The Financial Accounting Standards Board (FASB) has approved publication of its final standard for writing down bad loans and securities. It’s expected to be finalized by the end of June. The long-awaited guidance is generally considered the FASB’s most important work in response to the 2008 financial crisis. It will require major changes to the way banks and other financial institutions report their financing receivables, held-to-maturity debt securities, contract-based receivables and insurance receivables. But the implementation date has been postponed to give the banking industry time to gather the requisite data.
A need for change
When reporting credit losses, banks must apply an incurred-loss model that’s been in place under U.S. Generally Accepted Accounting Principles (GAAP) since the 1990s. With the existing model, a bank doesn’t record a write-down until after something has triggered it, such as a missed payment by the borrower.
After the mortgage bubble burst, the incurred-loss model was criticized for forcing banks to delay recognition of a devalued financial asset until after markets sold them off. The subsequent appearance of a write-down in a quarterly or annual report came too late to do investors much good and exposed banks to steeper losses at a time when they needed to conserve capital.
Overview of changes
The FASB’s amendments to the existing guidance will fall under Accounting Standards Codification Topic 316, Financial Instruments — Credit Losses. They’re expected to require banks to look to the foreseeable future, consider all losses that could happen over the life of the loan, trade receivable or security in question, and book losses. The new accounting is based on the current expected credit loss (CECL) model, or its shortened form, the expected-loss model, which relies more heavily on estimates of future losses.
The previous draft version of the standard was published in 2012 in Proposed Accounting Standards Update (ASU) No. 2012-260, Financial Instruments — Credit Losses. It was met with significant opposition from banks that were concerned about the costs the new guidance would impose on them and the difficulty they’d face complying with it, including greater scrutiny from auditors and bank examiners.
These concerns have led to ongoing delays and numerous roundtables to discuss the costs and benefits of the revised guidance. Delays are common when the FASB is readying the release of a major standard. In this case, banks are especially resistant due to the increase to loss reserves that would come with the new guidance. Although the FASB refused to issue a revised draft for a new round of public comment, it did fulfill the requests to delay the implementation date by a year.
In addition, the FASB agreed to a handful of limited revisions to the guidance, including changes to 1) the process for estimating the expected losses on a loan or security and 2) the type of information that could be used to develop the estimate. The revised implementation guidance also includes a sample disclosure with a detailed schedule of loans by date of origination, to ease adoption of the guidance by private companies.
The FASB considers the information about the years in which loans are originated, or vintage, to be important for investors who are evaluating a lender’s underwriting standards. But board members differ on the degree of interest that investors in privately held banks have in the information.
The amendments are planned to become effective as early as 2019 for companies that choose early adoption. But public companies won’t be required to apply the changes until fiscal years that begin after December 15, 2019. Private companies will have an extra year to implement the changes.
To help facilitate the implementation processes, the FASB plans to establish a Transition Resource Group (TRG) for credit losses, similar to its TRG for revenue recognition. Your accounting advisors can also help you prepare for this new standard before it goes live in 2020 for public companies and 2021 for private ones.
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