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Accounting group leaves CECL credit card payments question to banks

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Accounting group leaves CECL credit card payments question to banks

The accounting standards board gave financial institutions the freedom to determine what approach to use when calculating the expected life of credit card receivables, sidestepping a potentially complicated operational issue for how banks account for credit cards.

That decision, from an Oct. 4 board meeting, resolves the last outstanding issue raised from the credit losses transition resource group in June. The conclusion reiterates the Financial Accounting Standards Board's interest in providing flexibility within the current expected credit loss model, or CECL, to allow banks to use judgement when deciding how to calculate the expected life of and model the expected losses of their respective portfolios.

The board tried to address how banks should determine expected future payments and then how should payments be allocated between existing balances and future draws. For example, at the end of a year, a borrower has a credit card with a $500 balance. For the next three months, the borrower draws $200 a month and pays $200 a month, and then ceases to make payments. Banks need to determine which $500 was lost based on how payments were allocated — the balance at December, or from the $600 in additional draws lost over the next three months.

The question is complicated because credit cards are essentially open-ended loans, and the unused portions constitute unconditionally cancellable amounts. Under CECL, banks are not allowed to reserve for the unused portions of a line of credit if they are unconditionally cancellable.

FASB considered two approaches when it came to payment allocation. A bank could assume that a user's credit card payments are linked to their card use and that future payments in part relate to future draws. The staff said this approach may make sense if banks feel that payment behavior relates to borrowing behavior. If a bank knows a borrower with a $500 balance will pay a certain amount and would pay an incremental amount more if the balance was $700, the bank could take that incremental amount and earmark it for undrawn future balances. During the meeting, FASB staff said there is "conceptual merit" to this view for certain types of receivables, but said that if this approach was required, it might affect smaller institution's flexibility and ability to scale.

But a bank could also take a "first in, first out" approach and apply payments to the oldest balance. Under this approach, the bank avoids allocating payment toward a future draw, which could feel like a reserve on a portion that is unconditionally cancellable.

The board agreed with the staff that management teams should be allowed a number of approaches to use when determining their best estimate of future payments and allocating previous ones, and that either approach could be appropriate depending on the individual institution.

"Consistent with the rest of the model, there is judgment here, there is flexibility here. As long as you are working towards the ultimate objective of current expected credit losses, you should be OK," FASB Chairman Russell Golden said.

But even if FASB did not state a preferred approach for credit card payment allocation and related future payment estimates, banking regulators could still weigh in, said Graham Dyer, a partner in the accounting principles group at Grant Thornton and member of the transition resource group, after the meeting. Regulators have occasionally narrowed the acceptable accounting approaches that supervised institutions can use, and Dyer said banking regulators have stated "a fairly clear preference" for a payment allocation approach that links payment and borrowing activity.

As far as broader CECL implementation goes, FASB staff said they are looking at some limited questions from banks, but there are no other broader issues before the transition resource group. FASB will share a memo of this decision with the board and then publish the memo as an addendum to the June advisory group meeting.