SEC Chief Accountant Schnurr on CECL: Focus on the objective

Sep 18, 2015

James Schnurr, chief accountant for the Securities and Exchange Commission, outlined his thoughts on the FASB’s new credit impairment standard Thursday during the AICPA’s National Conference on Banks and Savings Institutions. According to his prepared remarks, Schnurr advised SEC-registered financial institutions to focus on the objective of the changes – namely, to reflect the credit risk in the portfolio – as they prepare to implement the FASB’s current expected credit loss model, or CECL. He also urged managements to take responsibility for the development, documentation and application of methodologies used to come up with the lifetime expected credit loss estimates. Schnurr noted that his comments, which came during a speech on several accounting issues affecting the financial institution industry, expressed his personal opinions and not those of the SEC.

Portions of his prepared remarks are reprinted below:

“I would like to turn now to a topic that continues to be relevant to the banking industry: accounting for credit impairment. Last year, the IASB released its new credit impairment standard, and the FASB is expected to release its credit impairment standard in the near future. I would like to recognize the efforts made by both boards to respond to constituent feedback following the financial crisis. Both models focus on expected losses and allow for the consideration of a broader range of information in determining credit loss estimates, which are viewed by many to be positive changes from today’s standards.

“I also want to recognize the current steps being taken by both boards to prepare for implementation of their respective standards. The IASB has created a TRG subsequent to the issuance of their standard, and that group has already held an initial meeting that generated important dialogue around some key issues. The FASB has formed its TRG prior to issuance of a final standard to identify and resolve any remaining key issues prior to issuance of the final ASU. Consistent with the efforts being made with respect to revenue recognition, I believe the creation of these TRGs will prove beneficial to the boards, preparers, auditors, investors and regulators, and I am pleased to see these groups have been formed to assist with the implementation of the credit impairment standards.

“While the IASB and FASB standards are not converged in all respects, I believe this is primarily the result of different standard setting processes that address the needs of their respective constituencies. I also believe that it is important to focus on the many key areas of the standards that are converged. Perhaps most significantly, the application of the lifetime expected credit loss measurement is converged in many respects. The proposed FASB standard would require the use of lifetime loss expectations for all loans. While the IASB standard limits the measurement of expected losses on loans with no indication of credit impairment to the next 12 months, lifetime expected credit losses will be recognized for those loans that have experienced a significant increase in credit risk. Under both models, the definition of expected credit losses is an estimate of all contractual cash flows not expected to be collected from a recognized financial asset or group of financial assets. Therefore, while the models are not fully converged, I believe U.S. registrants preparing for the issuance of the FASB’s credit impairment model can learn from the current implementation efforts overseas and leverage some of those thought processes as they begin their implementation process here in the U.S.

“As registrants begin their preparations for implementation of the FASB impairment model, I would like to emphasize the importance of focusing on the objective of the standard, which is to reflect the credit risk inherent in the portfolio. It is expected that the methodologies and assumptions used by various constituents to achieve this objective will vary. As organizations implement the standard, I believe it is appropriate for them to evaluate cost/benefit considerations associated with the variety of different alternatives available to them in achieving the objective of the standard. If different methods achieve the objective of the standard, cost considerations could be a factor in selecting the ultimate methodologies to use. This is consistent with the standard’s overall approach to reducing complexity in determining credit loss estimates.

“While the methodologies and approaches to achieving the objective of the standard are expected to vary, one thing is clear — coming up with lifetime expected credit loss estimates will require significant levels of management judgment. In an area that requires significant judgment, and for which methodologies used are expected to vary, it is critical for management to take responsibility for the processes and controls used to develop their estimates, including robust documentation of their organization’s key accounting policies. The development, documentation, and application of a systematic methodology used to determine credit loss estimates, as well as policies surrounding the validation of such methodologies have always been, and will continue to be, critical in supporting the allowance for loan losses recorded in the financial statements.

“Credit loss provisioning is one area where the mission and priorities of various stakeholders consistently come into play. Therefore, it is important to highlight the tension that may exist between the goals of financial reporting and the desire to satisfy certain prudential regulation objectives. We continue to believe that the goal of financial reporting is to provide investors with credible, transparent, and comparable financial information they can rely on to make sound investment and credit decisions. The decisions made by the FASB and IASB in developing their models were made with these objectives in mind. Prudential regulation, on the other hand, exists to promote safety and soundness objectives. There may be scenarios where a bank’s approach to estimating expected credit losses meets both objectives. However, it is important for preparers to remember that in preparing the financial statements the objective is for management to make its best estimate of the expected loss, which may not reflect the estimate desired for safety and soundness purposes. In those instances, prudential regulators have the mechanisms available to make changes to the regulatory capital regime, similar to how changes in fair value for available for sale securities are currently addressed in the capital regimes.”