Remarks of FASB Member Hal Schroeder
Bloomberg Tax/Deloitte "Financial Instruments: The Way Forward" Conference
Washington, DC
May 7, 2019

I’ll start with the standard disclosure . . . official positions of the FASB are reached only after extensive due process and deliberations.  In other words, what I am about to say are my views and only my views.

With that in mind, I’ll make a few observations about the FASB’s new standard that deals with accounting for expected credit losses—better known simply as “CECL.”

Back on March 14th—for math lovers, it was Pi Day—I tuned into [a non-Bloomberg business channel].  One of the guests that morning was Mike Mayo, a well-known bank analyst.

He has a reputation for being a bit negative toward investing in bank stocks.  In fact, he was bearish on the sector for 17 years!

Mike also has set up meetings for me to talk with investors about CECL. Having sat through those meetings, I know he’s heard a wide range of perspectives.

So, I couldn’t resist needling him with the following tongue-in-cheek email:

Mike,
I heard your comments on [non-Bloomberg business channel] this morning, but I was shocked at your recommendation to buy banks.  Haven’t you heard that CECL is going to ruin the economy and stop all banks from lending!!!?  Therefore, how could you be recommending banks with less than 10 months to such impending devastation?

Happy Pi Day,
Hal

Why do I tell this story? Because reports of CECL’s destructiveness have been greatly exaggerated.

In fact, I strongly believe that CECL achieves the FASB’s mission.  That is, to provide investors and other users with better decision-useful information.  In turn, better information should contribute to improved pricing and capital allocation decisions.  And, by extension, a safer financial system and a more resilient economy.

I say this because—before I became a member of the FASB—I spent over 30 years auditing, advising, and investing in banks.  I witnessed the effects of five U.S. recessions and a collapse of the U.S. savings & loan industry; as well as the collapse of banking systems in other countries, including Mexico and Japan. 

I’ve seen the devastating effects those events have had on friends and on communities.  Both at home and abroad.  

When recessions hit:  Businesses close.  Workers lose their jobs.  Families lose their homes.  It’s not a pretty picture.

While at the same time, others have prospered . . . including some investors like myself.  That’s because we saw trouble brewing—no thanks to current GAAP.  If you have any doubt, consider that during virtually the entire crisis, “the market” valued banks well below GAAP-based book value.  In other words, investors were ignoring GAAP numbers.  Specifically, the loan loss reserves!

So, how did the FASB respond? Over the past decade, Board members and staff have met with hundreds of financial statement users, auditors, and regulators—and of course companies, both financials and nonfinancials.  

From the beginning, most agreed that GAAP’s “incurred loss” model was a problem.  The following excerpt from a 2009 speech by then-Comptroller of the Currency John C. Dugan captures the consensus view:
 
“As painful as it may be, timely provisioning to the reserve now is critical to staying ahead of losses that are plainly projected to rise; failing to do so would only make future problems much worse.”1

Input such as this led the FASB to develop the new CECL standard.  Please keep in mind:
  • CECL does not change the total amount of losses recorded . . . just the timing.
  • CECL alone won’t prevent a recession . . . no accounting can do that!
    • But CECL will provide “the market” with important early warning indicators about changes in credit risk.
And, based on the collective input from a wide range of stakeholders, we sought to develop an accounting model that’s scalable, operable, and can be successfully implemented by entities of all sizes.  One recent example:  a “FASB staff Q&A” about using WARM . . . an estimation method already familiar to many smaller financial institutions.

As the FASB continues to monitor implementation efforts, what have we heard? Some very positive developments including widespread improvement of  data quality, internal controls, and estimation processes.

We’ve also heard a chorus of concerns . . . from some . . . about how small banks can’t afford to implement CECL because it’s too costly and too complex.  Those concerns are largely based on misinformation provided by third parties . . . perhaps unintentionally.  To be clear . . .
  • CECL does not require banks of any size to radically change how they’re already estimating loan losses.
  • CECL does not require predictions 30 years into the future. 
  • And, CECL does not require an exhaustive search of all possible information.
CECL only requires a bank to take into consideration information that is reasonably available.  As one investor told us, “if a bank can’t do CECL, I want to know that.”  Because otherwise how can they properly price for risk?

Final thoughts. I agree with those that say, community banks and credit unions didn’t cause the last crisis.  But I’ll add:  they do swim in the same waters.

Regardless of how credit losses are accounted for, big banks will survive the next crisis.  The little guys will struggle, and some won’t survive.  They’ll be swept away by the next economic rip tide.  And that will hurt our economy . . . particularly those in underserved markets.

As an investor . . . I’d have been okay with keeping the status quo.  Frankly speaking, I made money estimating expected losses.  It gave me a competitive advantage.

But as an American citizen . . . I’m not okay with the status quo.  No competitive advantage is worth keeping accounting that:
  • in “good times” masks warning signs of rising credit risk, and
  • in “bad times” is ignored.
Thank you.

 
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