Why Every Bank Will Miss Earnings This Season

by thekingoftherodeo

For everyone wondering why JPM had a big EPS miss (& you’re going to see this with every bank btw); its because of a little doozy FASB pitched to the industry called Current Expected Credit Losses or CECL.

Now you autists, like most of the analysts who come up their shitty guidance, likely do not have the faintest idea of accounting. Which is why shit like JPM this morning confuses the hell out of you. How could they miss so badly? COVID must be crushing them.

Not really. Here are some salient points;

  • Key difference between old GAAP and new GAAP is that you must now estimate the lifetime expected credit loss for your loans adjusted for forecasted conditions. So the $6.8B increase JPM disclosed is their estimate of the total losses they expect to incur over the lifetime of the current portfolio. This is literally as bad as they expect it to get as of 3/31/20. Caveat that they’re limited on the accuracy of this by their modeling capability.
  • Day 1 (1/1/20 no COVID) impact goes through retained earnings (i.e. no income statement impact), but subsequent measurement (i.e. 3/31/20 big COVID) goes through income. Hence the massive pop in reserves.
  • They’re almost certainly using a multi scenario weighted macroeconomic model and would have shifted the weightings to reflect the COVID environment; think something like 80-10-10 of most stressed economic environment:moderate stressed economic environment:baseline. On 1/1/20, COVID related reserves were but a twinkle in some Chinese bankers eye.
  • Subsequent Q’s won’t see as big an income statement impact as the delta between prior Q provision (officially Allowance for Credit Losses) and current Q provision shouldn’t be as vast.
  • You effectively had a black swan event for this adoption where 1/1/20 (it’s effective date), you wouldn’t have weighted a stressed economic environment as heavily (if at all, we nearly had the tip in 30,000 DJI almost as recently as Feb), versus 3/31/20 the remeasurement date where you have to account for, well virtually total cessation of normal economic activity.

So when they speak to building reserves (FASB will have a conniption at that language btw), they’ve assessed their entire portfolio for lifetime expected credit loss. You see the numbers pop particularly in cards, which are unsecured and your loss given default would to all intents and purposes be 100% vs mortgage loans where you’ve collateral.

Also important to bear in mind that since ~2018 the bigger lenders have been keeping higher quality mortgage loans on the books (basically they aren’t selling top quality 800 FICO stuff to FNMA FMCC much if at all). This leads me to believe that JPM have been consistently strengthening their underwriting criteria and that the ratings the model is using should be relatively accurate to the risk.

TL;DR: Watch out for the banks who elect to defer CECL implementation because it likely meant their models adjusted for COVID gave them numbers they didn’t want to push through Q1 earnings

TL;DR of the TL;DR = Accounting rules will screw Q1 EPS but it shouldn’t be as volatile going forward



Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.