CECL Comes Under Fire at House Subcommittee Hearing

The current expected credit loss model, or CECL, had few fans during a Congressional subcommittee hearing Dec. 11, when bankers, Congressmen, and investors all called for the accounting standard to be changed, delayed or scrapped altogether.

Three of the four witnesses providing live testimony before a House subcommittee hearing to assess CECL’s impact on financial institutions and the economy told lawmakers that booking expected losses from day one of loans would ultimately make it harder for homeowners, small businesses and farmers to get loans, especially during tougher economic times. Banks under CECL would have less incentive to make longer-term loans and loans to those with nonprime credit, since they would have to book expected losses long before they could recognize any expected interest earnings that might be higher due to the riskier nature of the loans. That disincentive, witnesses said, would exacerbate any recession and undermine financial stability.

“Had CECL been in place during the financial crisis, we estimate that banks’ capital ratios would have been 1½ percentage points lower in the third quarter of 2008,” said Bill Nelson, chief economist of the Bank Policy Institute. “Those lower capital ratios would have reduced bank credit supply in the crisis by an additional 9 percent, significantly worsening the recession.”

Capital One Financial Corp. CFO Scott Blackley agreed that CECL would constrain lending at the worst time possible, saying, “My view would be the best course of action would be to eliminate CECL.”

Calls for cost-benefit study

In written testimony, the American Bankers Association called for a delay until a quantitative impact study could be completed that assesses the impacts of shifts in pricing and availability of credit to consumers and commercial borrowers.

Only Moody’s Analytics Chief Economist Mark Zandi spoke favorably of CECL, noting that while the banking industry has “reasonable concerns,” adoption “will lead to a stronger, safer financial economy.” Zandi noted that the U.S. is behind other countries when it comes to recognizing expected credit losses. “We’re not leading the way on this accounting change; the rest of the world is,” he said.

The International Accounting Standard Board’s International Financial Reporting Standard IFRS 9 also incorporates forward-looking models for estimating credit losses and was implemented by financial institutions with annual periods beginning on or after Jan. 1, 2018. CECL goes into effect for financial institutions with annual periods beginning after Dec. 15, 2019 for SEC filers and periods after Dec. 15, 2021 for non-public business entities (PBEs).

House Financial Services Committee member Rep. Brad Sherman, D-CA, who is a CPA but not a member of the hearing subcommittee, was among several lawmakers who spoke in favor of FASB providing more quantitative cost-benefit analyses before implementing CECL. “You don’t recognize the profit [from a loan] on day one, you shouldn’t recognize the loss on day one,” he said. If more loan-loss reserves were necessary, he added, “You’d think the bank regulators would decide you need to allocate more reserves.”

Several speakers during the hearing said they didn’t believe FASB had provided a cost-benefit analysis, but FASB tweeted a link during the hearing to its June 2016 report, “Understanding Costs and Benefits” for CECL. In an email, FASB spokeswoman Christine Klimek was asked if the board had any plans to do additional cost-benefit analyses, given concerns about the adequacy of its previous study. She responded:

“The FASB undertook the credit losses (CECL) project a decade ago because many stakeholders—including regulators and banks—recognized there was a misalignment between accounting and credit risk that resulted in delayed recognition of expected losses. The financial crisis of 2008 underscored that misalignment between accounting and risk.

The goal of high-quality accounting standards is to provide investors and others the most accurate information about a firm’s economic transactions. We believe transparent information has the best long-term economic effects because it allows capital market players to make better-informed decisions.

To develop CECL, the FASB conducted a rigorous process of extensive stakeholder outreach and analysis. That process was described in the final standard, and included a detailed cost/benefit analysis. Furthermore, the FASB has continued that process since issuing the final standard–including the creation of a Transition Resource Group (TRG) whose members include financial institutions of varying sizes.”

Subcommitee Chairman Blaine Luetkemeyer, R-MO, said he found it worrisome that the FASB seemed most interested in helping investors have good information about banks, yet only about 200 of the nation’s 5,200 banks are publicly traded. Additional costs to consumers are also a concern, he said. “Either they’re going to pay a whole lot more for this or they’re going to do without services,” he said.

Proposals under review

Klimek said the FASB staff is researching the proposal that banks have asked it to consider regarding changing the way CECL’s impacts are recorded in financial statements. Under the proposal by 21 regional and larger banks in a Nov. 5, letter, provisions for loss expectations within the first year would be recorded in the income statement, while loss expectations beyond the first year would be recorded to Accumulated Other Comprehensive Income. Lifetime credit losses for impaired financial assets would be recognized entirely in earnings. Klimek said the FASB plans to discuss the results of that research at a public meeting late in the first quarter.

As Sherman noted early in the subcommittee hearing, Congress has little formal power over the FASB, but lawmakers repeatedly expressed concern about the impact of CECL.

“Mr. Chairman, I think we ‘ve got an opportunity to be able to address something that’s going to be regulatory overreach, and I hope this arena’s going to be able to highlight the real impact this is going to have on the financial institutions but ultimately on the moms and dads who are trying to be able to provide for their families at home and to be able to build those small businesses,” said Rep. Scott Tipton, R-CO.

And as bankers await the FASB meeting in the first quarter, the Treasury’s Financial Stability Oversight Council, which might actually have some sway with FASB to delay or change the standard, will discuss CECL at a meeting on Dec. 19.

The Bank Policy Institute, on behalf of its member banks, in October asked Treasury Secretary Steven Mnuchin and the Oversight Council, which is tasked with identifying risk in the financial system, to review the systemic and economic risks posed by CECL. They sought a delay for CECL in the meantime.