Congress Enters the Fray on CECL Delay

Following expressions of investor concern and reports of significant impacts on banks, members of Congress have introduced legislation to require reconsideration of the CECL (Current Expected Credit Loss) accounting standard.

A bill introduced in May by Senator Thom Tillis, Republican of North Carolina, and several Republican colleagues calls for a pause in implementation of CECL to allow for a quantitative study of its impact on bank capital and on the economy. A similar, bipartisan “stop and study” measure was introduced in the House on June 11.

CECL, issued by the Financial Accounting Standards Board in 2016 and going into effect December 15, 2019, represents a significant shift from accounting for loans and leases on an incurred-loss basis. The Bank Policy Institute and other trade groups called for a delay and further study of CECL late last year (see CECL Pushback: Banks Want Deadline Extended). Estimates of CECL's impact by big banks including JPMorgan Chase & Co. and Wells Fargo & Co. reinforced those concerns.

The Senate bill calls for analyzing CECL's impact on:

• The availability of credit, especially for consumers and small businesses.
• The rate of depletion of bank regulatory capital during a recession.
• Financial institutions of different sizes.
• Investors' decisions.
• U.S. banks' competitiveness.

Michael Gullette, senior vice president, accounting and tax at the American Bankers Association, said the bills are unlikely to be signed into law, in part because of time pressure before the December effective date.

Sending a Message

Gullette said, however, that “initial passage” could get the Securities and Exchange Commission “to the table to reconsider what to do. I know [the SEC has] talked to over a dozen significant fund managers - mainly specializing in financial institutions, but also managing a lot of other monies - that initially contacted me about their concerns.”

Those fund managers likely included Capital Group, which manages nearly $2 trillion in assets, and Franklin Templeton Investments, managing upwards of $750 billion. Both submitted letters to the FASB last December raising questions about CECL's effect on financial disclosures.

“We believe it will reduce, rather than enhance, our ability to analyze credit risk and other important factors,” said the Capital Group letter. “Because of the embedded assumptions that will be required, we fear up-front provisioning for expected impairments over the life of a loan will not be useful in understanding the financial condition or the earnings of a business.”

Franklin Templeton went further, arguing that CECL's implications go far beyond financial statements and that FASB should reconsider its implementation: “The ramifications of these changes will likely stretch beyond accounting to the cost of capital for businesses and, therefore, economic activity. They will serve to drive activity further away from the regulate banks and into the shadow banking market.”

If so, said Michael Fadil, until recently executive vice president and CECL program director of Providence, Rhode Island-based Citizens Financial Group, that would appear to contradict FASB's mission statement, which is to “establish and improve financial accounting and reporting standards to provide useful information to investors and other users of financial reports and educate stakeholders on how to most effectively understand and implement those standards.”

Neither FASB nor the SEC have publicly addressed that concern.

No Sign of Retreat

FASB appears to be set on its course.

Jon Howard, senior consultation partner at Deloitte & Touche, noted that regional banks in a letter to FASB last fall expressed concerns about establishing allowances on day one for expected losses over the life of the loan. They instead proposed splitting allowances: one piece representing losses over the next year, another for losses after that, with changes in the one-year portion going to the income statement; and the second portion to other comprehensive income.

In a FASB-sponsored public roundtable on the issue in January, large banks already testing CECL models and smaller banks concerned about producing two allowance numbers expressed disfavor for the proposal.

“FASB has said in a public board meeting it is not going through with [the regional banks' proposal], and all the messages from FASB have been that CECL is happening,” Howard said. He added that FASB board member R. Harold Schroeder stated at a Bloomberg-sponsored event in May that the standard-setter had no plans to defer CECL or change it significantly.

Bank Projections

CECL requires banks to recognize credit losses expected over the life of the loan on day one, but does not allow them to recognize any of the corresponding future interest income from the loan, determined by its credit risk. Under the existing incurred-loss approach, losses are recognized losses when they become probable.

Citigroup reported in February that for the fourth quarter 2018, using forecasts of macroeconomic conditions and exposures at that time, the CECL methodology would increase its loss reserves between 10% and 20%.

In an April investor presentation, JPMorgan Chase estimated an increase in loan-loss reserves under CECL of about 35%, or $5 billion. Marianne Lake, then chief financial officer and now CEO of consumer lending, said that credit cards are the bank's biggest driver of current allowances for loan and lease losses. The bank is currently reserving for about 12 months of losses, while the weighted average life of its revolving balances is closer to two years, hence doubling the reserves under CECL.

Reduction at Wells Fargo

Wells Fargo, also in April, reported a reduction in its reserves by as much as $1 billion. It said the decrease reflects short contractual maturities of commercial loans and the current economic environment.

Deloitte's Howard pointed to the longstanding practice of banks assuming, depending on their borrower relationships, that many relatively short-term commercial loans will be rolled over. As a result, under current accounting, they may allow for potential losses past the current loan. Because CECL restricts allowances to the contractual terms of the current loan, they may set aside less.

Similarly, a lender engaged in construction financing may now establish an allowance that considers both the upfront bridge loan and the subsequent 20-year term loan, since the latter is when losses are most likely to occur. Under CECL, however, it can only set aside an allowance on the bridge loan.

Those types of loans could result in allowance numbers dropping.

The Credit Card Challenge

Fadil said credit card assets are particularly problematic under CECL, since the “life of loan” concept only captures the amount borrowed on the reporting date, but cardholders are free to borrow up to their credit limit soon after.

What's more, weak borrowers with high balances and low monthly payments increase the life of the loan and, under CECL, potential losses over that life, thereby requiring greater loss reserves. Customers who, by contrast, pay off their balances monthly have only a one-month CECL credit risk to be calculated.

JPMorgan's sizable projected reserve increase could reflect a high concentration of weak borrowers in its card portfolio. Fadil said a more likely explanation may be that the initial CECL reserve increase doesn't go through net income in the financial statements. That allows the bank to stockpile reserves, given CECL's unclear application to credit cards, and enables it to ensure higher future earnings by lowering future CECL reserve allowances or pulling money out of reserves.

“That's just a guess, but it's exactly what I would do - and it's 100% OK under the new accounting standard,” Fadil said.

Economy and Procyclicality

The provision in the Senate bill to analyze CECL's effect on bank regulatory capital during a recession appears to address Wells Fargo's estimated loss. A benign economic outlook today and for the foreseeable future reduces expected losses under CECL and the resulting reserve allowances, especially for commercial loans that typically have shorter maturities.

“Folks thought that CECL would just boost reserves across the board, but in a benign economic environment, that's not true at all,” Fadil said.

If reserves entering a downturn are lower under CECL than current-day reserves but have to be increased even more as the economy slows, this would reduce banks' lending power at exactly the time when businesses need the financing.

Such interactions between the financial system and real economy that amplify the business cycle are known as procyclicality. “That leads to the concern, which the banks have had for years and now politicians also have, that the CECL loan-loss-allowance methodology won't help to counter the procyclicality of the existing incurred-loss reserve methodology, but rather it will exacerbate procyclicality,” Fadil said.