Bankers prepping for a new accounting standard for loan losses have been thrown a curveball.
The Financial Accounting Standards Board has signaled support for an amendment that would require financial institutions to break charge-offs and recoveries out by vintage year. The late-hour change to the standard for Current Expected Credit Losses, or CECL, received enthusiastic backing from investors and analysts because it will provide more insight into credit trends.
The response from bankers has been more subdued.
Banks tend to report charge-offs and recoveries in aggregate terms, so accounting for them on a year-by-year basis could require new systems, Daniel Palomaki, a managing director for accounting policy and controller of the Institutional Clients Group at Citigroup, said at a Nov. 1 meeting of a group FASB formed to discuss CECL implementation.
The effort — and expense — would be significant, even for a bank with Citi’s resources.
“From our perspective, it’s a surprise,” Palomaki said of the proposed amendment. “We weren’t planning on making the disclosure, so we’ll have to begin to manually pull together this information and build a systemic process. It’ll be difficult to fold this into the parallel runs we do.”
The change also upset credit union executives.
“This will add operational complexity to an already complex standard,” said Doug Wright, chief financial officer at the $3.5 billion-asset Mission Federal Credit Union in San Diego.
In another indication of the issue’s potential impact, FASB’s board instructed staff to detach the amendment from a list of other, less impactful CECL changes and detail it in a special exposure draft. A second exposure draft, outlining the rest of the changes, is slated to be released the week of Nov. 19.
While no specific date was set for the special exposure draft’s release, FASB is targeting a release toward the end of the year, spokeswoman Christine Klimek said. The board earmarked 60 days for public comment, or twice the time allotted for the other changes.
Vice Chairman James Kroeker was the only member of the six-person FASB board to express any doubts about the plan.
“I’m not disputing the benefits, but I don’t like to go forward with an exposure draft when we don’t have a cost-benefit analysis,” Kroeker said.
The move comes as more publicly traded banks begin to embark on what many say will be a year of “parallel runs,” where they calculate an official loan-loss allowance under the current, incurred-loss methodology, and a second, in-house number using CECL.
“Everybody is talking about that right here,” Glenn Rust, president and CEO of Virginia National Bancshares in Charlottesville, said at a recent roundtable discussion hosted by OTC Markets Group. “You just can't run away from it. Time is tick tick ticking away and you know everybody's going to begin their parallel runs in the first quarter."
Even so, banks’ ongoing concern about CECL’s complexity, as well as the possibility that it could lead to spikes in their loan-loss allowances, have prompted a group of institutions to ask the standards board to consider another significant change to the standard.
This group is advocating a plan that would create a two-tier allowance structure. One tier would include charge-offs expected within 12 months, which would flow through net income. The second would include charge-offs expected over the remaining contractual life of a loan, which would flow through other comprehensive income.
The group, which includes regional banks like BB&T, Fifth Third, Capital One, Huntington, SunTrust and U.S. Bancorp, sent FASB a letter outlining the details of its proposal, which is intended to mitigate CECL's effect on capital.
"The proposal could be leveraged ... to reduce the effect on capital thereby avoiding the unintended consequences of additional capital cost passed on to consumers and small businesses through higher pricing, reduced loan tenors, and less access to credit for already underserved borrowers," the banks wrote in the Nov. 5 letter.
The banks also suggested that a delay in CECL effective dates might be necessary, given their proposal.
FASB board member Hal Schroeder, who had advance notice the letter was on its way, said last week that he and his colleagues would consider the plan during an upcoming board meeting — but he added that deliberations would include a healthy dose of skepticism.
The FASB board "considered that alternative and several very similar alternatives," before approving CECL, Schroeder said. “We had heard feedback at that time, when we were considering that alternative, that this would be very difficult for them to do and in many ways would be very costly and arbitrary."
The accounting standards board will press banks advocating a tiered system to explain “what’s changed since we considered this about five years ago," Schroeder added. "What’s changed that would make this more operable or cost-beneficial to do?”
The American Bankers Association is arguing that the CECL implementation process should be halted indefinitely until a quantitative impact study of its potential cost can be conducted. The association sent a letter to Treasury Secretary Steven Mnuchin last month suggesting that the Financial Stability Oversight Council, which Mnuchin chairs, should ask FASB to suspend implementation.
CECL, approved in April 2016, is scheduled to become effective for publicly traded banks on Jan. 1, 2020, and for nonpublic institutions the next year.
The standard, which many have called the most significant accounting change in generations, is controversial because it asks financial institutions to estimate the losses they expect over the lifetime of a loan at the time the credit is placed on the books.
Under the current standard, banks aren’t permitted to reserve for loan losses until signs of credit-quality deterioration become evident.
Still, there are supporters, particularly if CECL requires an annual breakdown of charge-offs and recoveries.
“Economic conditions change by vintage and underwriting criteria change by vintage,” said Fred Cannon, director of research at Keefe, Bruyette & Woods. “So, being able to project out what you expect the future allowance to be and how you expect charge-offs and the allowance to roll forward is really going to be determined by the timing of those events.”
