LUTZ BUSINESS INSIGHTS
Loan Losses: It’s Time to Sync the FASB and SEC Guidance
In August, Securities and Exchange Commission (SEC) officials announced plans to update the interpretive guidance for estimating loan loss allowances to reflect the updated credit loss standard. The accounting standard goes into effect in 2020 for public financial institutions.
Changes under U.S. GAAP
Under U.S. Generally Accepted Accounting Principles (GAAP), banks currently measure their loan losses when they become “probable.” In practice, “probable” has meant that the loss has already happened.
In the aftermath of the 2008 financial crisis, investors, regulators and banks said the so-called “incurred loss” accounting caused banks to delay their decisions to book reserves. As the mortgage market deteriorated, bank balance sheets showed inflated values.
So, the Financial Accounting Standards Board (FASB) created the credit loss standard in June 2016 to overhaul how banks and other financial businesses estimate the losses they expect to feel on souring loans and other financial products. Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, requires them to look to the future, make reasonable and supportable estimates that take macroeconomic factors like the housing market or unemployment rates into account, and set aside loan loss reserves based on these estimates.
The standard requires banks to use a current expected credit loss (CECL) model. The model isn’t supposed to estimate a best-case or worst-case scenario. Rather, it takes into account management’s past experiences, future estimates and current trends in the economy, using “best judgment” to record a loss provision. Bank loss reserves are closely followed by investors and regulators because they are an early indicator of trouble brewing in a bank’s financial condition or the broader economy.
Need to update SEC rules
Now it’s the SEC’s turn to modify the loan loss guidance. The SEC is in the early stages of examining the changes it may need to make to Staff Accounting Bulletin (SAB) No. 102, Selected Loan Loss Allowance Methodology and Documentation Issues (SAB Topic 6-L).
The SAB from 2001 expresses the SEC’s views on the development, documentation and application of a systematic method for determining the allowances that are set aside to cover losses on bad leases, securities and other instruments. “Loan loss estimates developed without a disciplined methodology or adequate documentation (of both a disciplined methodology and the resulting amounts of loan loss provisions and allowances) can undermine the credibility of an institution’s financial statements,” the SAB states.
“There’ll be an update to the SAB,” said Sagar Teotia, an SEC deputy chief accountant, at the American Accounting Association’s annual meeting in National Harbor, Md. Teotia provided no further details, but he indicated that some of the “core elements” continue to be relevant.
The FASB’s credit loss standard goes into effect in 2020 and 2021, depending on the size of the financial institution. So, the SEC has more than a year to review its guidance and decide on the necessary changes to better align it with U.S. GAAP.
©2018 THOMSON REUTERS
Many early-retirement Boomers feel comfortable that their estate plan is in order, having put their estate plan in place when they had younger children. With adult children and the increase in the estate and gift tax exemption amounts…read more
Lutz M&A announced that it served as exclusive financial advisor to Fantasy’s, Inc. in connection with its recent acquisition by Casey’s General Stores, Inc. (“Casey’s). Casey’s is a Fortune 500 company (NASDAQ CASY)…read more
Lutz, a Nebraska-based business solutions firm, recently announced a new service line, Family Office Services. Lutz’s Family Office team assists high-net-worth families manage their family enterprise by helping them determine…read more
SIGN UP FOR OUR NEWSLETTERS!
We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.
13616 California Street, Suite 300
Omaha, NE 68154
747 N Burlington Avenue, Suite 401
Hastings, NE 68901
601 P Street, Suite 103
Lincoln, NE 68508
3320 James Road, Suite 100
Grand Island, NE 68803