In October 2008, the U.S. Financial AccountingStandards Board and the International Accounting Standards Boardestablished the Financial Crisis Advisory Group as part of a jointapproach to address the credit-loss reporting issues arising fromthe global financial crisis and an ongoing effort to unify U.S. andinternational standards.  In July 2009, the FCAG publisheda report, recommending alternatives to the incurred loss model thatwould use more forward-looking information. After working onseparate models to address the FCAG recommendations, FASB and IASBpublished a joint proposal known as the three-bucket impairmentmodel in 2011.

In July 2012, FASB began to express concerns about thecomplexity of the three-bucket approach, leading it to propose andissue for public comment “current expected credit-losses model.” InMarch 2013, the IASB responded by introducing its own “creditdeterioration model.”

FASB's CECL model has ­several distinguishing characteristicsfrom previous guidance.

This model incorporates debt securities under the same modelrather than under the current other than temporary impairmentmodel. Current GAAP guidance requires the use of past and presentevents, but the new guidance would require an institution toutilize future information and supportable forecasts to estimatethe allowance. Currently, a financial institution is not requiredto record a loss until a loss on the asset is deemed to be“probable and estimable.” CECL requires that an institutionforegoes the worst-case or best-case scenario and instead evaluatesthe possibility that a loss exists or that it does not. It alsorequires the institution to estimate losses over the lifetime ofthe loan for all loans, thus expanding loss horizons used forestimating an allowance for its nonimpaired loans and causing theallowance for nonimpaired assets to rise from current levels.

The proposed guidance clarifies and updates the definition of acollateral-dependent asset, which could expand the scope of assetsevaluated under this method.

Generally, allowance levels would likely rise with theimplementation of this model, since institutions will now have toconsider all losses that a loan will incur during its lifetime fromday one. Many experts believe that the ALLL could increase by 10%to 50%, according to a survey conducted by SNL Financial. Theactual amount will vary and will likely be determined by aninstitution's portfolio composition, current methodology, forecastsof future events and other factors.

IASB's credit deterioration model builds upon the three-bucketexpected credit-loss model, identifying three different stages thatreflect the general pattern of the deterioration of a financialinstrument that ultimately defaults. The differences in accountingfor each stage relate to the recognition of expected credit lossesand, for financial assets, the calculation and presentation ofinterest revenue.

 All entities holding financial assets and commitmentsto extend credit would be affected by this proposal, with the modelapplying to loans, debt securities and trade receivables, as wellas lease receivables, irrevocable loan commitments and financialguarantee contracts.

The credit deterioration model would likely cause allowancelevels to rise, albeit less than the CECL model. CECL projectsexpected losses over the life of all loans, whereas the creditdeterioration model only calls for a projection of 12 months forthose loans that have not shown evidence of credit deteriorationsince origination and would still look at life of loan for thosethat have. Essentially, it is the loans that you're allowed to onlyproject out 12 months, as opposed to life, that make the differencein expected reserve amounts between the two models.

Both models would require forward-looking requirements andimmediate write-offs. The CECL model offers some improveddefinitions and clear guidance on PCI financial assets, but itoffers little clarity on how to calculate future expected losses,and it carries the potential for large, immediate allowance levelincreases. IASB's model, on the other hand, would not requirelifetime losses for pass-rated loans, but like the CECL, it offersno clarity on how to calculate future expected losses, and there'ssome ambiguity surrounding it's stage 2 classification.

Since 2002, the intentions of the FASB and the IASB have been toultimately align on all standards of accounting and financialreporting. Instead, the current divergence suggests that the FASBpath to align with the IASB will mirror the U.S.'s path to alignits system of measurement with the metric system prevalentthroughout the rest of the world. It's a great idea, but it may bedifficult to achieve as long as we lack any true driving force tomake the goal a requirement. It may very well take the precipice ofanother financial crisis to drive the FASB to reconverge with theIASB.

Assuming the two proposals are not modified into one,implementation from the FASB would start with a release of finalguidance, which could be anytime from late third-quarter 2013 tosecond-quarter 2014. Implementation requirements would likely bestaggered, with the first financial institutions required toimplement as early as first quarter 2015. The tiers would likely bebased on either asset size or public vs. private entity or acombination of the two. With a tiered timeline, completeimplementation could take until first half of 2017.

Regan Camp is a senior risk management consultant at Sageworks.Contact 919-851-7474 ext. 532 [email protected]