CECL, pronounced “Cecil,” requires credit card companies and banks to look at charge-offs in a much less forgiving manner than the decades old tradition of the former standard known as “Allowance for Loan and Lease Losses (ALLL).” That’s a mouthful, but expect significant change over the coming years. The approach is much more conservative.
In a recent Mercator Viewpoint on CECL, we noted that the American Bankers Association’s view is that “The CECL model represents the biggest change-ever-in bank accounting.” And from two other credible sources we are following: Moody’s, the rating agency, projects that “Firms may need to increase their ALLL by as much as 50% over current levels when CECL is implemented.”
Deloitte’s position is that “the FASB’s new current expected credit losses (CECL) accounting standard is the most impactful accounting change in over a decade,” which is similar to the position of the American Bankers Association quoted above.
Compliance Week, a regulatory trade journal, reviews number on the impact to large banks. Our conservative view seems spot-on.
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.
Bank of America views the change as a downstream opportunity with 2020 risk.
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.
And, Citi saw cards as a driving factor for future risk.
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.
And Wells experienced a pop in consumer risk offset by a decrease in commercial risk. This is most likely due to controls placed on Wells after their credit card debacle.
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 is below their current recovery value.
What Mercator is watching for during this transition year: Will banks tighten up lending as a result of the change, or will they wait for the economy to go into a downturn? We think the former is a good, conservative approach.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group