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Accounting & Disclosure

New FASB Guidance Leaves Lenders at a Loss

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November 28, 2018

Banks protest FASB change that could impact corporate and consumer loans

Falling dollarSeveral banking trade groups have sent Steven Mnuchin, US Secretary of the Treasury, letters requesting that a new accounting standard changing how banks calculate loan-loss reserves be delayed for further analysis, given its potentially detrimental impact on bank lending. The Financial Accounting Standards Board’s current expected credit loss (CECL) guidance, if unchanged, will likely affect large corporate loans, especially in certain industries.

CECL becomes effective December 15, 2019, requiring lenders to recognize upfront the expected credit losses over the life of the loan. That’s more than a year away, but the banking associations—the Bank Policy Institute (BPI), American Bankers Association (ABA) and Mortgage Bankers Association (MBA)—want implementation of the accounting to be delayed.

The organizations each recently sent letters, signed by numerous major banks as well as all 50 state banking associations, to Mr. Mnuchin. The letters requested that the Financial Stability and Oversight Council (FSOC), established under the Dodd-Frank Act to identify and monitor excessive risks to the US financial system, analyze in greater detail CECL’s impact.

The banking organizations argue that despite CECL’s goal of reducing “pro-cyclicality,” when banks increase loan allowances during times of stress, it’s more likely to increase that tendency since it requires lenders to recognize a loan’s potential credit losses upfront. Currently, banks apply the incurred loss methodology, which delays recognition of credit losses until they become probable.

“As a result, CECL creates a significant disincentive to lend during an economic downturn, as each incremental loan originated will require an upfront charge to earnings and therefore be immediately dilutive to capital…,” the BPI says in its letter.

Such an outcome is likely to impact all borrowers, especially those seeking longer-maturity loans, like consumers seeking mortgages or auto loans. Large commercial credits tend to have comparatively short tenors and will therefore be affected less, but corporates should nevertheless expect a more challenging borrowing environment, especially in certain industries.

A recent presentation to investors by BB&T’s chief financial officer included an analysis showing that the bank’s CECL loan-loss estimates for commercial loans would be 19% higher in stressed economic conditions than under the current method. CECL estimates for residential mortgages and other consumer loans would see much greater increases, at respectively 348% and 91%.

Michael Gullette, senior vice president of accounting and tax at the ABA, said that commercial loans should experience less impact than other types of bank loans because of their shorter maturities, reducing expected losses. Nevertheless, companies looking for new loans or to refinance existing ones may “see higher pricing and/or shorter maturities,” he said, and they may be wise to question their bankers sooner rather than later about the likely impact should CECL remain unchanged. In addition, he said, noninvestment-grade credits are likely to see greater volatility.

Since lenders will have to reserve upfront for expected credit losses over the life of their loans, the loans with the longest maturities and/or least creditworthy borrowers will require the most capital to be set aside. That explains the much greater CECL loan-loss estimates BB&T anticipates for mortgages and consumer loans—reductions in bank capital that would almost certainly curtail lending in those markets. As a result, the accounting change’s biggest impact may be on corporates whose businesses touch housing, automobiles and other industries that experience a credit crunch.

“MBA believes that the requirements of the CECL standard, which is effective for SEC registrants in 2020, and for all other companies in 2021, will adversely impact the availability, structure and price of credit,” the trade association says in its letter, adding, “with a larger proportion of such impact landing on longer-term loans, such as 30-year single-family residential mortgages, commercial and multifamily mortgages, student and business loans.

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