I would rate the problem at Kendallville Bank as an 8 on a scale of 1 to 10. There are a number of factors that contribute to this rating, including:

• The fact that Dan Davis, the Chief Credit Officer, has been manipulating the Allowance for Loan and Lease Losses (ALLL) to make the bank’s financial statements look better than they actually are.
• The fact that the Credit Quarterly Committee has not been adequately addressing the issue of the ALLL, and has been rubber-stamping Davis’s changes.
• The fact that internal audit has not been independent, and has not been able to provide an objective assessment of the bank’s financial condition.
• The fact that the board of directors and the audit committee have not been adequately overseeing the bank’s financial reporting process.

2. What is the main issue of the case?

The main issue of the case is that Dan Davis is manipulating the ALLL to make the bank’s financial statements look better than they actually are. This is a serious problem because it can mislead investors and other stakeholders about the bank’s financial condition.

3. What did Davis do to the ALLL in the second quarter?

In the second quarter, Davis changed the look-back period for the ALLL from 8 quarters to 12 quarters. This change had the effect of increasing the ALLL, which made the bank’s financial statements look worse.

4. Was the change appropriate?

The change was not appropriate because it was not based on any sound financial rationale. Davis simply changed the look-back period in order to make the bank’s financial statements look better.

5. How might changing the look-back period from 8 quarters to 12 quarters impact the ALLL?

Changing the look-back period from 8 quarters to 12 quarters would increase the ALLL. This is because the ALLL is based on historical loss rates, and the longer the look-back period, the more historical loss data is included.

6. How does changing the look-back period impact the financials?

Changing the look-back period impacts the financials by increasing the bank’s reported loan loss reserves. This, in turn, can have a negative impact on the bank’s profitability and capital levels.

7. What may have motivated Davis to propose changing the look-back period?

Davis may have proposed changing the look-back period in order to make the bank’s financial statements look better. He may have been concerned that the bank’s financial statements would not look as good if the ALLL was not increased.

8. Were the discussions at the Credit Quarterly Committee meetings at the appropriate level of detail?

The discussions at the Credit Quarterly Committee meetings were not at the appropriate level of detail. The committee did not adequately discuss the reasons for the change in the look-back period, and they did not consider the potential impact of the change on the bank’s financial statements.

9. What did Davis do to the ALLL in the third quarter? Was the change appropriate?

In the third quarter, Davis dropped the CRE2 category from the ALLL calculation. This change had the effect of reducing the ALLL, which made the bank’s financial statements look better.

10. Do using the historical loss rates from only the CRE1 loans distort the ALLL?

Yes, using the historical loss rates from only the CRE1 loans distorts the ALLL. This is because the CRE2 loans are a different risk profile than the CRE1 loans. By dropping the CRE2 category from the ALLL calculation, Davis is effectively understating the bank’s risk exposure.

11. What may have motivated Davis to propose dropping the CRE2 category at this time?

Davis may have proposed dropping the CRE2 category in order to make the bank’s financial statements look better. He may have been concerned that the bank’s financial statements would not look as good if the ALLL was not reduced.

12. If you were Sandra Renford, how would you manage Dan Davis?

If I were Sandra Renford, I would first try to understand why Davis is manipulating the ALLL. I would then have a frank discussion with him about the risks of his actions. If Davis was not willing to change his behavior, I would take disciplinary action, up to and including termination.

13. What is your assessment of the governance environment at Kendallville?

The governance environment at Kendallville is not good. The Credit Quarterly Committee is not adequately overseeing the bank