FASB may need to revise CECL to deal with coronavirus fallout

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The Financial Accounting Standards Board has come under pressure to relax its credit losses standard as banks and other financial institutions see the value of their assets plunging from the sell-off in the capital markets amid the coronavirus pandemic.

The Federal Deposit Insurance Corporation and other federal and state banking regulators issued a joint statement Monday encouraging financial institutions to work “constructively” with borrowers affected by COVID-19 and provided additional information regarding loan modifications.

The agencies are encouraging financial institutions to work with borrowers and said they won’t criticize institutions for doing so in a “safe and sound manner.” The agencies added they won’t direct supervised institutions to automatically categorize loan modifications as troubled debt restructurings, or TDRs. They reiterated that not all modifications of loan terms result in a TDR. “Short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs. This includes short-term — for example, six months — modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.”

The regulators noted that according to U.S. GAAP, a restructuring of a debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies said they have confirmed with the FASB staff that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs. That includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.

Borrowers who are considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. “Working with borrowers that are current on existing loans, either individually or as part of a program for creditworthy borrowers who are experiencing short-term financial or operational problems as a result of COVID-19, generally would not be considered TDRs,” they said. “For modification programs designed to provide temporary relief for current borrowers affected by COVID-19, financial institutions may presume that borrowers that are current on payments are not experiencing financial difficulties at the time of the modification for purposes of determining TDR status, and thus no further TDR analysis is required for each loan modification in the program. Modification or deferral programs mandated by the federal or a state government related to COVID-19 would not be in the scope of ASC 310-40, e.g., a state program that requires all institutions within that state to suspend mortgage payments for a specified period.”

FASB issued a statement Monday in response to the banking regulators’ guidance.

“Earlier today, the federal and state prudential banking regulators issued a joint statement that included guidance on their approach to the accounting for loan modifications in light of the economic impact of the coronavirus pandemic,” FASB stated. “This guidance was developed in consultation with the staff of the FASB who concur with this approach and stand ready to assist stakeholders with any questions they may have during this time.”

While the statement doesn’t refer to FASB’s credit losses standard, typically referred to as CECL for the Current Expected Credit Loss model it uses, it could provide further ammunition for those who think CECL needs to be put aside for now.

“It is clear that the earnings impact of current expected credit loss rules could be a minor disaster for several banks,” wrote former FDIC official Paul Kupiec in an editorial on the political news site The Hill on Monday. “The markets would have trouble differentiating weak banks from strong banks, and these new uncertainties could trigger widespread bank funding difficulties. It is time to use some common sense and suspend the implementation of current expected credit loss standards for at very minimum the next two years.”

Ariste Reno, a managing director of the global consulting firm Protiviti, believes banks will need to carefully assess the economic impact of the coronavirus on various portfolios right up until the March 31 filing date of their quarterly financial statements.

“Given the lack of the prescriptive nature of the CECL guidance, bank regulators and external auditors will be closely scrutinizing the initial CECL estimates in the 3/31 10-Q filings as there will likely be inconsistencies in the CECL approaches used,” she wrote in an email last week to Accounting Today. “As such, I expect regulators will be having urgent discussions with banks, if they think the CECL estimates are not indicative of the risk in various portfolios. It would be wise for banks to consider keeping the old ‘incurred loss’ model estimates in play as part of the CECL financial statement disclosures for two reasons:

1. This would allow for greater comparability of allowance estimates across the entire banking industry on a single more well understood system. 2. It would alleviate investor burden to decipher a massive accounting change while simultaneously trying to assess adequacy of the allowance under the current uncertain economic environment."

“Similar to the situation in the 2008 financial crisis, financial forecast models ‘break’ and are not always well-designed to perform well in volatile economic times where conditions are changing rapidly,” Reno added. “As such, use of ‘qualitative’ adjustments by management may increase in the near term for CECL estimation purposes.”

Jonathan Jacobs, global financial services leader at the financial consulting firm Duff & Phelps, believes CECl will have an impact on banks and other financial institutions if the economy moves into recession territory. “All the banks, all institutions have to be CECL compliant, and have to have CECL reserves as of the first quarter of 2020,” he told Accounting Today. “The banks and financial institutions have a lot more resources on it because their balance sheets are based on financial instruments, specifically banks with loans. The uncertainty with the coronavirus impacts the underlying borrower's credit. There’s a deterioration, and as part of CECL you have to measure the deterioration of credit to put up a reserve, by looking at not only how the loan and the borrower have performed in the past, but given the current economic environment that we are in today, as well as a reasonable supportable forecast of what might happen to the underlying credit quality of the borrower.”

Banks will need to set aside more money for their CECL reserves instead of providing it to borrowers to help spur the economy out of a possible recession.

“In general terms, as you enter into a recession, typically credit quality deteriorates for various reasons, whether it’s high unemployment, higher draws of lines of credit to meet working capital needs,” said Jacobs. “With CECL reserves, even though it might not be on the balance sheet, you still have to have reserves. The credit quality of the underlying borrower typically declines in a recession. Now what we’re seeing here with the coronavirus is it’s just accelerated everything. A month ago, we were projecting there might be a recession next year. The economy is now slowing down at an accelerated pace. That doesn’t mean that the banks aren’t lending money. There’s still liquidity in the system. There’s still lending in the system, but as this natural disaster impacts more and more not only the United states but globally, there’s going to be more of a deterioration in credit, which would increase the CECL reserves. That’s not just on individuals and corporates, but also on sovereign governments as well.”

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