To PCD or not to PCD: Key takeaways from the FASB CECL Roundtable
Should TDR accounting be completely rescinded? Does accounting for acquired loans misrepresent the economics of an acquisition? Does net income still matter? Our experts analyze the FASB’s virtual roundtable discussion on these questions and more.
Part of the FASB’s post-implementation outreach, roundtable participants included investment analysts, preparers, practitioners (auditors), and regulators, who gave candid feedback on three main topics:
- Current expected credit loss (CECL) implementation
- Accounting for purchased financial assets with credit deterioration (PCD) and non-PCD assets
- Troubled debt restructurings (TDRs) by creditors
CECL implementation: A method to the madness
As Jeffrey Geer, acting deputy comptroller and chief accountant of the Office of the Comptroller of the Currency (OCC) stated, CECL is “doing exactly what it’s designed to do.” Institutions that implemented CECL built up reserves quickly in early 2020 due to uncertainties of the COVID-19 pandemic and ultimately recognized credit losses sooner compared to the incurred loss model. Some of these institutions then saw themselves backtracking and reducing reserves six to nine months after buildup as charge-offs were no longer expected. Non-CECL preparers (institutions using the incurred loss model) said they had also increased reserves significantly using additional qualitative and environmental factors due to these uncertainties.
CECL is "doing exactly what it’s designed to do."
This volatility in provision made it hard for analysts to glean meaningful information and determine the impact on net income of CECL implementation versus the pandemic and related credit losses. Some analysts have even said CECL has made net income less relevant, and others have suggested non-GAAP metrics to incorporate actual charge-offs instead of provision expense. Proponents credit CECL with ultimately allowing institutions to change reserves in conjunction with changes in economic outlook.
Auditors stressed the need for preparers to understand methodologies used in third-party models. They also noted that preparers are required to ensure economic data used is reliable and relevant to an institution’s portfolio.
Accounting for purchased financial assets: If it ain’t broke, don’t fix it
While analysts and preparers seem ready to do away with non-PCD accounting, regulators are more hesitant to throw out the standard. Critics feel the current rules result in a “double count” of credit risk, as acquiring assets at fair value often includes a discount partly attributable to credit. CECL also requires immediately recording an allowance through provision expense for non-PCD loans. Proponents say an application of PCD accounting to all purchased loans would potentially defer provision, antithetical to CECL.
Analysts and auditors also noted removal of the non-PCD classification would simplify acquisition accounting. It could also eliminate some confusion around financial reporting regarding different yields for similar types of investments and loans when the purchase discount is accreted through interest income under current rules.
Alternatives were proposed by participants of the roundtable group, but operational and transparency concerns were acknowledged as potential consequences of making a change to the current guidance.
TDRs: Are we done yet?
Participants discussed the TDR classification under CECL, which has become less relevant. Preparers said the forward-looking nature of the model made the classification unnecessary, as the intent of CECL is to calculate a life-time loss estimate. Institutions using a discounted cash flow methodology under CECL are already accounting for the effect of TDRs. A suggestion was made to eliminate the TDR classification and related accounting and instead require disclosure of modifications to problem loans.
Regulators noted the TDR classification and related assessment of impairment has resulted in earlier recognition of credit losses for smaller institutions, with the hope that CECL will further eliminate delays in recognizing losses.
All participants agreed that the additional voluntary disclosures for modifications during 2020 were helpful, although analysts argued for standardization of detail requirements in modification disclosures specifically for troubled borrowers, as well as a distinction between modifications initiated by the institution under normal operations (helping a troubled borrower) versus as a result of external forces (COVID-19 pandemic, other pressures) within the disclosures.
ASU 2016-13 was adopted by large public companies in 2020, and will come into effect in 2023 for most other entities. While regulators appeared open to further discussion on targeted revisions to PCD/non-PCD accounting and TDRs, they’re hesitant to “throw the baby out with the bathwater” or create a cure that’s bigger than the issue they’re trying to address. Additionally, it doesn’t appear CECL is going away or will be further delayed.
We recognize the significant amount of uncertainty and anxiety felt by institutions yet to adopt. While preparation should start sooner rather than later, we assure you that the road to implementation can be pragmatic and tailored to appropriately reflect the complexities of your institution’s portfolio. If your institution needs help working through CECL adoption or the other accounting impacts of COVID-19 and the myriad response programs, our industry experts can help you.