Opening Remarks of FASB Member Hal Schroeder
(as prepared for delivery)
ThinkBig 2019 Conference
 “Roadmap to the Future:  Fact vs Fiction (on CECL and Other FASB Standards)”
Orlando, Florida
September 26, 2019

Back in the spring—as the school year was ending—I showed my daughter a picture of what appeared to be an old, very thick textbook.  Knowing the last thing she wanted was another textbook, I jokingly told her we were going to buy it.  She then asked two logical questions:  Why? and How much? 

I won’t get the tone of her questions quite right, so I’ll just say there was a lot of eye rolling.  Now, in my defense:  She had no facts, she didn’t know the book’s history.  Without any historical context, without opening the book to see its contents, she couldn’t appreciate the importance of this book. 

What she saw was the tattered, brown-paper cover; blank, except for three handwritten letters.  So, she was shocked to learn what it would likely fetch at auction.
 
The book was Luca Pacioli’s Summa de Arithmetica.  In the press release1 announcing the auction, Christie’s noted its broad-ranging contents: “from double-entry bookkeeping to probability theory and computing, the mathematical principles of the most vital features of contemporary finance are all present.”   In other words, this 525-year-old tome is the “first practical how-to book on succeeding in business.”

During a multi-city tour, Christie’s invited the FASB to experience the book firsthand.  As the curator opened the cover to read passages and to highlight various illustrations, I developed a deeper understanding of what was inside the book, why it was important, and how it was constructed.  No wonder this book has stood the test of time.

I tell this story because it’s a great example of the idiom:  You can’t judge a book by its cover.  The same can be said for the FASB’s projects I’ll talk about today.  And, for our stakeholders—particularly preparers and auditors—it’s imperative that you get past the cover of each new standard in order to distinguish fact from fiction; what’s changed and why. 

Hence, the title of my presentation Roadmap to the Future:  Fact versus Fiction.  So, today I’ll provide some facts about what we’ve been doing since issuing CECL in 2016.  And, I’ll try to separate fact from fiction by laying out what we hear. 
 
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Before going any further, I must first remind you of 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.

The standard disclosure I just read appropriately puts an emphasis on the FASB’s “process” for setting accounting standards.  And, that’s where I’ll start.

About the FASB

Last year alone, Board members and staff spoke at 156 events nationwide and hosted 575 liaison, advisory group, and project outreach meetings.2

The People

At one such meeting a few years ago, a group of community bankers came to visit us in Norwalk, CT.  A CEO—from a small town near to where I grew up—told us he’d been at a Rotary Club lunch the day before.  He said someone at his table was surprised to learn he was going to meet real people at the FASB.  I asked him to please reassure the folks back home, we are real people!  So, to provide some perspective on the FASB process, it helps to first understand the people; both the Board members and staff.

Speaking for myself, the comments I make today—as well as my votes at the Board table—are informed by four decades of experiences:  as an auditor and advisor to a wide range of financial services companies—from the largest global entities to the smallest community banks in south Louisiana; as a CFO; as both an individual and institutional investor; as a manager and owner of private businesses; and, now, as a member of the FASB in my second and final term. (Yes, we have term limits.) 

Combine my experiences with those of my fellow Board members and staff, and you begin to see a wide array of experiences and multiple perspectives.  This diversity of views is by design.  Think of it this way:  If any two Board members always agree, one of them is redundant.  Now, add to the mix the boots-on-the-ground experiences and perspectives of our advisory groups and stakeholders like yourselves—that participate in our outreach meetings—and it’s clear that the process of setting accounting standards is not done in a vacuum or an ivory tower.

The Process

The Board and staff often talk about the standard-setting process, up to the point of issuing a new standard.  We don’t talk as much about the equally important post-issuance phase.  Once a major new standard is issued, we spend the time—often years before its effective date—educating stakeholders and monitoring company implementation efforts. 

One reason we do this is to re-confirm that a new standard’s wording is understandable, operable, and auditable.  Another is, we want to ensure it will stand the test of time.  

During numerous education and monitoring sessions—based solely on the questions and comments of the participants—it becomes readily apparent who’s gone past the cover and is deep into implementing a new standard.  And, equally apparent, who hasn’t broken the book’s binding.

With the latter group, we often find ourselves reiterating and relitigating a range of questions.  Personally, I enjoy the debates.  However, most of their questions have already been asked and answered in the due-process documents and final standards issued in accordance with the FASB’s Rules of Procedure.3
 
Addressing What & How

As much as I enjoy the debates, I’ll simply highlight a few points about what’s required and how to do it. 

Regarding the “what” of CECL specifically—in the past year the staff has received very few questions, many of which could be quickly answered by referring directly to the guidance.  Considering that our technical inquiry service is free and accessible online,4 the limited number of questions is at odds with the view—some have voiced—that there are many unanswered questions and, therefore, CECL should be delayed.

For other more-involved questions, we’ve made targeted improvements to enhance understandability and operability.  Answers to those questions can be found at our CECL implementation portal.5

Regarding “how,” we’re committed to looking for ways to ease transition efforts.  For example, in January, we published a Staff Q&A about using WARM6 (weighted-average remaining maturity), which is an estimation method already familiar to many smaller financial institutions.  It was followed in July by another that addresses developing estimates7 by responding to 16 frequently asked questions about:
  • using historical loss information,
  • developing reasonable and supportable forecasts, and
  • applying the reversion to historical loss information. 
Both Q&As are part of the Board's continuing commitment to educate stakeholders.

They cover common questions we’ve heard during the last three years at various post-issuance educational sessions—the same questions covered in numerous PowerPoint presentations we’ve delivered.  So, the Staff Q&As are a more formalized version of what we’ve been saying.

In addition to those Q&As, the staff are hosting several implementation workshops around the country.  Again, please check our CECL implementation portal for dates and locations.

Assessing Costs & Benefits

And, despite some very public comments to the contrary, a thorough cost-benefit assessment of CECL was conducted—as is done on all standards in accordance with our Rules of Procedure.  We explain why we came to our decisions in the “Background Information and Basis for Conclusions” section of the standard.  A summary8 of the assessment is also provided on our CECL implementation portal.

Disciplined Process

In my now over eight years on the Board, I’ve come to appreciate the high-quality standards that result from its disciplined process.  CECL may not be perfect, but it’s a vast improvement over the status quo.  And, we’re doing everything we can to support your success.

So, I have a request:  When you hear someone say the FASB didn’t follow its due process, please ask if they’ve gotten past the cover, past the headlines in media reports.  Have they read the standard, in particular, the basis for conclusions? 

Like any classic book, standards such as CECL should be read multiple times.  The same is true for the Staff Q&As.  With each subsequent reading, new insights are gained, leading to greater benefits and a more cost-effective implementation.

Final thought on process:  disagreeing with a Board position is fine.  I certainly have, in fact, about 10% of the time—just read any one of my dissents.  But I’m troubled by those that make public statements, unsupported by the public record documenting the process.

Calls to “Stop and Study”

During the Past Year

Despite years of discussions and debates, there continue to be efforts to relitigate CECL.  As you may have heard or read, reconsideration of CECL was the focus of a roundtable meeting this time last year.  It was hosted by three congressmen to facilitate a discussion of a “regional bank proposal.” 

A few months later, a modified version of that proposal was formally submitted to the FASB.  Again, following established process, the FASB staff held dozens of meetings that included financial and nonfinancial entities, as well as other stakeholders. 

The views heard in those meetings were very consistent with stakeholder comments at a public roundtable we hosted in January—splitting the provision, with a portion flowing through net income and the remainder in OCI, was not operational.  This was not a surprise.  Banks—large and small—had provided the same feedback in 2013, when the Board had explored the same idea and its many variants.

We also heard from investors that, if the provision is split, they would need additional disclosures.  However, those re-proposing a split did not support expanded disclosures.  After hearing all sides, and consistent with its 2013 decision, in April the Board again voted to not move forward with any requirement to split the provision.

On the Regulatory and Legislative Fronts

In October 2018, a trade associations' letter9 was sent to the chair of the Financial Stability Oversight Council10 (or FSOC).  Voicing concerns about CECL, the letter recommended that FSOC “seek a delay in implementation until such a study can be completed.”

As a refresher, FSOC is an interagency body consisting of ten voting members—those being the principles of the federal agencies that regulate the U.S. financial services industry—and five non-voting members—those representing various state authorities.11  And, it’s chaired by the Secretary of the Treasury.

At FSOC’s December 2018 meeting, there was a discussion of CECL.  In reading the publicly available minutes12 you see mention of the “extensive work undertaken by the FASB, including publicly issuing proposals in 2010, 2011, and 2013, prior to adoption of CECL in 2016.”  The discussion was led by the Comptroller of the Currency, who stated that “the OCC believes CECL is an improvement over the incurred-loss accounting model.”

With no reduction in regulatory capital imminent, the “stop-and-study” movement is now seeking a “legislative fix” with bills proposed in both the House13 and the Senate.14  However, it’s worth noting that in separate actions, study-only directives have been attached to both House15 and Senate16 appropriations bills.  The requests are directed toward others including the SEC and the U.S. Treasury, but not to the FASB.  The Senate action specifically directs the Treasury, in consultation with the federal bank regulators, to “conduct a study on the need, if any, for changes to regulatory capital requirements necessitated by CECL, and to submit the study to the Committee within 270 days of the date of enactment of this act.”  Note that this study will assess the need for a change to regulatory capital; not to CECL.

My views?  Those in the audience that know me won’t be surprised.  I do have views on the matter.  But as a reminder, these are my views and should not be interpreted as the Board’s views.

Calls for Quantitative Impact Study

“Stop-and-study” efforts call on the FASB to perform an economic or quantitative impact study on CECL.  (Going retro, I’ve heard it called “delay-and-pray,” mimicking the approach used by some to deal with problem loans in past banking crises.)  Those advocating stop-and-study allege dire consequences from CECL’s so-called procyclical effects on lending.  However, independent studies17 already conducted do not support such concerns.

Consider data contained in a recent study18 published as a working paper in the Federal Reserve’s Finance and Economics Discussion Series (or FEDS).  The study, and I quote, “shows that a disproportionate share of the associated provision expenses occurs prior to the recession under CECL, rather than during it.” 

The study quantifies CECL’s earlier provisioning, estimating that “roughly 62% of the trough to peak increase in allowances occurs prior to the recession [compared to] only 11%” under the incurred loss model.

Now, combine that finding with other independent studies showing banks that provision earlier are better positioned to lend in an economic downturn.

Quoting from one such study:  “Consistent with the pro-cyclical provisioning hypothesis we observe a greater reduction in lending during recessions by banks that delay expected loss recognition more compared with banks that delay less.”19  That conclusion was based on 24,788 bank quarters of data, stretching over a 16-year period (1993 to 2009) that included 2 U.S. recessions.  Another study,20 based on 3,091 bank-year observations, across 27 countries over 11 years (1995 to 2006), yielded complementary results.

Yet, I expect critics will point to the FEDS working paper to show that CECL reserves would go up during a recession and would be higher than under the incurred model.  I agree with the observation.  CECL allowances would likely increase during a recession and peak at a higher point.

In fact, using the same data, I calculate21 CECL-based allowances would have increased an estimated 29% from the beginning of the recession and peaked in the fifth quarter.  However, those same critics are unlikely to mention that under the incurred model, allowances actually increased 264% during the last recession—8 times that expected under CECL—and, didn’t peak until the ninth quarter—taking almost twice as long to recognize losses.
 
Bottom line:  As independent studies show, banks that are better reserved heading into a recession are better positioned to lend during a recession.  And, it is the banks that reserve later, and take longer to work through existing losses, that cut lending during a recession.

Therefore, I believe concerns about CECL’s impact on lending are misplaced.

Studies—Yes, Stop—No

My comments today should not be interpreted to mean I’m anti-study.  In fact, just the opposite.  I believe well-designed, well-executed independent studies—a few of which I’ve cited—are an invaluable tool to standard setting.  And I believe there should be more in the future, using real data as it becomes available.

What I’m opposed to is stopping CECL’s implementation.  Here are a few reasons why.

No Change to Cash Flows

A key point to remember, under CECL:  a good loan will still be a good loan; a bad loan will still be a bad one.  This is because CECL doesn’t—in fact, it can’t—change the ultimate cash flows or a borrower’s ability to repay.  And CECL doesn’t even change when to charge off a loan.  It changes only the timing of when loss provisions are recognized in net income and, in turn, reserves built on the balance sheet.

Greater Transparency

Even absent CECL, investors are and will be making their own estimates of expected losses.  Speaking with firsthand knowledge, investors began ignoring GAAP allowances—effectively making their own, much-higher loss estimates—18 months before the beginning of the last recession.  This is in stark contrast with the fact that GAAP-based allowances didn’t hit bottom—a multi-decade bottom—until just 12 months before the recession began.

What CECL does is provide greater transparency into changing credit risk.  Instead of having to rely solely on their own estimates, investors and other users will be able to start their analyses with managements’ more-informed estimates.

If there’s any doubt in my view:  In the last few months, I’ve been talking with investors.  What some have shared is that they’re already beginning to again ignore GAAP provisions and allowances and, to again, make their own loss estimates.  As Mark Twain is often credited with saying: “History never repeats itself, but it rhymes.”

So, how do we reconcile the clear need for better alignment between accounting and changes in risk, with calls to stop a standard that provides much-needed transparency?   I can’t.

On a Personal Note . . .

In my former job as a portfolio manager, I’d have been okay with keeping opaque accounting.  Frankly speaking, our investors earned better returns because we were estimating expected losses.  It gave us a competitive advantage.

But as a member of the FASB, 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.
Effective Dates for Private and Smaller Public Companies

At this point, you may be asking:  If he’s so pro-CECL, why does he support delaying its effective date?  As a reminder, the Board is tentatively scheduled to vote on this matter at its October 16th meeting.  So, you should know before the yearend holidays whether and who will get a delay in applying CECL.

I support a delay because some of you in this room made a compelling case—and our research confirmed—that implementation challenges are often magnified for private companies, smaller public companies, and not-for-profit organizations.  Access to resources, education, and technology varies considerably among organizations of different sizes.
 
We did not want those hurdles to block the path toward a successful implementation for anyone.

We also observed that when it comes to applying standards, private and smaller public companies can learn a lot from the experiences of larger public entities.  More time between effective dates means more time to learn.

It’s also worth noting a practical implication—roughly 90% of financial services companies (by number) would get extra time to adopt the standard.  However, I don’t believe investors will be significantly affected, because the 10% that won’t get extra time represent 90-ish% of the industry assets.

But I wouldn’t be surprised to see some entities that could take more time, elect to early adopt—which I expect will be permitted.

Not All Smaller Institutions Agree 

I say this because, minutes before an August vote, a community bank CEO called me to express his strong disagreement.  He said his bank didn’t need the additional time.

It was not the first time the two of us had debated various aspects of CECL.  We’ve had numerous discussions; the same as with other bankers.  So, at a high level I shared with him what I’d heard.  It was a good rehearsal for what I was going to say at the Board table in just a few minutes:  When implementing major standards, such as CECL, it’s more cost effective to take an integrated, wholistic approach that coordinates accounting changes with other changes needed to run a successful business—what I refer to as a “business approach”—which contrasts with treating accounting changes as simply a “compliance exercise”—incurring costs with minimal to no benefits for running a business.

I believe providing an opportunity to take a business approach is the strongest, most compelling argument for extra time.

Benefits to Taking a Business Approach

In fact, as we monitor progress among larger lending institutions—those preparing to implement CECL next year—we’ve observed the benefits.  In private meetings—including a few where we’ve had to sign non-disclosure agreements—we’ve been told that the effort to adopt CECL has resulted in widespread improvement of data quality, internal controls, estimation processes, and internal coordination and communication.

A few bankers have gone even further, saying that they expect additional improvements will be achieved over time.  Think of it as a virtuous—some say vicious—circle.  More and better data leads to improved estimation processes.  Those processes benefit from technology advances, such as faster processing speeds and more memory.  Advances in technology facilitate the use of more and better data that improves estimation processes . . . and the cycle continues.

As a banker told me, “Improvements were needed; CECL simply accelerated the timing.”

One Cautionary Note  

Now that the Board has voted to provide the 90% with extra time, I believe there’ll be an even greater expectation for high-quality implementation efforts.

Don’t look at it as an extra year off.  Treat it as an opportunity to improve your data quality, estimation processes, and internal controls.  Start now.  If you’ve yet to break the book’s binding, do it today.

Reference Rate Reform

Now, on to another issue—one that likely affects everyone in this room:  reference rate reform.  This is a global issue driven by market forces, not the FASB.

What Is Reference Rate Reform?

The London Interbank Offered Rate, or LIBOR, is expected to be phased out in 2021.  Globally, there’s an estimated $350 trillion of financial instruments—over half of which is in the U.S.—that reference LIBOR22 including, for example, adjustable-rate mortgages.

Efforts are under way (1) to identify risk-free alternative rates to replace IBORs and (2) to develop transition plans that support reference rate reform.  Those industry-led efforts are focused on tying benchmark rates to observable, arm’s-length transactions.

In July, the SEC issued a public statement23 noting that the transition away from LIBOR could have “a significant impact on the financial markets and may present a material risk for certain market participants.”

Addressing Accounting Obstacles

Reference rate reform has been a major priority for the FASB.  We’re proactively addressing accounting obstacles that could hinder smooth transition.

Simplifying Accounting Evaluations.  And earlier this month, we issued a proposal that would make it easier to transition contracts and other arrangements to a new reference rate.

First, we proposed to simplify the accounting evaluation of a contract modification.  For a contract that meets certain criteria, the change in its reference rate would be accounted for as a continuation of that contract, instead of the creation of a new contract.

We also proposed to simplify the assessment of hedge effectiveness—and to allow hedging relationships affected by reference rate reform to continue.

Optional and Temporary.  Application of this relief would be optional.  We think it will minimize the disruption of reference rate reform on financial reporting and provide users with more useful information.

Companies and other organizations that elect to apply the guidance would do so prospectively—in other words, the new guidance could be elected for contract modifications and hedge evaluations that occur after we issue the final standard.

The guidance would be temporary, expiring on January 1, 2023.  To my knowledge, if finalized, this would be the first time we’ve ever issued an accounting standard with a “sunset provision.”

Looking Ahead

The comment period on this proposal is open until October 7th.  I encourage you to review it and get your comments to us as soon as possible.  As always, your insights will help us develop a better standard.
 
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Closing Remarks

Before concluding, I want to thank you for your engagement in our process.

We may not always agree on outcomes.  But we will always engage in the conversation.  And we will work with you to help ensure a successful transition to our standards.

And now, I’m ready to take your questions.
 
 
1Christie's NY to Auction Pacioli's "Summa de Arithmetica," June 12, 2019, https://www.finebooksmagazine.com/news/christies-ny-auction-paciolis-summa-de-arithmetica
 
2Financial Accounting Foundation 2018 Annual Report, Standards That Work/Rising to Meet the Future, page 4, https://www.accountingfoundation.org/cs/ContentServer?c=Document_C&cid=1176172719304&d=&pagename=Foundation%2FDocument_C%2FDocumentPage
 
3FASB Rules of Procedure, Amended and Restated through December 11, 2013, https://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1351027215692
 
4FASB Technical Inquiry Service, https://www.fasb.org/inquiry/
 
5FASB Implementation Portal, Credit Losses, https://www.fasb.org/creditlosses
 
6FASB Staff Q&A, Topic 326, No. 1, Whether the Weighted-Average Remaining Maturity Method Is an Acceptable Method to Estimate Expected Credit Losses, January 2019, https://www.fasb.org/cs/ContentServer?c=Document_C&cid=1176171932989&d=&pagename=FASB%2FDocument_C%2FDocumentPage
 
7FASB Staff Q&A, Topic 326, No. 2,  Developing an Estimate of Expected Credit Losses on Financial Assets, July 2019, https://www.fasb.org/cs/Satellite?c=FASBContent_C&cid=1176172971977&pagename=FASB%2FFASBContent_C%2FGeneralContentDisplay
 
8FASB Understanding Costs and Benefits, ASU: Credit Losses (Topic 326), June 16, 2016, https://www.fasb.org/cs/Satellite?c=Document_C&cid=1176168233403&pagename=FASB%2FDocument_C%2FDocumentPage
 
9Letter to Hon. Steven T. Mnuchin, Chairman, Financial Stability Oversight Council, Re: Request for a Quantitative Impact Study and a Delay in the Implementation of CECL, October 25, 2018, https://www.aba.com/-/media/archives/letterstocongress/aba-states-letter-fsoc-cecl-102518.pdf
 
10As stated on the FSOC website, “The Financial Stability Oversight Council has a clear statutory mandate that creates for the first time collective accountability for identifying risks and responding to emerging threats to financial stability. It is a collaborative body chaired by the Secretary of the Treasury that brings together the expertise of the federal financial regulators, an independent insurance expert appointed by the President, and state regulators.”  https://www.treasury.gov/initiatives/fsoc/about/Pages/default.aspx
 
12Minutes of the Financial Stability Oversight Council, December 19, 2018, https://home.treasury.gov/system/files/261/December192018_minutes.pdf
 
14S.1564 - Continued Encouragement for Consumer Lending Act, https://www.congress.gov/bill/116th-congress/senate-bill/1564

15116TH Congress, 1st Session, House Report 116–122, “The Committee directs the SEC, in consultation with the Federal Reserve, the FDIC, the Office of the Comptroller of the Currency, and NCUA, to conduct a study of the potential impact of the CECL accounting standard issued by the Financial Accounting Standards Board (FASB) and provide the study to the Committee, and to the Financial Services Committee, within 180 days of the enactment of this Act. The study shall address the impact of the CECL standard on credit availability, costs to consumers, and overall stability of the banking sector, and assess whether the FASB employed sound economic analysis and modeling.”  https://www.congress.gov/congressional-report/116th-congress/house-report/122/1?overview=closed
 
16116TH Congress, 1st Session, Senate Report 116–111, The Committee on Appropriations reports an original bill (S.2524) making appropriations for financial services and general government for the fiscal year ending September 30, 2020.  https://congress.gov/congressional-report/116th-congress/senate-report/111
 
17Refers to comprehensive studies conducted by researchers not associated with individual banks or trade associations.
 
18Loudis, Bert, and Ben Ranish (2019).  CECL and the Credit Cycle," Finance and Economics Discussion Series 2019-061. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/FEDS.2019.061.
 
19Beatty, Anne, and Scott Liao. 2011. “Do Delays in Expected Loss Recognition Affect Banks’ Willingness to Lend?” Journal of Accounting and Economics 52: 1-20.
 
20Bushman, Robert M., and Christopher D. Williams. 2012. “Accounting Discretion, Loan Loss Provisioning, and Discipline of Banks’ Risk-Taking,” Journal of Accounting and Economics 54: 1-18.
 
212019 Barclays Global Financial Services Conference presentation, slides 7 and 8, https://fasb.org/cs/Satellite?c=Document_C&cid=1176173358156&pagename=FASB%2FDocument_C%2FDocumentPage
 
22Bloomberg, August 27, 2019, Wall Street Prepares for the End of a Crucial Benchmark,   https://www.bloomberg.com/news/articles/2019-08-27/libor-undertakers-wanted-wall-street-braces-for-benchmark-s-end
 
23SEC Staff Statement on LIBOR Transition, July 12, 2019,  https://www.sec.gov/news/public-statement/libor-transition#_ftn1

 
 
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