The Financial Accounting Standards Board is getting an earful from credit unions concerned about its proposal that would require financial institutions to base loan loss allocations on expected losses, rather than incurred losses.
Sixty-two of the 153 comment letters posted on FASB’s site are from credit unions – and that’s not counting letters from credit union trade associations and vendors.
Most of the letters report that the proposed change would require credit unions to double or even triple current Allowance for Loan and Lease Losses, eating up revenue and capital just as financial institutions are gaining a post-recession foothold.
However, credit union financial managers said the proposed accounting change presents more problems than a loss of income.
Ronald Kampwerth, chief financial officer at the $1.4 billion Anheuser-Busch Employees Credit Union in St. Louis, acknowledged that given the severity of the financial crisis, the range of information considered when allocating for loan losses has broadened and will continue to expand.
“My Board of Directors requires it, my external auditors require it, my regulators require it, and I require it,” wrote the former Big 8 accounting firm CPA.
However, Kampwerth objected to the proposal’s requirement to include forecasts on the expected collectability of asset cash flows.
“We need to leave economists, or our attempts at being economists, out of this determination of future credit losses,” he said.
Marva Frazier, president/CEO of the $12 million Linkage Credit Union of Waco, Texas, said attempting to predict future credit losses over the life of a loan would not only be difficult, it could possibly lead to balance sheet volatility.
“Predicting the future is subjective and predicting cash flow that you do not expect to collect is unjustified,” she said.
“You can have a room full of economists and they will not agree with each other on financial outcome. This crystal ball approach is disturbing and defending our calculations to regulators would be in the mystic realm.”
Peter Putnam, chief financial officer of the $716 million Credit Union of Southern California, pointed out in his comment letter that the proposal violates the Matching Principle, a cornerstone of accrual accounting.
The Brea, Calif.-based CFO explained that the Matching Principle requires expenses to be recorded in the same period as the revenues that relate to those expenses. By requiring expected future loan losses to be recorded immediately, the proposal violates that principle.
“This occurs because the interest income from the loan portfolio will be recognized over the life of the portfolio, while the credit losses will be recognized immediately,” he said.
Additionally, requiring provisioning of loan losses for losses that may or may not occur in the future also violates accrual accounting, he said.
The FASB’s rationale for requiring institutions to allocate more funds toward loan losses is to better protect against the losses that occurred after the financial crisis. However, Kampwerth pointed out that financial regulators already require additional reserves to cover for unexpected losses: it’s called capital.
“These reserves … are specifically set by the respective regulatory body and are constantly monitored for appropriateness,” the ABFCU CFO said.
Kampwerth added that credit unions typically consider the NCUA’s 7% net worth requirement as a minimum, and determine an ideal capital level by considering additional risks involving unknown credit risk, interest rate risk, liquidity risk, and other business risks.
Thomas Graham, president/CEO of the $1 billion System United Corporate FCU, suggested a three-part alternate proposal from his wholesale institution perspective. The Broomfield, Colo.-based Graham encouraged the FASB to:
- Establish the same accounting principles for the loan level as the security level, when the security is collateralized by those loans;
- Reintroduce an allowance type account change for Other Than Temporary Impairment on securities collateralized by loans; and
- Drop the requirement to guess about future losses that are based on factors other than historical performance.
Comment letters for the FASB proposal are due to the accounting standards body Friday.