The Financial Accounting Standards Board will be looking at techniques for grouping impaired loans as a possible alternative to individual treatment of troubled loans.
The board instructed its staff to find ways to group the troubled loans and estimate their expected future cash flows instead of doing the two functions on a loan-byloan basis, according to FASB staff. Despite calls by critics to abandon the project in favor of the more comprehensive multiyear financial instruments project, the board has decided to proceed with the project separately.
'The board believes that the loan impairment problem is more immediate,' said Timothy S. Lucas, FASB research director.
Critics argued that the board might get better answers ff it studied the problems within the context of the larger financial instruments project. The project, which was added to the accounting board's agenda in 1986, looks at recognition and measurement, disclosures, liabilities and equity.
Although the larger project might result in a different approach, Lucas said. the board saw no need to delay what can be resolved today.
Determining when a loan becomes impaired and how much reserves must be set aside to cushion against probable losses have been sore points between regulators and lenders. Accounting for troubled loans has been diverse, resulting in varied interpretations of existing accounting rules.
The Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation desire better information about the financial condition of institutions that sell them loans. The two companies want a market interest rate to be used in discounting impaired loans but split on when to recognize impairment. Fannie Mac favors recognition when impairment is 'probable' while Freddie Mac prefers a 'more likely than not' criterion.
FASB hopes that the standard, which establishes the 'probable' criterion for recognizing impairment and requires a discounting method for measurement, would be acceptable to U.S. financial institutions and their regulators.
Grouping or aggregating impaired loans for measurement was suggested by bankers and insurers who were concerned about language in the proposal that apparently would require separate evaluation for every troubled loan. The requirement implied precision that is impossible when making estimates, they said.
Lucas admitted that FASB did not do a good Job explaining its intent, which caused the confusion. He said the board is aware of the difficulty of measuring impairment and is not aiming for precision in the proposal.
'We did not not necessarily interpret the draft to require a separate spread sheet for every loan,' said Lucas. 'The board was trying simply to state an objective and, as usual, it is always up to the reporting entity how it would get to that objective.'
Thus, the objective of aggregation is to determine whether the reserve is adequate and, once the entity has determined that, it shouldn't do more work than is required. he said.
In the same meeting, the board reaffirmed its position that a loan is considered impaired when it Is 'probable' that the creditor would be unable to collect all amounts due according to the terms of the loan contract.
The General Accounting Office has argued for a 'more-likely-than-not' criterion to replace 'probable,' which it thought was too vague.
'Probable,' which many entities took to mean "virtually certain' caused banks and thrifts to delay recognition of impairment, a practice which regulators say allowed troubled loans to stay on the books as performing assets. Sifting through the rubble of collapsed thrifts and banks, regulators claimed that such disasters would have been avoided if impairment had been recognized earlier. A 'more-likely-than-not' standard, which means there is a 50% chance that the loan will go had, would have alerted regulators at once.
In retaining the 'probable' criterion. FASB made clear that probable does not mean virtually certain. It is defined in the draft as 'an area within a range of the likelihood that a future event or events will occur.' That range is from 'probable' to 'remote,' which the draft defines thus:
* Probable. The event or events are likely to occur.
* Reasonably possible. The chance of the event or events occurring is more than remote, but less than likely.
* Remote. The chance of the event or events occurring is sight.
FASB Project Manager Carol Clarke said the board further reaffirmed that 'all amounts due' referred to both contractual interest and contractual principal.
Clarke said the staff was also asked to study suggestions to recognize collateral dependent loans at the fair value of the collateral.
'We are now trying to get people to explain that approach to us and see if we can make it work,' she said.