Financial Instruments: Impairment

Date recorded:

Recognition of initial expected losses

The IASB and FASB continued their deliberations from Wednesday and Thursday on the impairment recognition for financial instruments.

The acting Chair of the FASB started the meeting my informing the IASB members that the FASB had recently received loan loss trend information from one of the U.S. banking agencies on a confidential basis. However, they had received permission to share the information with the IASB and therefore the FASB proposed to schedule an education session during next week's joint meetings in Norwalk, CT to go through the information provided. Multiple IASB Board members agreed that analysing this information could be a useful exercise, although it was noted that if the information was only for U.S. loans, then the trends may not be the same throughout other jurisdictions of the world. The acting Chair of the FASB emphasised that the purpose of the data was not to attempt to develop or estimate specific loss periods for certain asset classes, but rather to see if the information provided may assist members from either Board into developing a principle over how best to recognise expected losses over the anticipated loss period.

An IASB member proposed another alternative recognition approach for consideration which he felt helped to bridge the gap between the two Board's positions. This model would recognise the loan at the funded amount at issuance, while recognising the expected credit losses immediately as the loan loss allowance but offset by deferred revenue related to the credit spread implicit in the contractual interest rate related to credit risk. The deferred credit risk amount would then be accreted into income as the loan amortises down. This would help to alleviate the FASB concerns over not having an appropriate reserve recognised in the balance sheet while also retaining the IASB income statement recognition approach of recognising the credit risk component as part of the contractual yield of the loan. There was mixed reaction to the idea with some feeling that it helps to achieve both Board's objectives while others feeling that it reintroduces the complexities with the original IASB exposure draft.

The IASB Chairman took an inventory of the various alternatives that had been discussed over the last three days and requested the staffs to prepare brief summaries of each alternative in anticipation of further discussions at next week's joint meetings. The identified alternatives currently under consideration include:

  • Alternative 1 - Spread the expected losses over the life of the loan using a partial catch up approach for subsequent changes in estimates of expected losses; a "bad book" approach would also overlay this model for specific loans that have been identified as going bad where the full amount of expected loss would be reserved for immediately (the IASB approach post re-deliberations of their exposure draft)
  • Alternative 2 - Alternative 1 with the addition of a "middle book" concept for loans projected to go bad over the near term (an incurred but not reported 'IBNR' approach) which speeds up recognition of the expected losses for those loans
  • Alternative 3a - Spread the expected losses over the expected loss pattern (e.g., for 5 year auto loans where most loans go bad within 24 months, expected losses would be spread over the first two years)
  • Alternative 3b - Project expected losses over the near term (perhaps 2 to 3 years) and recognise those losses immediately rolling that estimate over from period to period (continually looking out over the near term expected loss period)
  • Alternative 4 - Recognise the expected credit losses immediately as the loan loss allowance but offset by deferred revenue related to the credit spread implicit in the contractual interest rate related to credit risk which is accreted into income as the loan amortises down
  • Alternative 5 - Bifurcate the portfolio between those loans before or during the anticipated loss period and those loans that have passed through the anticipated loss period; those within the loss period would have a higher loss rate accrued during that period while those loans past the anticipated loss period would have a much lower loss rate accrued, and
  • Alternative 6 - Recognise the expected losses immediately upon loan origination so that the loan loss allowance is always sufficiently provided for the anticipate losses (the FASB exposure draft approach).

The FASB staff agreed to prepare summaries for the alternatives under consideration including a basic summary of the approach and what the balance sheet and income statement would represent under each approach as well as potentially including operational considerations.

This concluded the special three day joint meeting on impairment.

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