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Big Banks Tout Flexibility of Credit Loss Rules But Investors Hate the Resulting Volatility

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

Denise Lugo  Editor, Accounting and Compliance Alert

· 5 minute read

Large banks found the FASB’s credit loss accounting rules sufficiently flexible to adopt amid the COVID-19 pandemic last year, but investors saw a lot of volatility in their income statements that made them skittish, according to a roundtable hosted by the board on May 20, 2021.

The current expected credit loss (CECL) model allowed banks to build reserves faster, but then banks quickly pivoted and reduced the reserves, which perplexed investors, Joseph Stieven, CEO of Stieven Capital Advisors, said.

Banks reduced their reserves “literally six to nine months after they’ve built these reserves – and I guess I’m questioning ‘is that really good information to be coming through the income statement for investors,’” he said.

Disclosures companies provided in general have been healthy, but some disclosures complicated matters, analysts also said. Frustrating was the quality of the information provided because it lacked consistency across different institutions and did not always provide the desired level of detail, UBS analyst Saul Martinez said.

Overall, financial statement preparers’ views differed from analysts – believing the rules were flexible and worked well and as intended.

One of the biggest issues banks faced was no one contemplated having to adopt CECL amid the proportion of the COVID-19 pandemic, and so banks had to rerun their models to provide management adjustments to contemplate the additional severity of the crisis, Linda Bergen, director of corporate accounting policy at Citigroup Inc., said.

In response to the volatility that the analysts mentioned, Bergen said that is what CECL is designed to do – i.e. a bank builds its model based upon what it sees today and as its outlook changes, its reserve changes.

“No one knew how long it would take to put a new vaccine into effect and whether or not those vaccines would work in bringing down the infection rates – no one knew how long the stimulus programs were going to continue, so there was lots of uncertainty and the models reflect that and I think they reflect that pretty widely across all the big banks,” she said.

Bergen said that banks reacted similarly though maybe not with the exact same numbers. “All banks are different, their models therefore are different, their portfolios are different,” she said.

The panel discussions, which comprised of preparers, auditors, investors, were part of the FASB’s efforts to do a post-implementation review of the standard, issued as Accounting Standards Update (ASU) No. 2016-13Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, in 2016.

The rules took effect in 2020 for large public companies and will take effect in 2023 for all other companies and organizations. The standard was developed in response to the 2008 credit crisis to require a more timely report of losses banks and others expect to incur from soured loans.

Kudos from Auditors, Regulators

Auditors and regulators also gave the CECL rules the thumbs up, viewing the standard as an improvement from prior rules that helped banks recognize credit losses quickly amid an unprecedented crisis.

“Everyone recognizes what a tough year 2020 was, it was a tough year of volatility and uncertainty, and given everything everyone had to deal with, I think everyone should feel good – to the preparers and practitioners – being able to successfully navigate all the challenges and implement CECL in such a tough year,” Lara Lylozian, an assistant chief accountant at the Federal Reserve, said.

Lylozian said the Fed is currently still learning about and monitoring CECL implementation efforts and its impact on financial institutions.

Overall CECL is an improvement to the old incurred loss model, the discussions indicated.

“We’re seeing that CECL generally results in the recognition of credit losses, sooner, which actually surprised me a little bit,” Jeffrey Geer, associate chief accountant at the Office of the Comptroller of the Currency, said. “The new standard is doing exactly what it’s designed to do.”

U.S. Banks Moved Quicker Than Those Overseas

When compared with banks overseas, U.S. banks provided more detailed disclosures about expected credit losses, and they more quickly built loss reserves and did so more responsibly than their international counterparts that used IFRS 9Financial Institutions, a global analyst said.

Implementing international financial reporting standards (IFRS) can be influenced by a particular country and regulators, Louis Lau, senior financial analyst at Brandes Investment Partners, said.

“For example for the French banks, they have a universal banking model so they’re a little bit slower to build reserves so we didn’t see that go up fast,” Lau said. “They and the U.K. banks are both implementing IFRS 9. The U.K. banks still reserve much faster because of the influence of the Bank of England and the FSA, so even within IFRS 9 there are differences in the speed of response, depending on the influence of the country regulator,” he said. “So accounting standards are one thing, but you also have to look at the culture of reserving in each particular country.”

For in-depth analysis of the FASB’s guidance for credit losses, please see Catalyst: US GAAP—Financial Instruments-Impairment, also on Checkpoint.

Additional analysis of the credit loss standard can be found at Accounting and Auditing Update Service[AAUS] No. 2016-29 and SEC Accounting and Reporting Update Service[SARU] No. 2016-34 (July 2016): Special Report: Accounting for Credit Losses on Certain Financial Assets—An Explanation and Analysis of Accounting Standards Update No. 2016-13.


This article originally appeared in the May 21, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.

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