Making no promises about what action, if any, it will take, the Financial Accounting Standards Board will meet in March to determine whether and how it might further modify the CECL standard on credit losses.
FASB met with banks and others to hear emerging concerns about the current expected credit losses, or CECL, approach to reserving for loan losses under Accounting Standards Codification Topic 326. The new standard takes effect for public companies Jan. 1, 2020.
Some financial institutions have asked FASB to delay the standard and further study the effects it will have on the economy. Some others have asked FASB to reconsider how the CECL reserve is presented in the income statement, permitting projected losses for many performing loans to be presented through equity rather than income. The board hosted a roundtable to air concerns as it determines how to respond.
FASB developed the CECL model as a response to the 2008 financial crisis, when a rapid crash in debt-based banking portfolios exposed a serious weakness to the current incurred loss approach to recognizing loan losses. Investors had little forewarning that debt-based instruments were in trouble until it was too late to take action.
The CECL model requires financial institutions to take a more forward-looking approach to estimating losses, relying on their own historic data and market information to develop forecasts and capital reserves accordingly. As financial institutions have worked to develop their CECL models and prepare for implementation of the new accounting, some banks have raised concerns about unexpected consequences of the new approach.
“We are concerned that CECL could impact the availability and pricing of credit and create disincentives for banks to lend,” said Cindy Powell, corporate controller at BB&T Corp., which helped author a proposal to revise the CECL standard. Banks have said they are finding through their CECL modeling and implementation that the new accounting will be “procyclical,” which means it will drive economic consequences. When the economy is beginning to sour, banks say, CECL accounting will accelerate the downturn. Members of Congress have chimed in to support banks’ call for relief as well.
Banks have learned a great deal since the financial crisis about modeling, stress testing, and capital planning, said Tim Golden, senior vice president and controller at Capital One. “What hasn’t changed is our ability to predict turns in the credit cycle,” he said. “The further out the forecast goes, the less reliable it becomes, particularly in times of stress.” That makes the use of forward-looking information in financial reporting and in reserving for loan losses challenging, he said.
Shayne Kuhaneck, assistant technical director at FASB, said the board’s nearly 10-year journey to develop the current CECL standard included consideration of approaches similar to what some banks are asking for now, which would require banks to sort loans into different buckets for recognition purposes. Feedback to earlier-considered approaches included concerns regarding the operability of using different measurement approaches for different instruments, ambiguity of criteria for determining what instruments belong in which buckets, and the potential for earnings management, among others.
That feedback is still relevant for consideration, Kuhaneck said. “Investors and other users strongly preferred a model that records the full amount of expected credit losses,” he said. “Investors stated that they saw no point in recognizing different amounts of expected credit losses on the basis of whether default events are expected within a specific time frame ... Investors also disagreed with the idea of using any other type of trigger for determining the amount of expected credit losses recognized, which they asserted would add another layer of subjectively into an already subjective estimate.”
FASB staff tasked banks to describe whether they believe they could still proceed to a Jan. 1, 2020, effective date if the board were to consider revising the CECL standard. Several said it would be difficult to recalibrate their currently planned loan loss models and still comply with a revised standard by Jan. 1, 2020.
FASB Chairman Russ Golden invited further input as the board continues to consider requests to change the standard. “If you reflect on this meeting and there’s anything else you want to provide, we’d like to hear in anticipation of our board meeting that will occur in March,” he said.