JPMorgan Chase’s investor presentation last week gave one of the first looks, if not the first, at how a new set of accounting rules for reporting losses on loans will impact the reserves set aside to cover them at a major U.S. bank.
JPMorgan Chase CFO Marianne Lake said the financial institution expects to have to increase reserves by about $5 billion, or about 35 percent, on day one of its implementation of the current expected credit loss standard, or CECL.
And while other banks may not see the same 35 percent increase that JPMorgan estimated it could have, people take notice when the nation’s largest bank by assets gives its outlook on the impact of the new accounting standard, which will go into effect on Dec. 15, 2019, for SEC-filing financial institutions.
So what was behind JPMorgan’s estimate, and are other banks – especially community banks who make up the majority of financial institutions in the U.S. – likely to see similar influences? It depends, according to Chris Emery, Abrigo Director of Strategy and Engagement.
“The impact of CECL on financial institutions’ allowance for credit losses will likely vary by institution because CECL is based on many factors, and one of the most important is the types of loans in the institutions’ portfolios,” he said. Credit cards, for example may have different loss rates than mortgages, so if a financial institution has very few credit cards on its books, its CECL impact may be dissimilar to one that has a large credit card portfolio.
Lake during the investor presentation called out credit cards as the biggest driver of JPMorgan Chase’s current allowance for loan and lease losses (ALLL), which is determined using the incurred losses method of estimating credit losses under GAAP. She also pointed out that JPMorgan Chase is currently reserving for a shorter period of losses on credit cards than the average life of its revolving balances.
“In cards today, we have a little over $5 billion in reserves,” Lake said. “And remember that we are currently reserving for about 12 months of losses, while the weighted average life of revolving balances is closer to two years. So obviously, the [CECL] modeling is considerably more complicated than that. But about two times our current reserves seems reasonable. And while there will be other pluses and minuses, across the remaining portfolios, in these cases, current reserve estimates including qualitative elements are much closer in terms of their coverage today to CECL estimates.”
Emery said that in addition to differences tied to the types of loans at an institution, the impact of CECL will vary among institutions because reserves are currently based on loss-emergence periods expected for each type of credit, as opposed to losses expected over the lifetime of the loan, which will be the case under CECL. The size of the delta between these period will, to some extent, drive how large the delta is between the incurred and expected loss, he added.
The impact of CECL could also vary significantly based on each institution’s current or forecasted view of the economic environment, Emery said. Indeed, JPMorgan Chase’s CFO Lake said, “Ten months from now when we implement [CECL], if then recessionary indicators are indeed flashing red, then obviously our estimate of lifetime losses would be higher,” up to $10 billion. JPMorgan also noted that its estimates of the CECL impact depend on its continuing review of its models, methodology and judgments, something other financial institutions are also likely to be reviewing in the coming months, according to Emery.
“Financial institutions need to be thinking about all of these impacts,” Emery said.
Abrigo provides both of the American Banker Association-endorsed solutions for CECL compliance, Sageworks ALLL and MST Loan Loss Analyzer, and offers advisory services to help financial institutions implement CECL. Abrigo also offers complimentary resources, such as webinars, whitepapers and a website focused on the allowance, ALLL.com.