PHOENIX-As two major accounting standards group attempt to improve the quality of financial instrument reporting, one expert sees new problems being created.
With the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) continuing their convergence efforts, one joint project has concerned accounting for financial instruments. At the CUNA CFO Council conference here, Todd Sprang, CPA and partner in Oakbrook, Ill.-based CliftonLarsonAllen LLP, said the project is supposed to address the topic of incurred loss versus expected loss.
"Weaknesses were identified following the economic crisis-specifically the delayed recognition of credit losses under the incurred-loss model," he explained.
The expected loss model was released Dec. 20, 2012, and requires an estimate of present value of cash flows not expected to be collected based on quantitative and qualitative information, including historical loss experience, current conditions and borrower credit worthiness. It also proposes to include forecasts of expected credit losses and of the direction of the economic cycle.
Not A Workable Solution
Sprang said the latter two are very difficult to estimate, much less document.
"I do not see this as a very workable solution," he declared. "It is very difficult to foresee economic conditions over the life of a loan. There are a lot of subjective factors."
The problem, Sprang continued, is too many solutions "are being worked on in silos," and there is little understanding that "managing capital is different than managing risk."
The new standards will result in more rapid changes to allowance for loan losses, and more volatility, he predicted. If there is a crisis, reserves will spike up more sharply. In better times, a credit union's allowance will go down quickly.
"The expected loss model requires even greater judgment, will result in greater regulatory scrutiny, more challenging math and attempting to predict the future," he said. "Smaller institutions will face a lack of data. Calculation of an expected loss depends on the reason for collateral dependence."
ALLL, TDRs & Acquired Loans
Sprang covered a number of other FASB-related topics, including: Allowance for Lease and Loan Loss (ALLL), Troubled Debt Restructuring (TDR) and acquired loans.
Unallocated reserves are acceptable in most circumstances, but CUs were advised to exercise caution if that category gets higher than 10% to 15% of reserves.
Historical periods for calculating allowance for loan and lease losses used to be three to five years. When recession hit it shrank to 12 to 18 months. Today the time period is expanding again as big losses are dropping off.
Initial assessments for Troubled Debt Restructuring include an impairment calculation. When do these initial assessments change? "Some say once a TDR, always a TDR, the lender needs to keep it there until the borrower pays it off or someone else takes it. There is no guidance to tell credit unions what to do, so it is best to set a policy and stick to it."
Segregation of acquired loans must be done by deterioration of credit quality. Treatment is more complex if there is significant deterioration. CUs should separate performing versus non-performing loans and document the thought process. Pooling criteria for significant deterioration includes similar credit risk, collateral, size, interest rate, origination date, term and geographic location.
