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CECL Standard Disrupts Net Income Performance Gauge

 

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Banks began implementing the Financial Accounting Standards Board (FASB) current expected credit loss (CECL) model nine months ago, but significant fluctuations in reported bank profits have started to raise a few eyebrows. According to The Wall Street Journal, despite the pandemic and subsequent economic volatility, revenue among banks has remained flat throughout all of these events despite what their earnings report might otherwise indicate1.

The intention of the CECL standard was to alter the use of financial statements to show investors what losses might be expected to occur rather than provide a description of past losses, the Journal of Accountancy reports2. Of course, as the pandemic began to unfold, initial economic projections were bleak, particularly in regard to unemployment and how that might impact mortgages. Prior to federal intervention, The Wall Street Journal reports that the banking industry foresaw inevitable losses and prepared to account for them accordingly by bolstering reserves as the CECL dictates banks must set aside funds to offset potential future loan losses1.

When the initial projections proved inaccurate, those funds were ultimately released. As a result, wild deviations in net income percent change can be found on the banking industry’s quarterly performance report. Long used as the bar by which bank performance is measured, it is clear that net income isn’t necessarily a reliable indicator any longer, which is troublesome as stock valuations still rely on it as a gauge1.   

Despite net income continuing to serve as a broad indicator of profit, many analysts are using alternative numbers, which do not include the loan-loss provision, to make forecasts:

“Citigroup bank analyst Keith Horowitz said investors making long-term bets on banks should look at what the provisions say about bank forecasts. ‘What’s most important on earnings day is what are you telling me about the future earnings potential,’ Mr. Horowitz said. ‘It’s a measure of the direction the banks are going1.’”

Have thoughts about the affects of the CECL standard and how it has modified company behavior and is impacting income statements? Share them on MICPA Connect


References:
  1. Benoit, David. “How a New Accounting Rule is Making Bank Earnings Go Wild.The Wall Street Journal. 03 Jun. 2022. Accessed on 08 Jun. 2022.
  2. Tysiac, Ken. “Credit Losses: 4 Things You Need to Know.Journal of Accountancy. 17 Nov. 2021. Accessed on 08 Jun. 2022.

Source: MICPA

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