The Financial Accounting Standards Board is getting an earful from credit unions and trade associations. Even NCUA Chairman Debbie Matz, like others, is concerned about the accounting board’s exposure draft that would require financial institutions to base loan-loss allocations on expected losses, rather than incurred losses. In addition to requiring complex economic modeling, the standard would also require the allowance for loan and lease losses to cover the entire life of the loan at the time of funding.
Matz wrote in a comment letter that FASB’s proposed credit-loss accounting standard presents safety and soundness concerns for small and medium-sized credit unions. Industry experts estimate the accounting standard could double or even triple current allowances for loan and lease losses.
“I urge the FASB to consider the unintended consequences of enacting financial reporting rules that may unduly impact the financial performance of small and medium-sized credit unions and discourage these institutions from making loans to low-income borrowers, particularly during times of economic distress,” Matz wrote. “Since credit unions were the only federally insured financial institutions to increase lending throughout the recent economic downturn, discouraging credit union lending would negative impact consumers going forward.”
Small and mid-sized credit unions don’t have the resources to perform complex economic analysis at the time of loan underwriting, Matz said. As a result, they would be forced to either hire a third-party consultant or cut back on lending.
“Either choice would result in lower net income and reduced services to consumers, which would threaten the viability of these institutions over the long term,” she wrote.
Instead, Matz suggested the standard include basic, scalable examples for credit unions that are not able to reasonable calculate expected credit losses.
Both NAFCU and CUNA also oppose the proposal.
In her letter, NAFCU Regulatory Affairs Counsel Angela Meyster pointed out to FASB that unlike for-profit entities, the primary reader of credit unions’ financial statements is the NCUA, not individual or institutional investors.
“As such, standards geared toward publicly held entities are often inapplicable or extremely difficult and costly to apply to credit unions,” she said. She added that for credit unions, the cost to conform to the standard would far outweigh any benefit.
CUNA President/CEO Bill Cheney called the proposal “the most critical regulatory concern credit unions have faced in quite some time, including rules or proposals that have been issued under the Dodd-Frank Wall Street Reform and Consumer Protection Act.”
Of the comment letters posted on FASB’s website, 109 of the 333 are from credit unions, and that’s not counting letters from vendors and almost every CUNA-affiliated league.
Most of the letters say the proposed change would consume revenue and capital just as financial institutions are gaining a post-recession foothold. However, credit union financial managers said the proposal creates more problems than a loss of income.
Ronald Kampwerth, chief financial officer at the $1.4 billion Anheuser-Busch Employees Credit Union of 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 that affect 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.
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.
Community banks aren’t crazy about the proposal, either.
James Kendrick, vice president of accounting and capital policy for the Washington-based Independent Community Bankers of America, said small banks also worry about the effect the increased loss allotments would have on their income statements.
Because the ICBA does recognize that the too little, too late impairment standard does need to be changed, Kendrick said ICBA is proposing FASB overlay a forecasted loss reserve in addition to current incurred loss models. The additional reserve would be based upon historical loss rates rather than complex modeling, he said.
At the conclusion of their respective comment periods, both the Financial Standards Accounting Board and the International Accounting Standards Board will engage in additional discussions and deliberations before releasing final credit loss accounting standards, said Robert Stewart, vice president of communication for the Financial Accounting Foundation.
Stewart said both FASB and the IASB will attempt to coverage their differing proposals before issuing final standards. The IASB proposal differs from FASB’s in that the IASB model would record just 12 months’ worth of expected credit losses until significant credit deterioration has occurred, at which point the full loss estimate would be recognized.
While credit unions contributed a sizeable percentage of comment letters, they represent a much smaller percentage of entities that would be affected by the rule. Stewart said the standard setting body considers credit unions to be important constituents, but FASB must also take into consideration feedback from others affected by the standard, as well as input from regulators.