Having a single credit loss standard for all financial institutions makes sense.
The Financial Accounting Standards Board’s current expected credit losses methodology, the new forward-looking, credit-loss accounting standard triggered by the Great Recession, will filter down to credit unions by June 2023, reports CU attorney Michael Edwards, based in Upper Marlboro, Maryland.
Two major accounting problems that arose during the financial crises of the Great Recession helped spur the new standard, according to Edwards:
- mark-to-market accounting rules that did not look at the economic fundamentals of bonds, and
- some market participants delaying the recognition of unrealized losses because those losses had arguably not yet been “incurred,” even though they were probable to occur.
“When senior tranches of mortgage-backed securities backed by complicated mortgage securitizations were current on their payments to the senior-tranche holders but had a mark-to-market value approaching 10 cents on the dollar, something had to give,” he says. “Arguably, misleading securities disclosures given by large publicly-traded banks during this period, as well as the failures of Bear Sterns and Lehman Brothers—both investment banks regulated by the Securities and Exchange Commission—also played a role in FASB’s development of CECL,” he explains.
CECL, adopted in final form in 2016, takes a more forward-looking valuation based on discounted future cash flows, Edwards explains, presumably more aligned with economic fundamentals. It will be required for CU financial statements for fiscal years beginning after Dec. 15, 2022.
Single Standard Can Be Smart
Having a single credit-loss accounting standard for banks and credit unions is smart, Edwards thinks. He recalls when, during the S&L crisis, the Federal Home Loan Banks board and the Federal Savings and Loan Insurance Corporation tried to substitute regulatory accounting principles for generally accepted accounting principles to delay loss recognition at S&Ls, in part because their insurance fund was too cash-poor to handle further losses.
“Word got around that S&Ls were using funny accounting rules, and confidence in the FSLIC and S&Ls in general went down,” he recalls. “One common standard is a good idea.”
It spurs a personal recollection: “When I worked for World Council of Credit Unions,” he says, “there were similar concerns in Ireland about 10 years ago because of public comments made by government officials regarding the credit unions using a loan-loss recognition RAP. Those concerns about the Irish credit unions’ accounting were unfounded—the credit unions were solvent even though the Irish commercial banks basically had failed. But I remember that my taxi driver in Dublin was very concerned about the credit unions possibly having dodgy accounting, and I had to talk him down.”
CECL Trouble Spot
The problem with CECL, Edwards notes, is its interplay with Section 216 of the 1934 Federal Credit Union Act, which defines credit unions’ net worth based on U.S. generally accepted accounting principles. As a U.S. GAAP standard, CECL will require credit unions to write off part of their retained earnings, which will reduce their net worth ratios, even though they will not have incurred new losses. The amount of the net worth reductions will vary from credit union to credit union, he notes.
The change means that the set-aside funds would no longer count as net worth, even though they will still be in a reserve, he points out. For some CUs, implementing CECL under the Federal Credit Union Act could in theory result in a 1% or greater reduction in net worth, something the industry is trying to avoid, he says.
Amending Section 216 of FCUA to allow the unallocated portions of a federally insured credit union’s allowance for loan and lease losses to qualify as net worth would be the best solution, according to Edwards. Without that legislative solution, “NCUA’s final rule on CECL phase-in will allow credit unions to spread out the impact of CECL over three years by accruing the ‘Day 1’ reduction in the credit union’s asset value stemming from CECL as a capital item that will be straight-line depreciated over three years.
“This means that CECL’s Year 1 impact should be negligible in 2023,” he notes. “It would have a 33% impact in 2024, a 67% impact in 2025, and by be fully phased in by 2026,” he concludes.
Richard H. Gamble writes from Grand Junction, Colorado.