Banking & Finance Expertise

Banks Look to Lessen Credit Loss Standard’s Effect on Regulatory Capital

Banks Look to Lessen Credit Loss Standard’s Effect on Regulatory Capital

Topic(s): FASB, GAAP, Financial Reporting, Disclosure, Specialized Industries, Regulated
Industries, Risk, Debt, Equity, Derivatives, Financial Management

Summary: Banks want federal banking regulators to make it easier to adopt the FASB’s credit loss
standard. Some banks think the standard as it is currently written does not accurately reflect how they
manage their loan portfolios, and they believe more time is needed to study the standard’s effects
before it can be properly implemented.

Bank regulators in April issued a proposal to ease the regulatory capital impact of the biggest bank
accounting change in decades. It is not enough, banks and trade groups are telling regulators.

In letters to the Federal Reserve, Federal Deposit Insurance Corp., and the Office of the Comptroller of
the Currency, banks and trade groups say regulators need to lessen the capital blow of implementing the
FASB’s new accounting standard beyond what the regulators offered in Regulatory Capital Rules:
Implementation and Transition of the Current Expected Credit Losses Methodology for Allowances and
Related Adjustments to the Regulatory Capital Rules and Conforming Amendments to Other
Regulations. The proposal allows banks the option to phase in, over a period of three years, the adverse
effects on regulatory capital banks expect to feel when they adopt the FASB’s new accounting standard,
published in June 2016 as Accounting Standards Update (ASU) No. 2016-13 , Financial Instruments –
Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard goes
into effect in 2020 or 2021, depending on the size of the financial institution.

The American Bankers Association, the Independent Community Bankers Association, and several
individual banks want the regulators to consider changing its proposal from a three-year phase in to a
period of five years.

“The longer the better,” said James Kendrick, first vice president of accounting and capital policy at the
Independent Community Bankers of America. “The more time you’ve got there to make the transition,
the better off all the institutions will be.”

Some banks asked the regulators to go a step further, asking them make the FASB consider changes to
the accounting standard itself. The American Bankers Association (ABA), asked regulators to analyze
the standard’s effect on capital before allowing it to be implemented.

The credit losses standard “is inconsistent with the economics of lending, and therefore will not provide
financial statement users with decision-useful information,” wrote BB&T Corp. in a letter that asked the
regulators to delay the standard’s implementation until a full study of its economic effect can be
conducted. In addition, the Winston-Salem, North Carolina, banking company asked regulators to have
the FASB consider breaking up loan loss estimates into two components: an estimate of expected
losses over the next 12 months and a second estimate of the expected losses over the contractual term
of the underlying financial instruments. KeyCorp of Cleveland called for a similar change.

The FASB’s credit loss standard requires banks and other businesses to look to the foreseeable future,
consider the losses that could happen over the life of a loan, trade receivable, or security, and set aside
reserves to cover the losses. The new accounting attempts to address criticisms that the incurred-loss
standard that is being replaced resulted in a delayed recognition of the losses on bad loans and
declining securities that came too late in the credit cycle. By the time the banks submitted quarterly
filings to the SEC that recognized the write-downs, their stocks and the instruments that were trading on
the open market had lost value because the banks were stuck with so many devalued instruments on
their balance sheets.

The comment period ended on July 13, 2018, and the FDIC, Fed, and OCC declined to comment on
how they might act on the banks’ requests for a longer phase-in. The regulators said they were
reviewing the banks’ comments.

The breadth of the requests, however, underscores the significance of the FASB’s new accounting
requirements as well as the changes – and work – banks expect to make to comply with the new

Michael Gullette, an ABA vice president, said the group’s request for a longer phase-in time was
secondary to its call for more guidance from regulators on how to comply with the FASB’s current
expected credit loss (CECL) accounting model.

“The calculations are easy – X times Y,” Gullette said. “It’s all the other analysis that needs to be done so
you don’t look really stupid in a board meeting, or someone comes to you and says, ‘That other bank is a
lot lower than you, or why are you so high?’ You need to have an understanding of that.”

In addition, the provisions of the credit loss standard overlap with other, post-crisis reforms that have
shored up bank loss buffers already, he said.

A FASB spokesperson said the board has met regularly with bankers and regulators to answer
questions after ASU No. 2016-13 was published.

“We will continue to work with both regulators and banking institutions to ensure a smooth and effective
implementation of the standard, and stand ready to answer any questions as they arise,” the
spokesperson wrote in an email to Accounting & Compliance Alert.

The FASB took the better part of a decade to publish the credit loss standard, which is considered the
board’s most important work to emerge from the 2008 financial crisis. The odds of the standard-setter
revising the standard at this late hour are slim.

“I really highly doubt it,” said Stephen Masterson, BDO USA LLP managing director and national leader
of the firm’s U.S. Financial Institutions Advisory Services practice. “It would be rare for them to reopen
something after so many years went into this and so much analysis.”

Banks’ common equity tier one capital ratio is the key ratio used as a measure of a bank’s financial
strength. The capital is reduced when reserves are set aside to cover losses on loans and other

The FASB’s new credit loss model requires banks to make new calculations to determine their loan loss
allowances, which most banks expect to increase under the new accounting.
“The expectation is that once we implement CECL, if our allowance was 100 today, under the new
model it may become 110 or 120 or 130,” Masterson said. “And once you deduct that from capital, it’s
going to have huge impact on your ratios.”


Read the PDF of Masterson in Reuters