The banking industry rose to the occasion to answer investor questions quickly about potential credit losses on loans during the current economic crisis, a major change from the financial crisis that took place 13 years ago, according to FASB advisory discussions.
The current expected credit loss (CECL) standard worked as intended in generating timely and more detailed information so that investors could quickly understand banks’ assumptions, some analysts on the Financial Accounting Standards Advisory Council (FASAC) told the FASB on Dec. 15, 2020.
“Obviously March came with a bang and the detail was in some cases lacking but by the time we got to June when you look at the competitive environment out there companies did rise to the occasion, providing some of the key metrics that they use to assess what the reserving level should be in CECL life of loan during the pandemic, specifically employment rate, GDP rate,” Elizabeth Graseck, managing director research, at Morgan Stanley said. Her remarks were made to highlight what investors are saying on the topic. “A couple of institutions went a little further than that and put into the Qs, kind of a bull and bear type of language – some with numbers, some without numbers, but at least giving you a sense as to how they think about the best case, the worst case, and the base case,” she said.
The information is important because it helps investors in their assessment of estimates, Graseck said. “Every investor has a point of view, every investor makes assumptions about what the future is going to look like, and they can then take these data points from the companies and put it into their own framework and have a better understanding of how over time the reserving is likely to flow relative to their own expectations,” she said. “So I would say that the industry did step up in providing more detail a function of investor request to help investors understand what is behind the assumptions that go into that reserve accounting, which is obviously so critical.”
The FASB published the standard in 2016 as Accounting Standards Update (ASU) No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, to require companies to provide a more timely report of the losses they expect to incur from soured loans.
The CECL standard was developed in response to the 2007-2008 global financial crisis, after market watchers said prior accounting provisions provided too little information too late to investors about the losses banks in particular expected.
Coincidentally, the rules took effect on Jan. 1, 2020, just three months before the COVID-19 pandemic began, which sparked another economic crisis that is still ongoing. Smaller public companies, private companies, and not-for-profit organizations have until 2023 to apply the changes.
“The banks have done a really good job about coming up with more data to help analysts this time,” Avi Berg, formerly with Elm Ridge Capital Management, said during the meeting. “I think probably the difference between this time with the banks is just how troubled the company is. So back in 2007 and 2008 the banks were in a lot more trouble than they are today,” he said. “It’s a lot easier and more comfortable for companies to come up with more information that’s helpful to users when there isn’t an event that might put them under.”
Earlier this year legislation was passed under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, to provide an option for banks and other companies to defer adoption of the CECL standard this year. The largest public banks however did not take the option, deciding instead to adopt the rules at the effective date. A little over 40 smaller banks took the CARES Act deferral.
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