Big banks, from Citigroup Inc. to JP Morgan Chase & Co., have told investors to expect large boosts in the reserves they must set aside to cover loan losses once they follow major new bank accounting rules.
But nearly all mid-size and smaller financial institutions are still mum about the looming impact of what is considered the biggest change to bank accounting in decades.
Seven months before publicly traded banks have to adopt the current expected credit losses (CECL) accounting standard, most analysts and investors don’t know what to expect.
“We’re running the clock real close to the end here,” said Matthew Breese, senior analyst at Piper Jaffray & Co. in Boston. “We don’t know how it’s going to shake out. We don’t know what the impact will be day one.”
Developed in the aftermath of the 2008 financial crisis, the Financial Accounting Standards Board’s new accounting rule requires banks to look to the future, consider past experience, and assess the current environment to calculate the losses they expect on loans and set aside corresponding reserves. It’s a significant shift from outgoing rules, which require losses to be tallied only after customers stop making payments.
With the notable exception of Wells Fargo & Co., most big banks have signaled that their reserves will have to increase. Investors care about changes in loan loss reserves because when a bank shores up its reserves, it signals that trouble is brewing. The reserve also is a deduction against a bank’s other assets, so when it rises, net income falls. When net income falls, earnings and stock price take a hit.
Drive a truck through it
Analysts clamored for details about the loan loss accounting rules on first-quarter bank earnings calls throughout the spring of 2019. Most came away empty handed.
“We’re not ready yet or willing yet to give out any estimates what we expect the financial impact of CECL will be,” said Gregory Dufour, president and CEO of Maine-based Camden National Bank on an April 30 earnings call. He added that the bank was on track, nevertheless, to implement the accounting standard by 2020.
Other financial institutions acknowledged that their reserves will go up, but didn’t commit to details.
“We’ll have increased reserves,” said M. Terry Turner, president and CEO of Pinnacle Financial Partners Inc., a Nashville-based bank, on an April 16 call. “That number will likely be anywhere from—call it 20 percent to 60 percent—somewhere in that range. I’ll give you a range you could drive a truck through, but it’ll be more.”
Others told investors to hang tight and they’d have details later in the year.
“We’ll probably disclose something in the second quarter, but we’re not quite ready to do that yet on the CECL front,” Regions Financial Corp. Chief Credit Officer Barbara Godin said April 18.
The lack of detail so far may be frustrating, but isn’t unexpected. Publicly traded banks are scrambling to compile the right data to properly comply with the new rule ahead of its 2020 effective date. They want to make sure whatever estimates they issue are correct.
“Because once you put that out, it’s out there,” said Crowe LLP partner Chad Kellar. “You don’t want to be backtracking.”
The major accounting change will affect many aspects of how investors assess banks’ financial health. The problem is, they’re still not sure by how much exactly.
“How does it impact earnings? And how does it impact volatility, and how does it impact all those things that are going to be real drivers in how we value stocks?” said Saul Martinez, managing director at UBS. “And that’s going to be tricky.”
Because the new rules require banks to estimate foreseeable losses the day they issue a loan, most financial reporting experts believe it stands to reason that banks will have to book more losses compared to what they report now. This is especially true for longer-term loans like 30-year mortgages, where the potential for losses ticks up because more things can go wrong over a longer time period.
Other financial institutions are saying that if they specialize in credit cards, where customers can run up balances or not pay them off at all, they also could have to increase reserves significantly.
Discover Financial Corp. on April 25 told analysts that if the business were to apply the new rules to calculate total losses this quarter, it would have to increase reserves by 55 to 65 percent.
On the other hand, some banks could see reserves decrease. Wells Fargo stunned investors on April 12 when it announced that its reserves would drop under the new loss accounting method. Its CFO told analysts that because the bank didn’t have as much credit card business as its peers and because the rules allow banks to also anticipate recoveries from loans they previously thought were never going to get collected, the bank could see its reserves decline by as much as $2.5 billion.
The varying estimates leave investors scratching their heads.
“It highlights the big uncertainty around CECL—and that’s just the lack of comparability,” Martinez said. “How does Wells come up with such a different number than JP Morgan or Bank of America? They must be doing stuff differently.”
Investors Do Own Math
In the absence of concrete numbers from banks themselves, investors and analysts are running their own estimates.
Piper Jaffray research indicates that many of the community banks and regional banks it analyzes have built up sufficient reserves even under existing accounting rules and some could reduce their reserves under CECL.
Timing plays a role, too, said Breese.
In addition to looking to the foreseeable future to estimate losses, banks also have to consider past experience and current conditions. Some banks say they will look back about a decade. By the time they implement the new rules, the worst years of the financial crisis will have declining weight on calculating the reserves, Breese said.
“And that inherently means your reserves are going to be bleeding down and down and down,” he said.
Amid the uncertainty, one thing is sure: the results of the major accounting standard may vary.
“It’s really a mixed bag in terms of where institutions are kind of leaning at this point,” Crowe’s Kellar said.
What Banks Have Said So Far:
Citigroup: Reserves would increase about 20% to 30% according to its April 30 10Q. This is an increase from its 2017 estimate of 10% to 20% percent.
JP Morgan: Reserves would increase $4 billion to $6 billion, primarily due to its credit card portfolio, according to its May 2 quarterly filing. In an investor presentation, its CFO said reserves could increase about 35%.
Bank of America: Reserves would increase by up to 20%, according to its April 26 filing.
Wells Fargo: Reserves could decrease potentially up to $2.5 billion, according to May 3 filing.
Discover: An increase of up to 55% to 65% in reserves if CECL were implemented in the first quarter of 2019, according to April 25 earnings call.
U.S. Bancorp: Based “upon current conditions, I think some of the other estimates that are out there, 20% to 30% sort of impact is kind of a reasonable estimate on day one,” CFO Terrance Dolan on a Jan. 16 earnings call.
BancorpSouth Bank: “I think when you look at the range of change that we’ve seen out there from the bigger banks that have been announcing, we’ve seen some that have announced a relatively modest or small impact to their numbers, and we’ve seen others that are talking about a 30%or 40% impact to their numbers. I think what we see is, we’re going to be somewhere between those two,” CEO James Rollins said on an April 18 call with analysts.