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FASB to Change How Banks Recognize Credit Losses

by Jon Winick
President, Clark St. Capital

FASB to Change How Banks Recognize Credit Losses

While many of you were enjoying your vacations, the Financial Accounting Standard Board (FASB) recently issued new guidance that will fundamentally change how banks recognize credit losses, specifically non-impaired loans. KPMG had a good update on the proposed changes.

The FASB recently issued a proposed Accounting Standards Update (ASU) that would change the way entities recognize credit impairment on financial assets. The FASB’s proposed impairment model is intended to result in more timely recognition of credit losses and provide additional transparency about credit risk. It is based on a single objective that would reflect an entity’s current estimate of contractual cash flows that are not expected to be collected.

The objective here is to make loan losses more forward-thinking than backward-thinking. The current methodology involved looking at 3-5 year time horizon in estimating a bank’s FAS 5 reserve. So, in 2008 while the economy was heading off a cliff, banks had very low FAS 5 reserves since it was based on the previous 3-5 years. Banks currently have a FAS 5 reserve for non-impaired assets, and a FAS 114 reserve for impaired assets. This proposal will not change how impaired assets are treated.

One of the problems is the subjectivity, as FASB copped out and left it to the banks on how to estimate expected credit losses. So, either the Regulators will impose their own standard on everyone, or you are going to have different banks with widely different methodologies.

Many bankers have criticized the proposed rule. Reserving expected losses for the life of the loan (this is not clear yet) could be painful and potentially restrict lending, as banks would then have to take a reserve at day one of origination. The ABA recently had a good summary outlining their position.

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Synovus Directors Can’t Lend

Synovus Financial Corporation settled a shareholder lawsuit over more than $200 million in bad loans to the Georgia luxury resort Sea Island that were approved with a “golf course handshake.”

The bank’s shareholders sued in federal court in Atlanta in 2009 after the real estate market collapsed and tourism declined, damaging Sea Island’s business. The 85-year-old resort filed for bankruptcy the following year. The investors accused current and former Synovus directors and executives of gross mismanagement in their handling of the loans and of making false and misleading statements to investors.

Under the settlement, which was given preliminary approval Jan. 9, the Synovus board will no longer be allowed to approve loans and agreed to adopt other policies to prevent “excessive risk.”

Ouch. If a board can’t participate in the approval of any loans, then you are removing a significant amount of their oversight responsibility. Are shareholders better off that solely the regulators will provide that oversight? It appears that the majority of the board has been replaced, so we’re not sure what investors are winning here.

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