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Bank Buybacks Are Dead for 2020 on Coronavirus Loss Provisions

Bank Buybacks Are Dead for 2020 on Coronavirus Loss Provisions

(Bloomberg) -- The biggest U.S. banks have to recognize potential loan losses more quickly under accounting rules that took effect in January, a shift that means share buybacks are unlikely for at least the rest of 2020.

As the economy buckles under the weight of the coronavirus pandemic and more borrowers struggle to make payments, top lenders may have to set aside as much as $164 billion in loss provisions this year, according to analysts’ estimates. That would wipe out profits, though trading revenue is expected to rise because of market volatility.

Regulators are trying to cushion the blow. In this year’s industry stress tests, which help set capital levels for the largest firms, the Federal Reserve won’t take into account the new accounting rule, known as CECL. But the banks themselves, which start reporting first-quarter earnings on April 14, will base their results on it, meaning they’ll have to be more conservative in capital planning, company executives and industry analysts say.

“Big commercial-loan portfolios will see big provision jumps,” Gerard Cassidy, an analyst at RBC Capital Markets, said in an interview. “It will hit earnings hard, even if they’re able to report profits. They won’t be asking for share buybacks for the rest of the year, which will also be the right move politically.”

JPMorgan Chase & Co., Bank of America Corp. and the six other banks considered systemically important by regulators have already suspended buybacks until the end of June to conserve capital and expand lending to companies and consumers coping with the virus fallout. Some regional banks have followed suit.

Analysts at Keefe, Bruyette & Woods, who project the five biggest banks will boost provisions by $80 billion this year, expect buybacks to be suspended until the middle of 2021. Even more pessimistic is Goldman Sachs Group Inc., whose estimate for provisions is roughly twice that of KBW. Goldman is predicting the buyback freeze will last until the end of 2022.

Bank Buybacks Are Dead for 2020 on Coronavirus Loss Provisions

The gap between the two forecasts underscores how difficult it’s been to make reliable estimates of bank results, including loan losses, amid the chaos of the first quarter.

CECL’s hit to earnings might also threaten a few of the banks’ dividends, Goldman analysts said, though that outcome could be avoided if government support for the economy averts enough loan defaults. The Fed’s emergency-lending programs will also help soften the blow.

“It’s not clear if companies will draw on all these rescue packages, so it’s hard to factor them into estimates of loan losses,” Brian Kleinhanzl at KBW said in an interview. “It’s also hard to tell how the Fed’s asset buying and other programs will provide support.”

RBC’s Cassidy expects first-quarter loss reserves to jump 20%, though he predicted a bigger surge in the second and third quarters as the economic fallout becomes clearer.

Congress and regulators have also given banks several months before they have to count as debt restructurings the temporary delays given to borrowers due to the pandemic. That will postpone the recognition of some loan losses.

‘Better View’

The Financial Accounting Standards Board came up with the new loss-recognition method after critics said banks were too slow to realize losses in the 2008 crisis. The rule requires lenders to predict how a deteriorating economy will spark defaults even before borrowers stop paying.

“CECL will do exactly what it was supposed to do, giving investors each bank’s more informed view of the situation,” Hal Schroeder, a FASB board member, said in an interview.

The new accounting rule also encourages a faster release of loss reserves when the economy rebounds. Goldman analysts, who expect a sharp downturn and a relatively fast recovery, predict provisions reversing course in 2021. KBW analysts, forecasting a stretched-out but less-severe contraction, see provisions continuing next year.

In the past, the Fed chastised big banks if their stress-test results fell too far from regulators’ calculations, seeing it as a weakness in their risk-management systems. In this year’s test, where the two results will diverge more than usual because of the CECL effect, the regulator won’t hold discrepancies against the firms, according to people familiar with the preparations.

The stress tests are also changing in a more fundamental way this year: The Fed will no longer approve or reject firms’ capital-distribution plans for the following four quarters. Instead, the test’s hypothetical losses will be used to create a new capital buffer on top of current requirements, which the banks will have to stay within. If capital falls below the stressed buffer, cash distributions to shareholders have to be curtailed in a staggered way depending on the shortfall.

Because the cash-return limits are based on reported net income, part of the calculation will still be affected by CECL even though stress tests won’t. That will also force banks to be conservative in their buyback plans to make sure their dividends remain intact, analysts and executives say.

©2020 Bloomberg L.P.