Thanks to last week's coronavirus relief law, U.S. banks have the ability to delay implementation of the controversial current expected credit loss accounting standard. But many might find it easier to proceed with CECL adoption all the same.
Delaying CECL gives banks that were scrambling to prepare for the first quarter report more time to refine their processes. Those that delay will not have to report the amount of loan loss reserves needed for consumer loans under CECL. That could be significant: Consumer loans are expected to perform poorly through the pandemic, and the loans tend to require greater reserve builds under CECL. Before the coronavirus crisis, consumer lenders such as auto-focused Ally Financial Inc. and credit card-heavy Discover Financial Services estimated that CECL would require reserve builds of 75% to 100%, compared to 20% to 40% increases for diversified banks.
However, taking advantage of the delay brings risk and cost. Large public banks already adopted CECL on Jan. 1, so reverting to the old incurred loss model would mean undoing a change that took years of preparation. Banks have to worry whether putting off CECL would trigger a poor reaction from a volatile equity market. And a switch in plans would require coordination among staff working from home.
The biggest banks were the first to adjust to CECL. JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. all provided reserve estimates by the 2019 first quarter earnings season.
"The biggest banks, who largely had all their work done as of early March … are prepared to move along and just get it done," said Christopher Marinac, director of research at Janney Montgomery Scott LLC.
While smaller banks might consider taking advantage of the delay, many factors could encourage them to stick with CECL. Top of the list is a March 27 interim final rule from federal regulators that said banks could delay the estimated impact on regulatory capital for up to two years. The capital delay applies to both the banks' "Day 1" reserve build that comes out of equity as well as the "Day 2" provisioning that affects quarterly income reports.
CECL's critics have expressed concern that the new accounting standard's impact on bank capital ratios would constrain lending.
"Anecdotally, I think the number of banks that were thinking about this [delay] was already very low," said Reza van Roosmalen a principal at KPMG US, noting that his clients skew to larger banks. "It was really the smaller banks that were thinking about this. My expectation is that, after [the capital rule], that number has decreased even further."
Van Roosmalen also noted that analysts and investors like to compare financial years across time. Postponing adoption in the first quarter and then having to adopt in the second half of the year would create an uneven financial year, complicating year-over-year comparisons. The relief law allows companies to delay the standard until the government lifts the state of emergency or Dec. 31, whichever comes first.
"You [would] create a financial year that is never going to be comparable to any other year," van Roosmalen said. "This is a very unprecedented time, so maybe people will forever ignore 2020."
Ultimately, it may be the complexity of reversing course that convinces banks to proceed with CECL. While banks have not yet reported their Day 1 reserve builds, well-prepared lenders have already implemented policies that track loan loss reserve accounting. And even if they opt to delay adoption, banks would still need to calculate what their CECL builds would have been, Marinac said.
"You still have to keep two sets of books because you're expected for GAAP purposes to adopt CECL as soon as the emergency act is pulled," he said.
There are also logistical considerations. With many bank employees working from home, a last-minute switch back to the CECL standard would be hectic. And as banks work to accommodate their clients' needs and operate a complex financial institution in an unprecedented environment, the additional work to avoid adopting an accounting standard they already embraced might seem frivolous.
"What I have heard from the clients I've talked to is they're going to look at it, but they already put in place the infrastructure to start reporting," said Robert Klingler, a partner with Bryan Cave Leighton Paisner. "So I think they're more inclined to go ahead [with CECL]."