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Banks’ Loan-Loss Reserves Seen Jumping 50% in FASB Proposal

Banks’ loan-loss reserves may jump about 50 percent under a proposed U.S. accounting-rule change that redefines how quickly firms must recognize bad debts, standard-setters said.

“Speaking with many of the larger financial institutions in the U.S., they’ve told us -- again without the rigor of a complete adoption of the proposal -- that they’re estimating that their losses might increase in the range of let’s say 50 percent,” said Leslie Seidman, chairman of the Financial Accounting Standards Board, in a conference call today.

The proposed rule, revising a February draft, pushes banks to start recognizing losses on loans, debt securities and other financial receivables when firms see early signs of potential loss. The policy would move from an “incurred loss” model to an “expected loss” model, similar to changes under consideration by the International Accounting Standards Board, which sets the rules used in most nations outside the U.S.

FASB’s estimate shows banks probably would need to boost reserves by billions of dollars if the new rule is implemented. JPMorgan Chase & Co., the largest U.S. bank by assets, had $24 billion in its allowance for credit losses at the end of September. Charlotte, North Carolina-based Bank of America Corp., ranked No. 2, had $26 billion.

There is likely to be “plenty of pushback from the industry,” said Glenn Schorr, an analyst with Nomura Holdings Inc. Banks may stop cutting loan-loss reserves in anticipation of rule changes, he said. Reserve releases have buoyed profits in the last two years.

Comment Period

“The new guidance would require higher initial recognition of credit losses as new loans are originated,” Schorr wrote in a report after the proposal’s release.

Spokesmen for Bank of America, New York-based JPMorgan and Citigroup Inc., the third-largest U.S. bank, declined to comment.

The FASB draft is open for comment until April 30. Even if the final proposal is adopted next year, it probably won’t take effect before 2015, according to a person with knowledge of the plans, who requested anonymity because the timing wasn’t announced. The effective date was left blank in today’s draft.

The accounting board is looking to change how reserves and asset values are measured after the financial crisis forced lenders to devote capital to losses, leaving some of the world’s largest banks struggling to meet regulatory thresholds and remain solvent. Last year, FASB proposed rules that would have made lenders mark deposits and loans to market values, as they already do for traded securities. It later backed off that plan.

Pushing Firms

U.S. banking regulators have been pushing the firms recently to recognize more losses on their housing-related lending. In October JPMorgan and Wells Fargo & Co. said they took almost $1.4 billion in charge-offs on home-equity loans and other mortgages after being prompted by the Office of the Comptroller of the Currency. The OCC said in a report today that it expected increased losses from home-equity loans in coming years as most of those originated from 2003 to 2007 come due.

FASB’s proposed change to accounting standards complements OCC and other regulators’ efforts to get banks to recognize potential loan losses more quickly and to stop releasing reserves, said Charles Peabody, an analyst at Portales Partners LLC in New York. Peabody has been predicting since September that loan-loss provisions could double in 2013 at the largest banks.

“Regulators are getting help from the accountants to justify a higher level of charge-offs,” Peabody said in a telephone interview. “FASB is going to give them the intellectual and accounting rationale.”

Three Buckets

In a previous version of today’s proposal, FASB, like the IASB, envisioned three separate “buckets” of loans with expected losses. After the U.S. regulator received opposition from companies and investors, it abandoned the buckets, Seidman said. The three-bucket option would actually lower the reserves banks now hold for loan losses, she said.

Lenders currently need to show evidence of a loss before writing down the asset. The new rules would require banks to make provisions much earlier, booking expected losses through the income statement and on the balance sheet.

“We think taken together these changes from U.S. GAAP will address the concerns that we’ve heard that today’s GAAP results in losses being recognized ‘too little, too late,’” Seidman said.

The IASB’s approach bases loss estimates on expectations for the coming 12 months. The FASB proposal doesn’t have any such time limit, Seidman said.

It’s key that firms “contemplate the losses that are expected based on all available information,” she said. “Unlike current GAAP, you would not wait for observable deterioration and we would not limit the estimate to losses that are expected in the near term.”

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