Accounting & Auditing

FASB faces challenge on credit loss standard, announces advisory group

Facing further challenge from community bankers and credit unions on its upcoming credit loss standard, the Financial Accounting Standards Board has announced the members of a Transition Resources Group, or TRG, on the standard.

Although the two moves are not directly linked (FASB Chairman Russell Golden had previously announced that the Board has formed a TRG for the credit losses standard), the annoouncement of the members appointed to the TRG follows the issuance of a joint letter by associations representing community bankers and credit unions, raising continued concerns about the upcoming credit loss standard. The letter, which cc's banking regulators, raises concern about the Current Expected Credit Loss (CECL) model. The bankers argue that their understanding of the model and related implementation expectations differs substantially from current practice, raising practical implementation issues as well as concerns about the potential economic impact of the upcoming standard. 

CECL model arose from FCAG recommendation
A suggestion to shift toward a CECL model was identified by the joint Financial Crisis Advisory Group (FCAG) formed by the FASB and the International Accounting Standards Board following the economic downturn. Although FCAG concluded that accounting standards did not contribute to the crisis, weaknesses in accounting standards could be addressed relating to fair value accounting, off-balance sheet assets and liabilities, credit losses, and impairment. Although the FASB and IASB diverged in their development of impairment standards, the joint FCAG included the following recommendations (among many others) in the FCAG Final Report, which led both boards to consider a CECL model:

  • In the financial instruments project, the Boards should explore alternatives to the incurred loss model for loan loss provisioning that use more forward-looking information. These alternatives include an expected loss model and a fair value model (emphasis added).
  • If the Boards pursue an expected loss model, care must be taken to avoid fostering “earnings management,” which would decrease transparency.

Estimated economic impact
A previous report published in 2014, citing remarks by Comptroller of the Currency Thomas Curry, noted that the allowance for loan losses (more generally, credit losses) could increase by 30 to 50 percent under the revised model (i.e., under the CECL model vs. the previous incurred loss model) in FASB's upcoming credit loss standard. (See Research Report: The FASB CECL Model's Impact on Banks.)

Community bankers voice 'grave concerns'
Community bankers voiced concern during the development of FASB's credit loss standard, most recently filing a comment letter with FASB on March 17 (see Independent Community Bankers Association/Credit Union National Association joint letter to FASB). The letter, addresed to Golden and signed by ICBA President and CEO Camden Fine and CUNA President and CEO Jim Nussle, takes the step of cc'ing a quartet of financial services regulators, including Federal Reserve Board Chair Janet Yellen, National Credit Union Association Chair Debbie Matz, Comptroller of the Currency Thomas Curry, and Federal Deposit Insurance Corporation Chair Martin Gruenberg. 

Describing what they term "grave concerns" with FASB's proposed CECL model, the ICBA / CUNA letter states, in part:

"As you are now well aware, regulatory agencies have been quite vocal in stating that adoption of CECL as now proposed will materially increase the allowance for loan losses for community financial institutions engaged in local lending. ... Dramatic increases in loan loss allowances with no credible evidence of heightened risk and forceful adoption of modeling techniques is a sure path to stunt economic growth as community financial institutions are forced to severely limit or curtail a multitude of lending opportunities that promote economic growth. The end result is a significant reduction in credit extended, fewer homes being purchased, fewer small businesses being cultivated, fewer families being able to send a child to college, and overall economic malaise."

The letter concludes with what they call a "simple ask" (emphasis added):

"We ask you to consider communities across the nation as you finalize CECL to ensure that you do not bring harm to the country. We believe that a more sensible approach to projecting credit losses is the remedy. The final accounting standards update (ASU) should specifically mandate the avoidance of day one loss recognition at transition and on newly originated loans by community financial institutions. Additionally, the use of modeling tools that deviate from the community financial institution’s current techniques used in provisioning for credit losses should not be required. In that regard, the final ASU should also include an example promoting the use of spreadsheet tools for noncomplex financial institutions to bring transparency to the need for simplicity in the adoption of CECL by these community financial institutions. Our associations believe that these accommodations are crucial to avoid great economic damage to the nation."

FASB chairman responds
Although the issues outlined in the letter can be expected to be raised at an upcoming TRG meeting, Golden previously responded to similar issues in his remarks at the AICPA's December 2015 conference, including with respect to sources of perceived complexity of implementing the standard, the relationship between the proposed accounting standard and the economic substance of the loan model, and the role of community banks during the credit crisis. 

Some highlights from Golden's December 2015 remarks include:

Let me take just a moment to address the most troubling misconceptions or concerns that are being circulated about the impairment standard.

One: The new standard will require businesses to develop and install costly, complex new systems.

That’s simply not true. In the underwriting process, most banks—including small community banks—already make some kind of lifetime loss assessments. I would find it very surprising to learn that any lending institution is not already making some type of assessment. ... We are not asking banks to change their methods of estimating losses, but we are requiring banks to change the assumptions used. Nor are we asking banks to look forward 20 or 30 years—we are requiring assumptions only as long as there exists reasonable and supportable data about the future, generally two to three years.

Two: Bank examiners will take a more conservative view.

We are working with banking regulators, with whom we meet regularly, to address these concerns... In fact, we already are working on educational materials about the new standard that the banking regulators will be able to use to help educate their field examiners.

Three: The credit crisis involved only large banks.

In 2007, the FDIC closed three banks. In 2008, the FDIC closed 25 banks. In 2009, the FDIC closed 140 banks. Nearly all of those 168 banks were small, community banks. Clearly, community banks have been a major part of the problem. Based on these statistics, the FASB felt it was important that all lending institutions be included in the new guidance.

Four: The standard takes an unrealistic view of the economics of loan financing.

The FASB simply wants banks to reflect the true economics of their loans. We know—and they know—there are losses associated with the loans. We’re just trying to get them recognized today before the bank goes “belly up” tomorrow.

The CECL model was developed based on extensive feedback from stakeholders. In fact, this issue was brought to the FASB’s attention by a group of financial statement preparers who were concerned about the high threshold for recognizing loan losses and requested that the FASB change the existing incurred loss model.

During a meeting, they told us that they knew there were losses within these assets, but the high probability threshold in current GAAP prevented them from booking losses—even when there’s a substantial amount of risk in those loans. In other words, current GAAP was prohibiting banks from looking forward.

The credit crisis of 2008 underscored the need for a more forward-looking model—one that gives preparers the opportunity to recognize losses that exist in the loan portfolio, and recognize them up front. Many aspects of the CECL model in its current form were developed in direct response to bank stakeholders, who provided feedback intended to reduce the cost and complexity of implementation. 

GAAP vis-a-vis safety and soundness
Interestingly, the ICBA / CUNA letter did not cc the Securities and Exchange Commission, for any number of reasons. One reason could be that although the SEC oversees the FASB, the FASB also aims to operate under "neutrality," free of outside pressure, including any form of political pressure. Another reason could be that the SEC could be watching for signs of "earnings management," something that the latter of the FCAG's two recommendations cited above warns the standard-setters to be wary of, in any move from the current "incurred loss" to an "expected loss" model. Yet another reason could be differing views on the GAAP / RAP divide, (i.e., results presented under Generally Accepted Accounting Principles developed by the FASB, under what could be viewed as "delegated authority" from the SEC vs. alternative "regulatory accounting policy" or regulatory reporting treatments in bank "Call Reports" or other financial institution reglatory reports, which may differ from GAAP and feed into regulators' determinations of financial institutions meeting certain regulatory ratios, such as bank capital requirements).

As to this last point, there is a school of thought that safety and soundness considerations should not have any bearing on GAAP standards established by the FASB, which endeavors to achieve relevant and representationally faithful accounting depictions of economic events, heavily weighted toward 'transparency;' this school of thought argues that regulators have the ability to set differing standards for RAP to address safety and soundness concerns or for any other reason that serves their regulatory purposes. (See, e.g. the remarks of former FASB Chairman Robert Herz at the AICPA's December, 2009 conference, in which Herz provides an indepth discussion about the role of GAAP vs. bank regulators' role in overseeing the safety and soundness of banks, in which he stated, "[I]n my view there should be a greater decoupling of bank regulation from U.S. GAAP reporting requirements. Doing so could enhance the ability of both the FASB and the regulators to fulfill our critical mandates. We can continue to work with independence and an unwavering dedication to market transparency; at the same time the bank regulators can utilize their authority to take whatever actions are required to keep the financial system stable and healthy." 

An alternative school of thought, however, could argue that even if financial services regulators establish different standards evidencing safety and soundness (i.e., causing a RAP-GAAP difference), that the general public, including investors and depositors will be more focused on the more readily available GAAP financial results. 

Role of FASB's TRG
According to FASB's announcement, the role of the Credit Losses TRG will be to, "solicit, analyze, and discuss implementation issues that could arise when organizations implement the upcoming credit losses standard." The TRG, to be Chaired by Board Member Larry Smith, will serve as a resource both to the FASB and to constituents, says FASB. Sharing issues with the FASB, "will help the Board determine what, if any, action is appropriate to address those issues." Additionally, says FASB, the TRG will "provide stakeholders with a forum to learn about the new standard from others involved with implementation." 

Golden noted the TRG advisory model followed on the succesful role played by the Revenue Recognition TRG.  (One notable difference between the two TRG's: the "Rev Rec" TRG is a joint TRG formed by the FASB and the International Accounting Standards Board, for their largely converged standards issued on revenue recognition. In contrast, the IASB and FASB diverged on certain significant issues in their financial instruments - impairment projects, such that the IASB released IFRS 9 in 2014 and formed its own Impairment TRG, whereas the FASB is finalizing its impairment / credit loss standard at this time, with its own IFRS Transition Group or ITG on Impairment of Financial Instruments.)

Another organizations that has identified implementation issues on the upcoming credit loss standard is the American Bankers Association. See, e.g.  CECL Implementation Challenges: The Life of Loan Concept (American Bankers Association, Oct. 2015)  

Final credit loss / impairment standard slated for mid-2016
The final standard on credit losses, more formally known as Accounting for Financial Instruments - Credit Impairment, or in short-hand, the "credit losses" standard, is expected this year. 

"We expect to issue the final credit losses standard in mid-2016," FASB spokesman John Pappas confirmed.

One of the final steps in finalizing a standard, under the FASB's Operating Procedures, is for the FASB Board to discuss the costs/benefits of a near-final standard. (This discussion follows earlier discussions of cost/benefit throughout the standard-setting process, including the public comment period on Exposure Drafts of proposed standards).

According to Pappas, the FASB is expected to hold a Board meeting in late April/early May to discuss cost/benefit of the upcoming (near-final) Credit Losses standard.

Learn more
Opportunities to learn more about the latest developments in accounting and auditing, tax, talent management and technology impacting CPAs in audit, business and industry will be addressed by MACPA CEO Tom Hood at the March 23 Town Hall / Professional Issues Update (attend in person or via webcast; follow on twitter @macpa, #PIU16). Information about additional Town Hall meetings taking place from March through June can be found at Updates will also be provided at the MACPA's annual Business and Industry conference on May 13 at the Hilton Baltimore BWI Airport.