By Soyoung Ho
The FASB is assessing the impact of certain accounting rules in light of the coronavirus pandemic, which is likely to bring about credit crunch without intervention. Among the accounting standards the FASB is reviewing are the credit loss and loan modification rules.
The effort -as of March 20,2020- comes in part as lawmakers in the past several days have introduced legislation that would push back the date when smaller banks have to start applying so-called current expected credit loss (CECL) accounting to their financial statements. And more recently, the Federal Deposit Insurance Corp. (FDIC) sent a letter to the FASB, also urging for a delay.
To slow down the spread of COVID-19—the disease caused by a new strain of the coronavirus— authorities have been restricting people’s movement and gatherings, causing businesses to start laying off their employees in high numbers. Fitch Ratings, Inc. on March 18 said it has revised its outlook for the U.S. banking sector to negative from stable because of concerns over the financial impact from COVID-19.
To try to stave off a looming massive economic turmoil that could rival that of the Great Depression a century ago, Senate Republicans on March 19 introduced a stimulus package that could total $1 trillion. The White House wants the relief bill to be passed as soon as possible.
“The nation’s banking industry is responding to rapidly evolving business conditions that are unprecedented in our history,” FDIC Chairman Jelena McWilliams wrote to the FASB on March 19. “To support the industry’s efforts to focus on their employees and customers, I encourage FASB to take these much needed actions to allow banks to help their communities at this time of need.”
The FDIC also asked the FASB to exclude COVID-19 related loan modifications from being considered a concession when determining a troubled debt restructuring (TDR) classification. McWilliams said that a public statement from the FASB will help encourage banks to work with their customers through this crisis. The FASB’s ASC Topic 310, Receivables: Disclosures about the Credit Quality of Financial Receivables and Allowance for Credit Losses, provides the basis for identifying and treating TDRs as impaired loans when estimating allocations to the allowance for loan and lease losses (ALLL).
“Based on our initial review of the letter, we agree with the need for close coordination with the SEC and banking regulators to address issues associated with loan modifications,” FASB spokesperson Christine Klimek said on March 20. “We’re also continuing to work with financial institutions to understand their specific challenges in implementing the CECL standard.” The SEC, which oversees the FASB, declined to comment.
This is welcome news for the financial industry because banks were opposed to the FASB’s effort to write CECL from the get-go as it will require them to make earlier recognition of their losses on their financial statements under Accounting Standards Update (ASU) No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which the board issued in June 2016. They had complained that it will be too complex and costly to apply. They prefer the old incurred loss model since they can write down losses after borrowers have essentially defaulted on their payments, and in the past few years have lobbied the board to delay the effective date. Large financial institutions that are regulated by the SEC have already begun applying the rule this year. However, after intense lobbying to delay the effective date, the FASB last year granted smaller banks more time to implement CECL from 2021 to 2023.
Even well before the coronavirus outbreak, banks have argued that CECL will have a procyclical effect because it requires businesses to look to the future, make reasonable and supportable estimates, and calculate potential losses on loans and certain securities as soon as they issue them and set aside corresponding loss reserves. Banks claimed that they would have to raise loan loss allowances during economic downturns, and this in turn would make banks curb the amount of money they can lend when customers need it most. This could mean more volatile levels of regulatory capital and an increased level of capital at all times. When banks have to raise capital levels, it means they have less money available to lend to customers and less money to invest, and they had asked for a delay.
“In view of the sudden and significant changes in the economy over just the past several days and the uncertainty of the future economic forecast, banks may face higher-than-anticipated increases in credit loss allowances,” FDIC Chairman McWilliams wrote. “Further, the growing economic uncertainties stemming from the pandemic and rapidly evolving measures to confront these risks make certain allowance assessment factors potentially more speculative and less reliable at this time.”
Credit rating agency Fitch said it had already expected a more challenging operating environment for earnings going into 2020, but the forecasted earnings is well-below what was contemplated last year.
McWilliams asked the FASB to give banks the option to postpone CECL implementation as it will allow them to better focus on lending to households and business, which in turn will support economic recovery. For smaller banks, the FDIC chief asked the FASB to impose a moratorium on the effective date.
“We applaud today’s call by FDIC Chairman McWilliams for FASB to delay required implementation of the CECL accounting standard for financial institutions,” Rob Nichols, president and CEO of the American Bankers Association (ABA) said in a statement. “ABA has long called for delaying CECL until a quantitative impact study can be conducted to better understand how it might impact credit availability during periods of economic stress. With economic stress now here thanks to COVID-19, it is critically important that banks of all sizes have all the tools they need to lend to creditworthy individuals and businesses.”
However, some investors are not likely to support a move that ends up scrapping the credit loss rule altogether. CECL is considered the FASB’s most important response to the 2008 financial crisis. Regulators and investors complained that the delayed recognition of losses in current GAAP made banks’ balance sheets appear healthy even when the mortgage market was collapsing in 2006 and 2007.
“The FASB faces an existential crisis all its own as FDIC Chair Jelena McWilliams requests a delay in implementation of the reviled new loan loss accounting standard,” said Jack Ciesielski, an investment manager who previously wrote The Analyst’s Accounting Observer. “Expect a delay, which will give the banking community a chance to ask for more delays or termination of the standard altogether.”
Updated on March 23: The banking regulators and the FASB on March 22 announced guidance on their approach to the accounting for loan modifications. Story related to this will be available on March 24 in Accounting & Compliance Alert. The FASB has yet to announce its decisions on CECL as of March 23 morning. (Editor’s note-ACA publishes a day after a story is written).
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 March 23, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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