Banks Releasing Loan Reserves Face Tricky Accounting Estimates as Economy Improves

Banks and other financial institutions are devising how to release large loan reserves under an accounting rule that complicates the task of calculating them.

To do so, executives at companies including

JPMorgan Chase

& Co. and

Citizens Financial Group Inc.

are scrutinizing metrics such as credit quality and loan growth to help estimate the level of future reserves amid the continuing economic uncertainty.

Many lenders bulked up their loan reserves this time last year to prepare for potential defaults during the onset of the pandemic, cutting into profits. Banks’ provisions for credit losses totaled $61.91 billion in the second quarter of 2020, compared with $12.84 billion during the prior-year period, according to the Federal Deposit Insurance Corp., a federal banking regulator.

Now, investors and analysts are increasingly questioning the banks on when their reserves will go back to pre-pandemic levels. But jumping the gun could be dangerous: Lowering reserves too quickly and then needing to rebuild them could hurt companies’ credibility and reduce income, accountants and advisers say.

Under U.S. accounting standards, companies are required to forecast expected losses as soon as a loan is issued. The rule, known as Current Expected Credit Losses, or CECL, went into effect for large public firms in January 2020, with some of them choosing to delay implementing it for a year because of the pandemic. Private and smaller public companies have until 2023 to adopt CECL.

Companies previously didn’t have to book losses until they had evidence—such as the default of a borrower—that the losses had actually occurred.

CECL particularly impacts financial institutions because loans comprise a large portion of their assets. The standard also affects nonfinancial companies with financial assets ranging from loans to debt securities. Bankers say the rule makes company earnings more unpredictable. The Financial Accounting Standards Board, which sets U.S. accounting standards, however, has said the rule more closely aligns companies’ accounting with actual credit risks and provides investors with more transparency.

The improved economic outlook and soaring markets are leading banks to slash the funds they held for loan losses, thus boosting profits. JPMorgan on April 14 said it freed up $5.2 billion in funds it had allocated to cover soured loans, bringing its reserves to $25.6 billion. The bank’s loan assets totaled $1.01 trillion as of March 31.

The bank released most of the $5.2 billion in its consumer credit-card division because certain mortgage delinquencies remain low and U.S. employment levels have improved, Chief Financial Officer

Jennifer Piepszak

said on an earnings call. JPMorgan declined to comment beyond its filing and the earnings call.

Executives are careful about the amount of reserves they hold because they are unsure about where the economy is headed, said Donald Fandetti, a managing director of equity research at Wells Fargo & Co.’s securities division. The bank on April 14 said it released about $1.7 billion, bringing its reserves to $18 billion in the first quarter. “Everybody is leaving a bit of cushion,” Mr. Fandetti said.

John Woods, chief financial officer at Citizens Financial Group


Citizens Financial Group

Citizens Financial Group also lowered its reserves. The bank on April 16 said it let out $298 million in the quarter ended March 31, compared with the $463 million it built up during the prior-year period. Citizens said it made the move because of the improved economic outlook. The bank’s credit-loss provision was $1.62 billion in 2020, up from an average of $352.3 million during the previous four years.

The Providence, R.I.-based bank overrode the economic forecasts it usually relies on from ratings firms and other external providers to better incorporate economic uncertainty into its reserve levels, CFO

John Woods

said. Those forecasts are highly dependent on factors such as the efficacy of Covid-19 vaccines, Mr. Woods said.

Citizens is weighing other scenarios to project credit losses, such as slower vaccination rates and consumer spending, he said. “That’s where the judgment comes in to layer in additional reserve requirements to deal with some of those contingencies,” he said.

Investors generally like it when banks bring down their reserves because it frees up capital for lending and investments, said Janet Pegg, an analyst at research firm Zion Research Group. Continuing to hold high reserves could signal to the market that a company is overly pessimistic about its loan book.

The FASB is considering whether to make changes to the standard. For that, it is consulting companies, investors and other stakeholders, and plans to host a roundtable discussion on May 20.

Firms that haven’t had to implement the rule yet are also watching closely. Texas Security Bank, a privately held Dallas-based lender, is studying the techniques that big banks use to determine their provision for credit losses, CFO Drew Keith said.

“The big takeaway we have is that you do have to be careful with the subjective part of it,” he said, referring to forecasting losses under the standard. Mr. Keith said he plans to consider a mix of different economic forecasts, including those from research firms


Analytics, a subsidiary of Moody’s Corp., and ITR Economics.

Write to Mark Maurer at [email protected]

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