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Investors Say They Need More Details on How Credit Losses Standard Will Work

Echoing concerns they raised in an April letter to the board, members of the FASB’s Investor Advisory Committee (IAC) said they wanted more information about how the FASB’s planned standard to revamp loan-loss accounting will work once it is implemented. The FASB aims to publish the much-anticipated final standard by the end of the year, but the panel’s members say they do not have enough information to sufficiently judge the standard and advise the board on its requirements.

In just a few months, the FASB is expected to wrap up a long-running project that will produce one of its most anticipated accounting standards in recent years — an amendment to U.S. GAAP that will push banks to make more aggressive write-downs of bad loans.

But some investors and analysts are concerned that some important questions about how the standard will change bank accounting have not been addressed at such an advanced stage of the project.

Members of the FASB’s Investor Advisory Council (IAC) on September 3, 2015, told the FASB they want more information and more real-life examples about how the standard will change the requirements for recording losses on bad loans once banks and other lenders begin to use it. They also reiterated concerns they expressed earlier this year that the standard under development would force reporting of inflated losses on the day a loan is originated, would be difficult to implement, and does not match the standard crafted by the IASB.

“This obviously has been a really complicated and challenging topic,” said David Trainer, CEO of New Constructs, an investment research firm.

Seeing the effects of the forthcoming standard “in the financial statements in as many scenarios as possible is critical for us to assess what’s going on,” Trainer said. “Without that, it’s much more challenging to follow and provide productive feedback.”

The FASB provided examples to the investor panel prior to the September 3 meeting, but Trainer and other members said they did not have enough time to digest them. In addition, the examples raised more questions than answers among panel members.

Trainer said it would be helpful to see examples presented in an Excel spreadsheet so IAC members could understand the math behind the FASB’s model, current GAAP, and the model developed by the IASB. In the immediate aftermath of the 2008 financial crisis, the FASB and IASB worked jointly on a new standard. By 2012 it was clear that the two boards could not agree on a common solution. In 2014, the IASB issued its revisions in IFRS 9, Financial Instruments , which is seen as taking a somewhat less aggressive approach to writing down loans than the standard the FASB is expected to issue.

FASB member Lawrence Smith pressed the group for more details.

“We need specificity in terms of what questions you specifically have and what additional examples you need to be provided with,” Smith said. “Because right now, I participated in that session, and I don’t quite understand what you’re asking.”

Joseph Stieven, CEO of Stieven Capital Advisors LP, said the group did not have enough time to review the latest examples provided by the FASB.

“When nearly every person saw these models, I think we all had more questions,” Stieven said.

The credit losses standard is considered the FASB’s most important response to the financial crisis and meant to address years of complaints by investors, analysts, and regulators that U.S. GAAP does not do a good enough job of requiring banks to estimate potential losses. This was a headline issue in the crisis when banks suffered deep losses, but their balance sheets remained healthy until long after it was clear that they were not.

Based on a proposal the FASB released in late 2012, Proposed Accounting Standard Update (ASU) No. 2012-260, Financial Instruments—Credit Losses (Subtopic 825-15) , banks and other businesses must look to the foreseeable future, consider all losses that could happen over the life of the loan, trade receivable, or security in question and immediately book losses. The estimate is not supposed to cover a best-case or worst-case scenario. It also is not limited to banks, but they are expected to be the chief user of the standard.

Under the model, banks are supposed to take into account past experiences, future estimates, and current trends in the economy, and use their best judgment to record a loss provision, a figure that shows up on bank balance sheets and income statements and is supposed to lend key insight into how a bank is performing.

Investors place a high importance on fluctuations in the reserve account from one quarter to the next. Rising reserves tell the markets that the bank has bad loans on its books and needs the extra cushion to absorb the losses.

Under the FASB’s standard-in-progress, reserves are expected to be large from the time the loans are issued, not necessarily because a business believes there are losses on the horizon, critics — including some members of the IAC — say.

The IAC outlined this concern and others in an April letter to the FASB.

While the discussion about the loan loss model took up the bulk of the public meeting, IAC members also discussed the FASB’s future agenda priorities. IAC members concluded that the FASB should prioritize finishing its financial statement performance project and then work on a project to improve companies’ statements of cash flows. IAC members also expressed support for improvements to segment reporting.

Finally, IAC members said they unanimously supported the direction of the FASB’s project to improve hedge accounting. The FASB expects to release a proposal by the end of the year that calls for some simplification to what is generally regarded as one of the most complex subjects within U.S. GAAP. The board wants to produce changes that let businesses better reflect their risk management practices.

“It seems like you’re allowing for more hedging to be included under hedge accounting, but eliminating the potential for manipulation, and allowing companies to account for hedges in concert with how they’re doing business,” said Matt Schechter, a forensic accountant at Balyasny Asset Management. “As a group we approve.”

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