When Citigroup assessed how its loan loss reserves would be affected by new accounting requirements soon taking effect, the company disclosed to investors reserves would increase by 10 percent to 20 percent.
Now that the company is deeper into its implementation activity, it is getting a better understanding of how the accounting works—and it has learned the reserve will actually be much bigger.
“This quarter, we moved to the 20- to 30-percent range as our models are getting finalized,” said Linda Bergen, director and head of external affairs and Securities and Exchange Commission reporting at Citigroup, at a recent conference hosted by Deloitte & Touche and Bloomberg.
Like all calendar-year, publicly held companies, Citigroup is preparing for Jan. 1, 2020, when Accounting Standards Codification Topic 326 takes effect. ASC 326 is the accounting rule that requires companies to transition from the current approach of recognizing credit losses when they are virtually assured of occurring to a “current expected credit losses” approach.
Under the new accounting, companies will use a more forward-looking approach to recognize credit losses, leveraging some combination of historic experience and market data to estimate losses they will experience in the future and book those losses as soon as those items are added to the balance sheet.
While the new accounting is only a little more than a half year away, at least one member of Congress is still hoping to block implementation.
Rep. Blaine Luetkemeyer (R-MO) is hearing from constituents that the economic consequences of the new accounting will be catastrophic for those looking to access credit, especially during market downturns, when increasing reserves will incentivize banks to reduce their exposure to risky loans. He’s worried banks not only will reduce lending during downturns but also raise the cost of borrowing to cover their increased reserves.
“It scares the heck out of me,” said Luetkemeyer. “A lot of people suddenly can’t afford to buy a home. It’s a bipartisan problem.”
“Reports of CECL’s destructiveness have been greatly exaggerated. In fact, I strongly believe that CECL achieves the FASB’s mission.”
Hal Schroeder, Member, Financial Accounting Standards Board
Luetkemeyer introduced a bill in late 2018, just before the Congressional season ended, but it went nowhere. He says work is now underway both in the House and Senate to renew the legislative effort.
Hal Schroeder, a member of the Financial Accounting Standards Board, which wrote the new accounting rule, says the concerns are overblown. “Reports of CECL’s destructiveness have been greatly exaggerated,” he said. “In fact, I strongly believe that CECL achieves the FASB’s mission,” which is to give investors a fair picture of a company’s financial position, including advance warning of signs of trouble.
“Better information should contribute to improved pricing and capital allocation decisions,” said Schroeder. “And, by extension, a safer financial system and a more resilient economy.”
While Congress and CECL experts debate its possible effects on the economy, organizations like Citigroup are moving forward preparing for the rule to take effect. Banks in particular have recognized the amount of work CECL represents and started early in gathering data and developing models to determine how they would comply.
Organizations like Citigroup are arguably on the leading edge of compliance. Given the size of their debt-related portfolios, they had to take it seriously and start early.
Citigroup is in the process of testing user acceptance and is preparing for parallel runs beginning in the third quarter, said Bergen. That means the company will calculate its loan loss reserves under both the current accounting and under the new standard to test how its new modeling is working in producing figures that are ready for reporting in financial statements.
Citigroup’s wholesale group is a little further along in preparing its CECL reserve than its retail group, said Bergen. The wholesale group was able to leverage work the company has undertaken in other countries where International Financial Reporting Standards apply. The international rule on recognizing loan losses—similar to, but also different from, CECL—is already in effect.
The retail group at Citgroup is more dispersed, said Bergen, with the company operating in some 100 countries. Retail is also home to some of the more complex CECL issues, she said, because it includes credit cards.
Figuring out a CECL model for revolving loan balances like those associated with credit cards proved tricky. “Cards is probably the most difficult product banks have to try to evaluate under CECL,” she said.
Early on, banks considered some different approaches to recognizing losses for credit cards, which were met with different reactions from banking regulators and FASB. Ultimately, most banks have determined they will follow a “pay-down methodology,” looking at payment history for accounts that are not routinely paid off each month.
As it turns out, the pay-down approach provides for a credit card receivable with a much longer life span than other methods that were considered, said Bergen. “The lesson learned: You need an awful lot of data and data not previously used for other purposes,” she said.
The company created a data warehouse for accumulating and testing all the data it would need to comply with CECL to assure it would be fit for financial reporting purposes. “If the data is not good, the output for the model is not going to be any good either,” said Bergen.
Citigroup also had to work out how far into the future it would take its forecasting. The company adopted different forecast horizons based on product. For credit cards, for example, the company determined 13 months was a reasonable and supportable forecast period. “Anything beyond that will be done through reversion to historical experience,” said Bergen. For mortgages, the forecast period is 40 years, she said.
“Most losses are in the early years,” said Bergen. “The further out you go with forecasts, the less reliable it becomes.”
Not all banks are taking the same position. At least one major bank is taking the view it can only forecast reliably for one year, said Bergen.
While banks are making steady progress to prepare for the new accounting, some companies outside financial services still may not recognize they are also affected by the new accounting. “Don’t think you’re escaping this standard just because you’re not a financial services institution,” said Catherine Ide, managing director of professional practice at the Center for Audit Quality. “If you don’t think this applies to you, think again.”
Jerry Trieber, director of audit services and support at HEI Hotels & Resorts, says his organization is exploring the extent to which it might be exposed to greater loan loss reserves as a result of credit card fraud. The company used to be able to rely on payment from credit card transactions, but rising levels of identity theft and credit card fraud produce greater risk of charge-backs, or reversed transactions due to fraud, he said.
“Most of our customers pay by credit card,” he said, and some pay by automated clearing house or wire transactions. “It’s this area of risk from our perspective that needs to be addressed.”
Deloitte and Bloomberg’s on-site poll would suggest plenty of companies still have much work ahead of them to prepare for the new accounting. Only a little more than one-third said they had developed a model for recognizing credit losses under CECL, and roughly a quarter said they were developing internal controls and processes for their new accounting. More than 20 percent said they hadn’t yet undertaken any preparations.