In their fourth-quarter 2019 earnings calls, large U.S. public banks began to discuss the impacts of adopting the new current expected credit loss (CECL) standard, which became effective for them on Jan. 1, 2020. Although it did not affect 2019 financial statements, analysts were very interested in what the transition to CECL would mean for 2020 results.
ASU 2016-13 changes the recognition of credit losses for assets recorded at amortized cost. Financial assets must be measured as the net amount expected to be collected, with changes in expected losses recorded in earnings. Prior GAAP called for impairment losses to be recognized when it was probable that losses were incurred, based on past performance and current conditions. This ASU requires that an estimate be recorded upfront for the full amount of all expected credit losses over the life of the asset, and it expands the information to be considered in making the estimate to also include reasonable and supportable forecasts.
The CECL model is a fundamental change in how financial institutions estimate credit loss allowances. Although it affects them in differing degrees based on the credit quality and duration of the assets they hold, the American Banking Association calls this standard “the most sweeping change to bank accounting ever.”
What follows is a look at what some banks are saying about CECL and the questions analysts are asking, revealing their desire to gain insights not only into the accounting change but also into whether there will be changes to the business practices relating to these assets.
JP Morgan Chase & Co.’s CECL adoption impact was an overall net increase to the allowance for credit losses of $4.3 billion, a $2.7 billion after-tax decrease to retained earnings. They elected to use the transition approach to recognize the impact on capital over four years.
This was at the lower end of the range of $4 billion-$6 billion they previously provided in their third-quarter 10-Q. The increase resulted mostly from an increase of $5.7 billion in consumer banking credit cards, which they attributed to a change to lifetime loss coverage compared to a shorter loss period under the incurred model. Their wholesale allowance decreased $1.4 billion, due to modeling changes and the use of macroeconomic forecasts that resulted in a decrease for their credit environment.
An analyst from Morgan Stanley asked the company why it was at the low end of its estimated range. CFO Jennifer Piepszak replied they continued to get more certainty later in 2019 about what macroeconomic forecasts were going to look like, along with strength in their portfolio’s performance. She explained that their reasonable and supportable period for the economic outlook was two years, and that they used multiple weighted scenarios. CEO Jamie Dimon pointed out these variables would be disclosed over time, and Piepszak indicated there would be more disclosure about CECL in the first-quarter 10-Q.
Bank of America Corporation did not provide CECL guidance in its earnings release, since CFO Paul Donofrio indicated he had previously provided guidance the company was comfortable with. In its third-quarter 10-Q, the bank disclosed that upon adoption, based on current expectations of future economic conditions, its allowance for credit losses on loans and leases may increase up to approximately 30 percent from its allowance as of Sept. 30, 2019, with a large portion driven by the U.S. credit card portfolio. Donofrio did indicate that due to CECL he expected the provision for losses in 2020 would be a little higher than net charge-offs.
An analyst from Wolfe Research asked whether preparing for CECL changed BoA’s practice of retaining a substantial percentage of mortgage loans the company originated on its balance sheet in lieu of selling them. Donofrio indicated these loans did not have a high amount of CECL impact, so the bank intends to continue this trend but will see how it develops over the long term.
Citigroup Inc. CFO Mark Mason responded to a Morgan Stanley analyst’s question about the impact of CECL by providing a day-one increase in expected credit loss reserves of about 29 percent, or $4 billion, at the high end of the 20 percent-to-30 percent range disclosed in the third-quarter 10-Q. Most of this increase is for consumer credit cards, offset by a decrease in corporate reserves, as indicated in the 10-Q.
In response to a question about day-two impacts of CECL, Mason indicated there are a number of moving variables, including economic conditions and business seasonality, impacting the calculations that would be discussed more in future quarters.
Wells Fargo announced it expected to recognize a $1.3 billion reduction in its allowance for credit losses upon adopting CECL on Jan. 1 and a corresponding increase in retained earnings. The company’s EVP/CFO, John Shrewsberry, reported there was a $2.9 billion reduction in the allowance for commercial loan credit losses due to shorter contractual maturities and the credit environment. This was partially offset by a $1.5 billion increase in the allowance for consumer credit losses reflecting longer or indeterminate maturities, net of recoveries in collateral value of residential mortgage loans previously written down during the last credit cycle that are below their current recovery value. He repeated his prior view that he anticipates more volatility under CECL due to economically sensitive forecasts and the impact of changes in the credit cycle.
Following that, an analyst from Evercore asked about the day-two impact of CECL and whether the new methodology would change Wells Fargo’s appetite to lend in longer-duration consumer areas. Shrewsberry said it was not likely anything would change, based on product return analysis. He did, however, indicate that depending on where you are in the cycle, it can cause you to think differently about what your returns are and consider the need for repricing.
As these and other financial institutions that are public business entities file their 10-K’s in the near future, many more details of the impacts of CECL will be reported.
Smaller reporting companies and nonpublic companies, with an effective date for CECL of January 2023, should take advantage of what the larger financial institutions are reporting now and start preparing for CECL implementation early.