FASB chair defends CECL: ‘The benefits justify the cost'
NORWALK, Conn. — Russ Golden, chairman of the Financial Accounting Standards Board, is defending the board’s decision to require all publicly traded firms to proactively report and set aside reserves for credit losses, saying the move would make the financial system safer and is worth the cost.
In an interview with American Banker, Golden said the recent surge in opposition to the current expected credit loss standard for generally accepted accounting principles starting next year is not uncommon whenever the board makes a big change to its reporting rules. But he said the board is considering delaying the implementation dates for smaller firms, consolidating compliance dates, and working on new guidance documents that should quell some concerns.
“Opposition to an accounting change is not new for the FASB,” Golden said. “In CECL, you can tell by the number of comment letters, the number of meetings we had with stakeholders, that we wanted them to understand — and help us come up with a cost-effective solution that can be implemented.”
Golden said that if CECL had been in place during the financial crisis, leading companies would have had to recognize loan losses more quickly and regulators would have recognized the depth and magnitude of the problem earlier on in the recovery.
“The board believes the benefits justify the cost,” Golden said. “Some of the information and the benefits — had that been in place since 2005, you would have had a more timely recognition of losses, and as the recession unfolded, there would have been a greater linkage between an increase in the losses as the recession was being forecast.”
Following is an edited transcript of the interview:
Can you briefly describe CECL and why FASB feels it's necessary?
RUSS GOLDEN: Sure. The current [GAAP] delays recognition of credit losses until it's probable a loss has been incurred. Financial statement users today make estimates of expected credit losses using forward-looking information, and during the financial crisis they were devaluing financial institutions before accounting losses were able to be recognized. The board sought to better align the accounting with changes in credit risk and to provide better disclosures. So what does CECL do? Well, CECL improves transparency by requiring management's best estimate of the expected credit losses, which gives investors a better starting point for their analysis. We constantly are looking to improve financial accounting to better align the accounting to what investors need, and it became clear — really, before the financial crisis — that the current incurred loss model was not providing the information that investors needed because it allowed for the delayed recognition of credit losses.
CECL has firms consider their loan losses prospectively rather than retrospectively.
It's a great way to look at it. It's really looking forward rather than looking in the rearview mirror.
What was FASB’s process for arriving at CECL, and why was this standard adopted over others?
Over the course of developing CECL, the FASB considered nine different models, including fair value for all financial instruments. That was widely rejected by most of our stakeholders, and they asked us to retain the amortized cost approach with a better impairment methodology. During the course of the project, we issued three exposure documents that generated over 3,000 comment letters. We held 25 field-work meetings, 10-plus roundtable meetings, met with over 200 users and had eighty five plus meetings with preparers in the form of workshops.
Fundamentally, there's three different ways in which you could do loan-loss accounting. You could do it all at the end, not have any recognition of the loan loss until ... until you have the loan loss. You could do it ratably over time, or you can do it up front. Doing it at the end wouldn't work — would not have met the objective of what we are trying to achieve. Doing it over time proved very difficult because losses are not incurred ratably in most loans. Interest income is ratable, but the losses are not. When you look at the data, losses do not occur ratably — that is, evenly over time.
Why do you think opposition to CECL is surging again now, if this has been in the works for so long?
Opposition to an accounting change is not new for the FASB. We have dealt with something like this before. When I first started at the board, we were working on improving the accounting for stock-based compensation. Prior to that improvement, companies did not, in certain circumstances, have to depict the value of consideration they gave employees. Very controversial. What we do in those cases is that we first want to make sure all of our stakeholders, including members of Congress, are educated about what we're doing why we're doing it and why we think this is an improvement.
In CECL, you can tell by the number of comment letters, the number of meetings we had with stakeholders, that we wanted them to understand — and help us come up with a cost-effective solution that can be implemented. And that's why we created the TRG, the Transition Resource Group, and I think that process worked really well. Subsequent to the issuance, we continue to meet with stakeholders, we continue to hold Transition Resource Groups, and we continue to go and talk to companies. As a matter of fact, on July 17, we're going to talk about some additional field-work training that we want to provide to smaller financial institutions and community banks across the country, where they can come in and meet with members of the board and the FASB staff about how to apply CECL.
Are there certain institutions or kinds of institutions that CECL impacts the most? And how has FASB taken those impacts into account?
Since I've been the chairman of the FASB, we have done some extensive work to better understand the pressures that small financial institutions — small companies in general — face on accounting changes. The push back for smaller institutions is similar to some of the pushback that we received prior to me becoming chair, and it has to do with the concerns that small businesses have on availability of resources. The cost associated with implementing IT — training their employees, training their users. And that is why we have begun to implement staggered effective dates for small institutions, private companies. CECL gives a two-year deferral for small private companies, and what we have learned from the implementation of other projects is perhaps a longer time between the date in which private companies are required to go effective than public [firms] could help mitigate some of their cost and concerns.
The questions that the board has received from various sizes of financial institutions has really been about making sure that they understand what the board intended. What we have found throughout the process is, we believe — and we've said this in the document, banking regulators have said it publicly — that this standard is scalable and can be applied by large financial fusions as well smaller financial solutions. We believe smaller financial institutions can apply and do this on an Excel spreadsheet. And banking regulators have agreed with that.
We observed that there isn't one particular methodology that you are required to do and that has been agreed to by the banking regulators. But what we have found confusion, we try to solve that confusion. And one of the areas that we observed a few months ago was whether or not smaller financial institutions could use a methodology that they use today called the weighted average remaining maturity method. And so I asked the FASB staff to put out a formal document under the board's oversight to make it clear that that methodology, which is used today, is a methodology you can use in CECL. You'll have to change your assumptions, but the underlying methodology is still appropriate.
The FASB staff is working on another document and the two of those will really help people understand the "how." The weighted the average remaining maturity Q&A was designed to help people understand, "You can continue with a similar methodology." We are working on another FASB staff Q&A to help financial institutions understand what are considered reasonable and supportable information. What CECL requires is that a financial institution look forward as far as they can. So if they have a loan that has a 10-year remaining maturity, we don't require them to look out and forecast the economic conditions for 10 years. But we do require them to look out as far as they have reasonable and supportable information.
And on July 17, I've asked the FASB staff to bring this research to the board to see if we should provide a longer period of time for not only private companies but also smaller public companies in implementing CECL, leases [and] hedge accounting so that they can learn from. ... The larger public companies so that some of the implementation concerns can be ironed out before these smaller companies are required to implement the change. CECL has three effective dates: publics are Jan. 1, 2020. Private companies without restrictions on their shares are Jan. 1, 2021, and all others are Jan. 1, 2022. That does cause some confusion. And one of the things we'll be looking at is it, is it easier for this system just to [not only] have a staggered effective date, but two effective dates.
There have been some concerns from firms undergoing trial runs that CECL contributes to procyclicality, or might make it harder for banks to lend at the bottom of a credit cycle. Can you address those concerns?
We have heard those concerns, and we have had the opportunity to meet with some of those financial institutions that have begun trial runs. First, they've all said that they'll be ready by the beginning of 2020 — that's the effective date for public companies. I think some of those concerns are due to uncertainty around the board's intent with respect to reasonable and supportable forecasts. And we're hoping they clarify that in the [Q&A] I talked about it. I think other aspects of it have to do with opinions about what the expectations will be when coming out of a cycle. For example, will a company be allowed to look forward and incorporate appropriate information in a timely manner, or will they be forced to remain focused solely on the past and tied to history?
It's the board's intent that companies should look forward and incorporate supportable information into their forecasts. And we continue to, and will work with all of our stakeholders — including auditors and regulators to make sure everyone is on the same page as they interpret CECL. We don't we don't have a role in determining the bank capital, but we do meet regularly with the banking regulators. And they talk about how they have the tools necessary to react to anything like that.
So you're saying that the regulators will are attuned to this, and that when that time comes, they know what levers to pull?
That's what they've said publicly, yes.
How does CECL change the U.S. GAAP framework relative to other accounting standards worldwide? Does it make it more similar or more different?
So with respect to the difference between [the International Financial Reporting Standard] and CECL, we both focus on expected losses. But the way we get to expect losses is different. We as we've talked earlier the FASB we do it all at once, the [International Accounting Standards Board, which oversees IFRS] takes a three-step approach where they forecast expected losses for the next 12 months and record that at the beginning, and then as the losses progress they get to full lifetime losses. We had worked closely with the IASB throughout the process to try to arrive at a consistent conclusion, and in the end we weren't able to be 100% aligned. We had worked on some other projects — lease accounting — where we also were not able to get 100 percent aligned, but we are closer than where we were before we started. Revenue recognition, stock-based compensation, business combination counties are much closer line between IFRS and US GAAP than leases or accounting for credit losses.
I believe [that] being aligned does reduce the cost of a multinational preparer. It does help an investor allocate capital across the globe. It doesn't have as great a benefit, however, for a small community bank in the United States that does not compete for capital across the globe or has international subsidiaries. So there are some companies and some users that have a greater advantage than others.
Several members of Congress are now talking about wanting to delay implementation of CECL. Do you think a compelling case has been made to delay implementation?
Throughout any project, we constantly meet with our stakeholders to monitor their progress towards implementation. We want to be in a position to answer any questions they have to narrow any diversity to provide additional cost savings. This standard is no different than other standards. We've made some changes since issuing it to make it more understandable, to narrow diversity. And we'll continue to make some changes — the Q&A I talked about is coming. We are confident that public companies are ready to implement this beginning Jan. 1, 2020. But as I said before, we do believe that additional time could be used by smaller public companies as well as private companies to learn from the implementation of larger institutions. And so on July 17 we'll be holding a board meeting to see if that is something we should do — not just on CECL, but also on leases and on hedging. Those are two other major standards that we issued and are currently effective for public companies.
Much of the concern around CECL seems to be about the costs of implementation, but what does the financial system get in exchange for those costs? How might CECL have impacted the 2008 crisis had it been in place?
So for CECL, the benefits that the board believes exists in relation to the costs — the benefits are more timely reporting of credit losses, measurement using forward looking information, greater transparency in the extent of expected credit losses, changes in expected credit losses, greater transparency on credit quality indicators and portfolio composition, and a decrease in cost for users because credit losses will now be reported based on expectations and forward looking information, which is consistent with what users do. That comes with a cost.
You have to gather data, you have to incorporate new inputs new processes, to review and audit the new information, you'll have personnel costs to provide education and training, and you'll have to educate investors about the change. We're starting to see that now with public companies. At that time, and still today, the board believes the benefits justify the cost. Now, some of the information and the benefits — had that been in place since 2005, you would have had a more timely recognition of losses, and as the recession unfolded, there would have been a greater linkage between an increase in the losses and as the recession was being forecast.