CECL’s impact on a financial institution is all about the portfolio makeup.
That’s the main message from the first financial institutions to report officially on the effects of adopting the current expected credit loss model. And while it may seem like common sense, it’s a point that can easily be lost in the anxiety of implementing the new accounting standard.
JPMorgan Chase & Co., Wells Fargo, and Citigroup disclosed the impact of adopting CECL for 2020 as they reported fourth-quarter 2019 earnings Tuesday, and allowances for credit losses (ACLs) tied to credit cards went up markedly. Allowances for longer-term loans, such as mortgages, increased some, but the impact tied to shorter-term, lower-risk loan portfolios was actually a reduced allowance.
CECL took effect Jan. 1 for larger public financial institutions reporting on a calendar year, based on the timeline issued by the Financial Accounting Standards Board (FASB). The CECL effective date is January 2023 for private banks and credit unions, as well as for what the SEC classifies as smaller reporting companies. (CECL also applies to non-financial companies.) And while much of the details on “what went into the numbers” will come out when SEC registrants file their 10-K forms and related disclosures in a several weeks, the initial reports provided some helpful information to financial institutions.
“Smaller consumer entities, such as credit unions, should pay close attention to the larger FI retail results,” said Garver Moore, Managing Director of Abrigo’s Advisory Services Group. “Of particular note was the impact to higher-risk, higher-yield instruments — consumer cards — for very large public reporters, which was indeed upward and significantly so. We found it interesting that the aggregation presented today treats these indeterminate instruments as ‘longer-term’ – 24 to 36 months.”
Meanwhile, Moore added, “the larger FI guidance for commercial lines of business is in line with our findings in the field for community FIs that the aggregate effects of CECL do not present a significant change from present-day balance sheet positions.”
JPMorgan, the largest U.S. bank by assets, said adopting CECL would result in an overall increase of $4.3 billion, or 30%, to its allowance for credit losses. Credit cards drove the biggest increase. The allowance for credit cards nearly doubled (up $5.5 billion) to $11.2 billion. For home lending loans, the allowance increased $100 million, or 5.3%, to $2 billion, and for other consumer loans, the allowance rose $100 million, or 7.7%, to $1.4 billion due to CECL’s adoption.
JPMorgan’s total estimate for the allowance for credit losses as of Jan. 1 is $18.6 billion. CFO Jennifer Piepszak noted during a conference call with analysts and investors that the accounting change results in a $2.7 billion after-tax decrease to retained earnings. JPMorgan plans to phase in the capital impact, at 25% a year between 2020 and 2023, which is equal to about 4 bp of Common Equity Tier 1.
“In [credit] cards, the increase is the result of moving to a lifetime loss coverage vs. a shorter loss-emergence period under the incurred model, whereas in wholesale, modeling changes like using specific macroeconomic forecasts vs. through-the-cycle loss rates under incurred model result in a decrease, especially given the forecasted credit environment,” Piepszak said.
More certainty around economic forecasts as the company got closer to reporting brought the final number closer to the lower end of previous forecasts, she added. “And obviously, the portfolio mix continued to be very strong as well, in terms of the performance.” she added. JPMorgan uses a two-year period for the reasonable and supportable forecast period and plans to disclose many of the details included in its estimate with its 10-K filing with the SEC.
Citigroup, too, said its credit card portfolio was the significant driver of its expected increase, which it estimates will be 29% or $4 billion. “From a regulatory capital perspective, that’ll be about 6 basis points of CET1 capital in 2020 with a full impact of about 24 bps by the time we get to the first quarter of 2023,” said CFO Michael Corbet during a conference call. “As you would imagine the significant build is on the consumer side. It’s being driven by cards.”
Wells Fargo actually announced a $1.3 billion, or 12.4%, reduction in its allowance for credit losses in 2020, along with a corresponding increase in (before-tax) retained earnings, as a result of adopting CECL.
Shorter contractual maturities on the commercial side of its business and the benign credit environment meant that the allowance for credit losses for commercial loans would be $2.9 billion lower under CECL, CFO John Shrewsberry said. On the consumer side, longer or indeterminate maturities resulted in an expected $1.5 billion increase to the allowance, net of recoveries in collateral value.
More SEC filers with 2020 deadlines will report CECL’s impacts in the coming weeks as they post fourth-quarter earnings. During a recent CECL webinar hosted by the American Bankers Association, an executive with one such institution urged financial institutions with later deadlines to start preparing early. Summit Financial Group Senior Vice President of Credit Administration Felicity Ours said this is essential to tackle data gaps and provide sufficient time to determine which CECL methodology or methodologies work best for the institution.
Some executives on Tuesday indicated that future provisioning could see incremental volatility as an impact of the accounting standard, given that reserves are more dependent on specific macroeconomic forecasts, which themselves can be volatile. “Having said that, we don’t see that that incremental volatility would be material for us, and of course, net chargeoffs are not changing,” said JPMorgan’s Piepszak. “And from a pricing perspective, we don’t foresee in the near term any pricing changes [as a result of CECL]. The cash flows with the customer have not changed.”
Abrigo’s Moore, too, reiterated that any volatility in future earnings under CECL would come from changes in the macroeconomic outlook.
“Under stable macro conditions, lending policies, and portfolio composition, users and managers should expect stable and predictable behavior in credit loss allowance ratios,” he said.
About the Author
Mary Ellen Biery is a Senior Writer and Content Specialist at Abrigo.