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Bank Accounting Change Turns Into an Earnings Tailwind

CECL turned into an earning booster last quarter, but that may not last.

Banks have started to release the fourth quarter 2019 earnings and it looks as though some help is coming from an unlikely place: CECL.
Big banks like JP Morgan Chase, Citigroup and Wells Fargo all announced better than expected quarterly earnings last week and citied reserve releases as a factor. Under the current expected credit loss (CECL) standard adopted last year, banks are able to release reserves if they have “reasonable and supportable” evidence that the economy will turn around.
During the earnings call, all the banks said that the combination of a viable COVID-19 vaccine and bottoming out of unemployment claims informed their reserve predictions and their ability to release them based on accounting standards.
“Even as you look at this, there's been further improvement even off of the fourth quarter '20 forecast that's here,” said Mark Mason, CFO of Citigroup. “And so those are important factors in the assumptions, and what we're able to model in the way of reserve levels. And as we see that improve or improve further, we would expect that that would play out in the way of even lower reserves.”
Although CECL was not a primary driver of the reserve releases, it did mean that banks were holding a great deal more capital that could be released when models and economic conditions shifted.
“We’re seeing what everyone else is seeing, which is that the performance is substantially better than we would have thought when we went into this, and when a lot of those CECL reserves were established,” said Charlie Scharf, CEO of Wells Fargo.
The reserve releases come after all three banks took more than $31 billion in loan loss charges in the first nine months of last year to prepare for a possible pandemic related shutdowns, defaults and the newly adopted CECL standard.
Analysts from Fitch Ratings said that a “massive buildup in loss reserves” in their first three quarter of the year were significant drag on earnings, but as Q3 earnings improvements and a vaccine mean that banks could put that cash back to work. But, they warned, that could easily change if the COVID-19 vaccine rollout plan does not meet expectations.
“Any potential earnings benefit is likely to be minimal if vaccine developments and stimulus expectations have already been factored into their reserves at 3Q20,” Fitch stated.
JPMorgan Chase CEO Jamie Dimon seemed to agree with that note of caution during his earnings call.
“We don’t consider a profit. It’s ink on paper. It’s based upon lots of different calculations,” Dimon, adding that he wasn't necessarily “cheering” about the impact of the reserve releases on the balance sheet. “I think you all should look at a little bit differently now, particularly with the change in accounting rules.”