Garnet Capital Advisors Blog

Excerpt:

The Financial Accounting Standards Board (FASB), which establishes accounting rules for American companies, turned down banks' proposal to modify CECL to alleviate its effect on earnings.

JPMorgan Chase expects to boost loan-loss reserves by about $5 billion by the time CECL is implemented.

The Financial Accounting Standards Board (FASB), which sets forth accounting rules for financial institutions, recently rejected banks' request to modify CECL. The proposed modifications would have softened the CECL's impact on financial institutions' capital and earnings.

Current Expected Credit Losses (CECL) is a new loan-loss accounting standard recently issued by the FASB, which now replaces the current Allowance for Loan and Lease Losses (ALLL). It is being put in place to help financial institutions more accurately predict estimated credit risk among loan assets.

The new model will require banks to have higher loan loss reserve levels, and make necessary changes to lending practices and loan portfolio management to offset risk.

The FASB adopted the CECL in 2016 after it was argued that loan losses were booked far too slowly following the financial crisis of 2008. Currently, banks are only required to record losses after they have actually occurred and evidence supports their existence. In turn, investors may be left out of the loop about the real viability of banks.

However, banks, credit unions, and finance corporations have had concerns over these accounting changes, claiming that the newly implemented CECL would require banks to record losses on bad loans a lot faster. Preparing for major accounting changes to reserve for losses is a huge undertaking, and such a concern has been brought forth to federal lawmakers.

Banks' accounting practices will be put to the test with the implementation of CECL.

Banks are also worried that the need to record losses up front could put a damper on lending and even hasten a potential economic downturn in the future. They presented their concerns to regulators and recommended that changes be made to the CECL to soften its effects on bank earnings.

Accounting rule makers ultimately decided to turn down the banks' proposal to ease up on the changes. Instead, the FASB rejected the request, and as such, the new CECL will be implemented for publicly traded American-based banks by 2020.

This will force many banks to increase their reserves, which could eat into their capital and earnings. As soon as loans are issued, banks will be required to record all expected future loan losses under the forthcoming CECL.

With such imminent changes to loan-loss recording requirements, banks are in a position to ensure their loan portfolios are robust. More specifically, banks should take a proactive stance and make necessary changes to their loan portfolios to help them ride the changes successfully.

This can entail inserting a 5-year balloon, which would avoid the need to project — and reserve for — longer-term losses, as well as selling longer-duration assets and replacing them with shorter-duration, higher-quality consumer assets. Garnet Capital can help with both.

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