I think it’s safe to say we all have some “Bad Blood” with the COVID-19 pandemic. Each of us has somehow been impacted by this pandemic, including banks. Today, I’ll give you an update on recent happenings when it comes to the current expected credit losses (CECL) model and financial institutions with a little help from one of my favorite musicians, Taylor Swift (because we could all use a little fun right now!). 

“Everything Has Changed”, except for the “End Game”

Accounting Standard Update (ASU) 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Loss on Financial Instruments was issued in June 2016 and created Accounting Standards Codification Topic 326 (ASC 326). ASC 326 fundamentally changes how banks estimate credit losses on financial assets. The CECL model is a complete mindset shift from the incurred credit loss of previous GAAP and was the result of the financial crisis of 2008 in an attempt to make banks more “Safe and Sound” by requiring entities to set aside reserves at the time of origination or acquisition of a financial asset. The CECL model requires entities to incorporate considerations of past events, current conditions, and forecasts of the future when estimating credit losses.

That said, the “End Game” of the allowance for credit losses, or ACL, remained the same – to reflect, on the balance sheet, the net amount of the asset (e.g. loans, securities, etc.) the entity expects to receive. If you are looking for an overview of ASC 326, check out our self-study, eLearning course.

“New Year’s Day”

Calendar year-end SEC filers were required to implement the CECL model on “New Year’s Day” 2020 (January 1, 2020). The effective dates of ASC 326 have changed a bit since the issuance of ASU 2016-13 in 2016! Implementing ASC 326 is a very big undertaking and many smaller filers felt as if the FASB was being “Mean” with their original effective dates. Many commenters suggested the delay in effective dates to allow smaller institutions more time to apply the guidance and use lessons learned by larger institutions. In November 2019, ASU 2019-10, Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates, resulted in a delay in the effective dates for smaller institutions. The chart below reflects the delayed effective dates of ASC 326.

“Look What You Made Me Do”

So, how did the adoption of CECL impact large banks? We performed an analysis of 20 financial institutions and found that the range of impact varied considerably! While most institutions reflected an increase to their reserves, two institutions actually reflected a decrease. Based on this analysis, the range of change to the ACL was a decline of 12% to an increase of 154%. In dollar figures, the impact ranged from a decline in the institution’s ACL of $1.3 billion to an increase of $4.3 billion. The average impact for our sample was an increase of 42.81% or $1.3 billion. Check out the full analysis here!

“Begin Again?”

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020 and includes provisions that temporarily delay the implementation of the CECL model with ASC 326. The delay stipulates a bank will not be required to comply with ASC 326 until the earlier of when the national emergency related to COVID-19 is terminated or on December 31, 2020. So, will most banks use this delay to revert back to the legacy GAAP incurred loss model used “Back in December” before they implemented CECL? Probably not, based on clarifications provided by regulators on their interpretations of how the delay will work.

Shortly after enactment of the CARES Act, regulators clarified some key points:

• Deferring the adoption of the CECL model would comply with U.S. GAAP for the periods the relief is provided by the CARES Act.
• If a bank is going to defer implementation of the CECL model, they must do so prior to filing any quarterly reports in 2020.
• Banks that defer the adoption of the CECL model will need to restate their year-to-date results when the CECL model is adopted. This means restating results as if the CECL model were originally adopted as of January 1, 2020 if the model is implemented later in 2020.

The last bullet point has many banks singing “I Knew You Were Trouble!” Essentially, this means that the bank can delay booking the impacts of the CECL model, but must track the impacts and “take the hit” of the CECL model once the delay ends. For this reason, we don’t anticipate many banks to utilize the delay provision of the CARES Act because they won’t want to “Begin Again” with CECL.

“Cruel Summer”

Unfortunately, it is shaping up to be a “Cruel Summer” when it comes to credit loss reserves for banks. On top of the impacts from the initial adoption of the CECL model (see above for those figures), the unknown of COVID-19 brings on more challenges and the need for additional reserves. Will customers fall behind on their credit card payments? Auto loans? Home mortgages? What about business loans? As a result of this uncertainty, many banks have significantly increased their reserves for credit losses.

While the first quarter financial data is starting to be released by banks, below are some of the impacts to the ACL we have seen thus far in press releases. The increases below are in addition to the impacts of the original adoption of CECL we noted above.

• JPMorgan Chase & Co. estimated an increase to their reserves by $6.8 billion.
• Citigroup, Inc. estimated an increase to their reserves by $4.2 billion.
• Wells Fargo & Company estimated an increase to their reserves of $3.0 billion,

These are startling increases! Keep watching as the first quarter 10-Qs are released to see the impacts on other banks. GAAP Dynamics has an analysis underway for a future blog post! 

“Are You Ready for It?”

Is your entity ready to adopt the provisions of ASC 326? Have a question on applying ASC 326 or IFRS 9? We currently have an online course on the CECL model. Let us know how we can help with your changing training needs during these interesting times. We have quite the “Reputation” of providing engaging training in various modalities!

Not “Out of the Woods” yet

While we may not be “Out of The Woods” with COVID-19, please join us in continuing to “Stay, Stay, Stay” at home. And don’t forget to take a dance break amidst all this craziness to “Shake It Off!” Hopefully soon we’ll all be able to tell COVID-19 that “We Are Never Ever Getting Back Together!”

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Disclaimer  

This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.