On June 16, 2016, the Financial Accounting Standards Board, (FASB) issued an Accounting Standards Update, that has been designed to “improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations.” The update, ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments – requires financial institutions to now “use forward-looking information” to better inform the users of financial statements of their expected credit losses.

According to FASB Chair, Russell G. Golden, “the existing incurred loss approach provides insufficient information about an organization’s expected credit losses…” necessitating the FASB’s issuance of ASU 2016-13.

Requirements of the New Credit Loss Guidance for Financial Institutions

The ASU changes the methodology for recognizing credit losses from the current “incurred loss” model to the new model referred to as the current expected credit loss (“CECL”) model. It requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts, including estimates of prepayments.

The ASU does not totally eliminate all of the loss estimate techniques currently in use, however, “the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances.”

Additionally, the ASU amends the treatment for “other-than-temporary impairments” on available-for-sale debt securities. Under current GAAP, an “other-than-temporary impairment” reduces the amortized cost basis of an individual security and any improvements in the debt security’s value cannot be reflected in earnings. The amendment requires that credit losses be presented as an allowance rather than as a reduction to the amortized cost, and any improvements in the debt security’s value can be reflected as a reversal of credit losses.

For financial institutions, the ASU could substantially change their accounting methodology for credit impairment. Banks and related institutions will have to modify their current processes for reporting on loan and lease losses and other-than-temporary impairments to ensure that they comply with the new guidance. This will likely mean making changes to their operations and systems associated with credit loss reporting.

The experts at MBAF can be instrumental in ensuring your systems, processes, and reporting technologies are all in compliance before the changes take effect.

When Do the Changes Take Effect?

ASU 2016-13 takes effect for U.S. Securities and Exchange Commission (SEC) filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. For public companies that are not SEC filers, the ASU on credit losses will take effect for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other organizations, the ASU on credit losses will take effect for fiscal years beginning after December 15, 2020, and for interim periods within fiscal years beginning after December 15, 2021.

Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.

Compliance and regulatory issues surrounding financial institutions and particularly FASB Accounting Standards Updates, can be quite complex. If you would like to benefit from our expertise in these areas or if you have further questions on this Advisory, do not hesitate to contact our Financial Institution specialists, or call us at 1-800-239-1474.