Coronavirus and CECL affecting regulatory capital at banks

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The novel coronavirus pandemic and the credit loss accounting standard are leading to lower regulatory capital ratios at global investment banks, according to a new report.

The report, from Moody’s analyst Peter Nerby, examines how COVID-19 and the resulting economic slowdown have caused the regulatory capital ratios for U.S.-based global investment banks to decline in the first quarter because of higher provisions for credit losses and rising risk-weighted assets, with pressure amplified by stock buybacks and dividends.

The report, which looks at data from Bank of America, Morgan Stanley, JP Morgan, Citigroup and Goldman Sachs, found that net income at the banks fell sharply compared with 2019 levels because of high provisioning under CECL to reflect more adverse economic assumptions resulting from the pandemic. At the margins, bank managers have a great deal of flexibility to control the growth of their balance sheets and risk-weighted assets.

“But, if the economic recovery is delayed, downward credit migration will drive credit RWA up further, making it more difficult to prevent regulatory capital buffers from eroding,” Narby wrote.

The CARES Act that Congress passed at the end of March to provide relief in the wake of the economic devastation caused by the coronavirus included provisions that give banks the temporary option to delay the credit losses standard, also known as CECL because of the Current Expected Credit Loss model that it uses (see our story).

The Financial Accounting Standards Board had already voted last November to delay the standard for the banks and credit unions that haven’t yet implemented it because of the difficulties many privately held financial institutions were having in complying with it. But many large publicly traded banks have already begun to implement CECL in accordance with the effective date. It was originally set to take effect in January 2020 for SEC filers, except for smaller reporting companies, which were supposed to begin implementing it in January 2021. FASB’s changes pushed back the dates for smaller reporting companies and all other public business entities from January 2021 to January 2023, and for private companies and nonprofits from January 2021 to January 2023. With the passage of the CARES Act, and a further reprieve from a group of federal banking regulators on estimating the impact on regulatory capital, all banks get the temporary option to delay compliance with CECL until either the end of the year or the end of the coronavirus national emergency, whichever comes earlier.

The CECL delay should be helpful to many banks. “The incurred loss methodology allowed banks to recognize credit losses when losses were probable or have been incurred,” said Kevin Tran, an attorney with law firm Waller. “The transition to CECL requires recognition of credit losses when the losses are ‘expected’ and FASB expects lifetime losses to be recorded on Day One. As a result, effective implementation of and compliance with CECL requires a large amount of data in order to make these forecasts. Further, modeling the forecasts likely will require banks to modify or install new technology infrastructure to aggregate, process and monitor this data.”

Concerns about CECL have been overshadowed in recent months by the COVID-19 pandemic and its impact on banks and the economy at large. “Be thankful for any reprieve you receive, if you need or want to take it,” said Wes Scott, another attorney at Waller. “Recall, the extension granted in the CARES Act is optional, and most large public banks have already created their CECL controls and procedures, transitioned from the incurred loss accounting methodology and signaled to the market their transition as of Jan. 1, 2020. That said, although our banking clients remain mindful of CECL, at the moment, it is safe to say that almost all, if not all, are primarily focused on the blocking and tackling attendant to running a bank and the lending money to creditworthy borrowers in light of COVID-19. ... Thus, while CECL remains on the stove top, it is not currently on the front burner.”

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CECL Accounting standards FASB Coronavirus Moody's