There is always something new in the long-simmering debate about how to account for loan losses, and yet nothing ever happens.
Until, perhaps, now.
The Securities and Exchange Commission touched a live wire in 1998 when it required SunTrust Banks Inc. to back $100 million out of its loss reserves to gain the agency's approval for an acquisition. The securities regulator, in the midst of an effort to stamp out earnings management, thinned the Atlanta company's credit cushion just as fears mounted about a turn in the lending cycle.
Banking regulators, who it has been said have never seen a loss reserve they considered too large, took issue with the SEC action, triggering a very public row - with bankers in the middle. At the implied urging of the SEC and banking regulators, and with the blessing of the Financial Accounting Standards Board, a task force put together by the American Institute of Certified Public Accountants started a project in early 1999 to find common ground.
The job, which always was considered unenviable, now appears to have been impossible. After seven years of fits and starts, brinksmanship, regulatory and industry meddling, and sincere hand-wringing, the task force's efforts quietly evaporated in September.
"The loss allowance project that has been going on for seven years is at best tabled and at worst totally defunct," said Carol Larson, a deputy managing partner at Deloitte & Touche LLP and the current chairwoman of the task force. "The ball is in FASB's court to decide what happens next."
What happens next could be a wholesale revision of loan-loss accounting. On the table are two competing models: one tied to expected losses, which would be logically consistent with a proposed new capital regime that banking regulators are struggling to implement; and one tied to fair value, which would mesh with a larger effort under way at the standards board.
The task force's seven-year journey into the wilderness may have been doomed from the start. It was expected to rationalize the practice of loss accounting by offering practice guidance - with the explicit understanding that it could not tamper with the accounting model put forth in generally accepted accounting principles.
Two years ago the scope of the project was sharply curtailed when the FASB told the task force to abandon guidance and settle for new disclosures in financial statements that would help bankers, investors, and regulators gain a truer sense of public companies' lending portfolios and loss exposure.
The task force members, who had committed no small amount of effort to the problem, took the news hard, but they turned to the task of crafting the disclosures and eventually came up with an exposure draft that the AICPA's executive committee approved this year.
The CPA group submitted the draft this summer to the FASB, where it now languishes in limbo, because the board's staff has recommended against putting it on the agenda. But the banking industry, which generally has taken positions against the project - first in its guidance form and later in its more modest disclosures-only form - has secured what may prove to be only an illusory victory.
"Even though our project is now off the table, I don't think people should relax - it's not that the schoolmarm has gone home and they are free to play," Ms. Larson said. "The questions around the appropriate accounting continue, as well as the appropriate disclosures."
Lawrence Smith, the FASB's director of technical application and implementation activities, said the board's staff was concerned that the CPA group had not done enough to vet its project with those who prepare and use financial statements.
He also said the standards board is considering an unrelated project that will require additional disclosures about derivatives, and he noted that public companies with the most extensive derivative activities are likely to be the companies wrestling with loss reserves.
The board decided that asking for disclosures on both issues was too much, he said.
Not to mention the fact that the FASB's support for the aging accounting theory - the same theory the task force was told to follow in crafting the disclosures - is, to say the least, tepid.
"There are some board members who are not all that enamored with the existing accounting model for the allowance for loan losses to begin with," Mr. Smith said. "The question that some board members raised was 'Does it make sense to go forward with a disclosure document when we really don't like the model to begin with?' "
The answer thus far appears to be "No."
Public companies reserve for pools of loans like credit card and mortgage portfolios in accordance with FAS 5, Accounting for Contingencies, and reserve for large individual credits like corporate loans under FAS 114, Accounting by Creditors for Impairment of a Loan. Accounting professionals express little enthusiasm for either.
FAS 5, which went into effect over 30 years ago, employs what is called an incurred-loss model. To establish a reserve, companies must document not only that the asset is impaired at the date of the financial statements, but also that the amount of loss can be reasonably estimated. Anticipated future losses do not qualify.
Because the precise point at which loss has been incurred is a heavy philosophical question, bank auditors frequently reach different conclusions about the same assets. This ambiguity has resulted in what accountants politely refer to as "diversity of practice."
Sydney Garmong, an executive in the financial institutions group at the audit firm Crowe, Chizek & Co., said FAS 5 relies upon "a complicated model that many believe is broken."
Mr. Smith said his staff may propose a new project addressing loan losses that would land on the FASB's agenda late this year or early next year.
"If the staff brings an agenda request to the board, it will include recognition and measurement," and not just disclosures, he said - in other words, a new model. The board has already shown a willingness to put aside the incurred-loss model in an interpretation that it put forth this year on uncertain tax positions.
One option is an expected-loss model, which is simpler because companies can record losses over the life of the loan without having to determine precisely when the loss occurred. The model fits practically with how many banks think about their lending portfolios, and it matches loss concepts in the proposed Basel II capital regulations.
Mr. Smith said the expected-loss model is "one avenue to go down." However, "another avenue that probably won't be too popular would be to account for loans at fair value."
Banks and their trade groups have argued against fair value in a variety of other projects pursued by the board, arguing that they rarely manage their business as if all assets have a readily determined market value. Banking regulators likely would prefer to avoid a fair-value model, as pricing assets according to market values adds an element of volatility that could threaten regulatory capital in extreme circumstances.
Donna Fisher, the director of tax and accounting at the American Bankers Association, said she is still meeting with bankers to determine their preferences.
"Basel II is more of an expected-loss model, and my guess is that's the direction that we will eventually move," she said. "We have started the discussion of whether the expected-loss model is a better model because others have said to us that's where this effort should go."
That could meet the approval of bank regulators, too, since providing for future losses generally supports a larger reserve than providing for current losses.
How long it might take the standards board to make up its mind is anybody's guess.
"It could be sooner than we all might think, especially if they decide to cut to the chase and choose between expected loss and fair value," Ms. Larson said.
But the process of approving new accounting standards is hardly noted for its alacrity, and she is hedging her bets. "I could also be retired before they get done with it," she said.
In the meantime, there is near unanimity that even though the CPA group's task force fell short of its goal, its efforts over the past seven years have been far from futile. Banking regulators and the SEC have edged toward a shared understanding of loan-loss accounting, though the intersection is still far from complete.
Investors also are getting more information about reserves.
"The disclosures have improved over the years, especially at the large banks, both on the quality of the loan information and the loan-loss information," said David Morris, a former financial director at JPMorgan Chase Bank and a member of the task force.
