New accounting may prompt more conservative lending terms post-Covid.
FASB’s new accounting for loan-loss reserves, current expected credit losses (CECL), directly impacts banks and other lenders and ultimately the loans they provide.
- Tim McPeak, principal industry consultant in the risk research and quantitative solutions division of SAS, the data analytics provider, said that the current pandemic and economic downturn have blurred the impact of CECL, effective for larger banks and most public companies since the start of 2020.
- Nevertheless, CECL will be a key factor in lenders’ credit decisions, and borrowers should query them about its impact on their loans.
- Bankers may not point to specific changes in terms, but CECL could impact banks’ risk appetites, Mr. McPeak said, adding that in regulatory filings such as 10Ks management discloses the effects of accounting policy.
What to watch for. CECL requires lenders to reserve upfront for potential losses they estimate over loans’ lifetimes, so the longer the loan, the greater the risk for potential loss, and the higher the associated reserve.
- The average lifespan of corporate loans is less than, say, residential mortgages, so CECL’s relative impact will likely be less. However, Mr. McPeak said, it is a factor lenders must now consider when negotiating terms such as maturity and credit spread. “Since lenders will have to take all that reserve upfront, that may result in slightly higher spreads or shorter maturities,” he said.
- Covenants and underwriting standards may also be affected,” Mr. McPeak said, adding that the lower a company’s debt rating, the greater CECL’s impact.
- Masha Muzyka, risk and account solutions team lead at Moody’s Analytics, said that because CECL does not consider extending loans, banks may be incented to offer short-term instruments with extension options cancellable by the lender rather than the traditional longer-term instruments with prepayment options.
- She emphasized, however, that CECL will be just one of several factors influencing their credit decisions.
- Corporate borrowers anticipating credit renewals would be wise to seek clarity about CECL’s impact from their lenders, Mr. McPeak said.
CECL’s long-term impact. In late spring meetings, NeuGroup members discussed lenders’ pandemic-induced unwillingness to provide longer-term loans. The pandemic started shortly after CECL went live, so its impact on loan terms is blurry, Mr. McPeak said
- “With the interest-rates so low, lenders’ search for yield, and the resulting competition, it may not move the needle all that much, but it’s likely a contributing factor,” Mr. McPeak said.
- He described CECL as an “accelerant” likely to fuel more conservative terms after the pandemic is gone.
Less work for captives. Corporate captives providing financing options to customers are also subject to CECL, impacting their reserves, Mr. McPeak said, but complying with it should be simpler operationally.
- “Captives’ loan types tend to be more uniform, with typically the same type of underlying collateral and loan structures,” Mr. McPeak explained.
- Still, some captives, such as those financing heavy equipment, may provide longer-term loans with more creative structures, resulting in either putting up more reserves or more conservative lending. “Depending on the type of financing they’re providing and its duration, the impact could be meaningful,” Mr. McPeak said.
- Those companies may securitize those assets, removing them from their balance sheets and lowering reserves, but institutions purchasing the loans would carry the reserve mantle.
Corporate portfolio impact. Most corporate treasuries place cash in money markets and other short-term investments unaffected by CECL. However, companies with longer horizons and/or oodles of cash may invest in longer-term securities classified for accounting purposes as “held-to-maturity,” and they may be subject to CECL.
- “It gives treasurers more to think about in terms of the accounting treatment of the bonds their companies are holding,” Mr. McPeak said, adding that “it could impact the types bonds these companies hold.”