not be practical, and simply accepting them is not a sufficient audit response.
Question 3: Which of the following is the primary objective of an independent loan review function within a financial institution?
- To re-underwrite all new loans originated during the period.
- To provide the board and management with an objective assessment of the overall quality of the loan portfolio and credit administration. (Correct answer)
- To ensure all required loan documentation is present in the file before funding.
- To set the interest rates and terms for complex commercial credit facilities.
Correct answer: To provide the board and management with an objective assessment of the overall quality of the loan portfolio and credit administration.
The core purpose of an independent loan review function is to serve as a key risk control by providing an unbiased evaluation of credit quality. This includes validating or assigning risk ratings, identifying loans with potential credit weaknesses, assessing adherence to lending policy, and evaluating the effectiveness of the overall credit risk management process. This function reports its findings to senior management and the board to enable timely corrective action.
Question 4: An auditor is examining the collateral documentation for a portfolio of commercial real estate (CRE) loans. The auditor notes that for several large loans, the most recent property appraisals are over three years old. This finding represents a significant weakness in which area?
- Fair lending compliance.
- Interest rate risk management.
- Collateral risk management. (Correct answer)
- Liquidity risk monitoring.
Correct answer: Collateral risk management.
Collateral is a secondary source of repayment for CRE loans, and its value can fluctuate significantly. Relying on outdated appraisals means the bank may not have an accurate understanding of its current collateral position. If property values have declined, the loan-to-value ratio may be much higher than policy allows, indicating an unacceptably high level of credit risk due to potential under-collateralization. Regulatory guidance requires banks to have processes for obtaining current collateral valuations.
Question 5: When auditing a bank's loan participation portfolio where the bank is a participant (i.e., it purchased a portion of a loan originated by another institution), which of the following is the GREATEST concern for the auditor?
- The lead lender is charging an excessive servicing fee.
- The participant bank did not perform its own independent credit analysis before purchasing the loan. (Correct answer)
- The loan documents were executed using an electronic signature platform.
- The participant bank's share of the loan is less than 50% of the total credit.
Correct answer: The participant bank did not perform its own independent credit analysis before purchasing the loan.
Regulatory guidance is very clear that a participant bank cannot delegate its credit approval responsibility. It must perform its own due diligence and independent credit analysis of the borrower and the loan terms. Over-reliance on the lead lender's analysis is a significant safety and soundness concern, as the participant bank retains the full credit risk for the portion of the loan it has purchased. The other options are lesser concerns or standard business practices.
Question 6: A bank has identified and classified several large commercial loans as Troubled Debt Restructurings (TDRs). When auditing these loans, the auditor's primary focus should be to ensure that:
- the bank has initiated foreclosure proceedings against the borrowers.
- the original loan officer has been placed on a performance improvement plan.
- the loans are segregated from the main portfolio for regulatory reporting.
- the concession granted to the borrower has been properly identified and the loan's impairment has been measured and recognized in accordance with accounting principles. (Correct answer)
Correct answer: the concession granted to the borrower has been properly identified and the loan's impairment has been measured and recognized in accordance with accounting principles.
The key audit and accounting issue for a TDR is its proper recognition and measurement. Under accounting standards (e.g., ASC 310-40), a TDR occurs when a creditor, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. The auditor must verify that these concessions are identified and that the resulting impairment on the loan is correctly calculated (either through the discounted cash flow method or the fair value of collateral) and reflected in the Allowance for Credit Losses (ACL).
CBA Financial and Lending Audits Questions and Answers
An auditor is reviewing a bank's Allowance for Credit Losses (ACL) methodology under the Current Expected Credit Losses (CECL) standard.
The auditor discovers that the historical loss data used in the model excludes loans from a recently acquired portfolio with a historically higher loss rate.
Which of the following audit conclusions is most appropriate?
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