The Financial Accounting Standards Board has proposed an Accounting Standards Update on credit losses that will require every community bank in the country to revise the way they account for their loan loss reserves (ALLL) and the way they account for their securities. Please read the Summary and Questions and Answers below. Also, we encourage you to send a comment letter to FASB (firstname.lastname@example.org) expressing your views on the proposal. A link to a sample letter is provided below. Please use this letter as a guide and customize to your bank’s specific concerns.
- The Office of the Comptroller of the Currency estimates that loan loss reserves on average will increase by 30 – 50% with adoption of the proposed expected credit loss model with the impact on some banks much greater; this radical increase in reserves harms community banks, the local economies they support, and the overall U.S. economy.
- Single approach for recognizing credit losses on loans, securities, and trade receivables
- Establishes an expected credit loss model based on the bank’s own expectations
- Bank estimates “life of instrument” expected credit losses using forward looking information and recognizes the net present value of those losses at origination
- Estimates of loss are maintained based on historical losses for similar assets, current economic conditions, and future management expectations based on forecasts
- Replaces the incurred loss model, which has been criticized as contributing to the recent financial crisis through the delayed loss recognition of expected credit loss events
The proposal front loads the recognition of credit losses—although the proposal shifts recognition of credit losses to an earlier point in the credit cycle when compared with today’s incurred loss model, the day one loss recognition concept creates an immediate day one loss that penalizes community banks for investing in loans and securities.
The proposal requires complex modeling—community bank underwriting is superior because these institutions have tremendous knowledge of the local community, the borrower, and the borrower’s ability to repay a loan based on a historical banking relationship that may stretch over many years. If community banks are required to invest in and maintain complex, dynamic forecasting and modeling tools, the bank’s ability to offer highly tailored financing solutions in the community would be hampered resulting in immediate harm to local economies.
The proposal is expensive—community banks would be required to source various data points about economic conditions and conduct variance analysis on how models differ from actual results over time. At least two projected expected loss scenarios would need to be generated for each loan. Community banks would be required to dedicate valuable resources and money to model selection, testing, production, and maintenance. Coupled with extensive data sourcing, warehousing, and administration, the proposed expected loss model limits the potential for increased loan growth and economic expansion in the local community.
Alternative Proposal for Financial Institutions
- Financial institutions with consolidated assets of $10 billion or less
- Expected losses are recognized ratably over time based on historical loss experience for similar assets starting on day one
- If a subsequent incurred loss event is experienced where a loss is deemed probable, an estimate of loss would be recorded and measured as an additional provision to the expected loss previously recognized
- Easy to implement, straight forward application throughout the credit cycle
- Eliminates the need for proposed complex modeling and is less costly to the bank
- Achieves the same goals as the proposed expected loss model in a practical manner using readily available information