New Accounting Rule to Accelerate Loan-Loss Recognition

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By Steve Burkholder

June 16 — U.S. banks and credit unions will report loan losses and other credit impairments more quickly under a major accounting standard issued by the Financial Accounting Standards Board.

The new, more forward–looking rules FASB issued June 16, spurred by the 2008-09 financial crisis, could affect financial institutions' earnings significantly. The impact depends on how large loan reserves are in 2020 and 2021, when the standard begins to take effect.

Larger banks and public companies that file their financial statements with the Securities and Exchange Commission must comply with the standard starting after Dec. 15, 2019. Smaller banks, public companies that aren't SEC fillers, and private entities must comply with the standard beginning after Dec. 15, 2020.

The eight-year writing of the rules—Accounting Standards Update 2016-13—has been closely followed by bankers, for whom the FASB standard heralds the biggest change in accounting in many years. Companies, including non-bank enterprises that hold financial instruments at amortized cost, will immediately book the full amount of credit losses that are expected.

A credit loss is a loss recognized by a bank or other company when customers don’t make payments under loan or other contracts. Banks set up reserves to cover such losses.

A loan or financial instrument is impaired when its market, or fair value, declines permanently below its initial, book value.

That upfront recognition of estimated expected losses has been a point of debate among US and international rule makers. Rules on the topic issued by the International Accounting Standards Board in 2014 don't call for the immediate recording of expected credit losses in a loan portfolio, for example.

Shifting Away from Incurred-Losses Model

Current U.S. accounting rules are geared more toward incurred losses—delaying recognition of them until it is probable that they have occurred—FASB stated June 16. Rule makers call that a “rearview mirror” approach to gauging loan losses and setting loss reserves properly.

The incurred-losses blueprint is widely seen to have contributed to the “too little, too late” recording of loan losses in the financial crisis.

The new standard—built on what FASB calls a “current expected credit loss” model—will provide investors with better information on such losses on a more timely basis, FASB Chairman Russell Golden said June 16. The new accounting prescription will also align accounting with the economics of lending, he said.

Dissenters

However, FASB Vice Chairman James Kroeker and board member Lawrence Smith voted against issuing the new standard. In their jointly worded dissent, Kroeker, a former SEC chief accountant, and Smith wrote that they “disagree with the requirement to recognize a credit loss at origination or purchase, at an amount equal to the ‘lifetime expected credit loss’ for financial assets.”

Harold Schroeder, a FASB member and veteran banking analyst, told Bloomberg BNA June 14 that the number of loans in the U.S. banking system increased 45 percent between the start of 2003 and the end of 2006, but loan loss reserves decreased by 10 percent in the same period leading up to the financial meltdown.

Schroeder, however, cautioned that the new standard is “not designed to stop the next crisis. It's not designed to give early warnings.”

Bankers', Investors' Readings

Investors have voiced concern about prospects of a lack of comparable reporting by global banks because of the misalignment of FASB and IASB standards.

FASB has formed a special advisory group, the Transition Resource Group for Credit Losses, to address questions about first use of the new rules to nip potential accounting problems in the bud (12 APPR 07, 4/8/16). US banking and security regulators take part in the group's meetings.

At the first meeting of the transition group, community bankers—previously outspoken opponents of the new FASB rules—suggested that they were comfortable seeing the accounting changes on the horizon.

Delegates of Independent Community Bankers of America appeared to be less worried about the burden of changes after hearing FASB members and federal bank regulators say that they didn't expect small banks and credit unions to put in place complex, computer-driven models to estimate loan losses and set up reserves. The methods could be “scalable” to the size of the institution.

Regulators and small bankers said in April they saw significant improvements in the final drafting of the new rules “in terms of understandability and addressing stakeholder concerns about” their ability to use the standard, as Jeff Geer, an associate chief accountant at the Office of the Comptroller of the Currency, said at the advisory group's first public meeting April 1.

At CFA Institute, the global group of chartered financial analysts, accounting policy chief Sandy Peters said of the FASB's accounting model in a June 14 interview with Bloomberg BNA: “We don't care for the model because it books all the losses up front.” She added: “Too little, too late has become all up front.”

The president of the American Bankers Association said June 16 that the ABA continues “to have strong concerns” about the cost of applying the FASB credit impairment model's “life of loan loss concept.” However, the group is “committed to working with both regulators and auditors to ensure banks of all sizes can meet the implementation challenges of the new standard,” ABA's Rob Nichols said in a prepared statement.

“Though the exact amount remains unknown, the new standard is expected to increase the allowance for loan and leases losses throughout the industry,” ABA said in its June 16 advisory on the new standard.

“Bank regulators have described” the introduction of the new FASB current expected credit loss model as “ ‘the biggest change to bank accounting ever' ” the banking group noted.

FASB permits early application of the new standard. The new rules allow all enterprises to apply the accounting changes in reports covering fiscal years, and interim periods within those years, starting after Dec. 15, 2018.

To contact the reporter on this story: Steve Burkholder, in Norwalk, Conn., at sburkholder@bna.com

To contact the editor responsible for this story: Steven Marcy at smarcy@bna.com

For More Information

The new FASB standard on accounting for credit losses is available a http://www.fasb.org/jsp/FASB/Document_C/DocumentPage?cid=1176168232528&acceptedDisclaimer=true.

A background brief on the new rules, issued as an edition of “FASB in Focus,” is posted at http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB%2FDocument_C%2FDocumentPage&cid=1176168232790.