Retailers who rely on in-house branded credit cards to fuel sales face a potential revenue hit this year because of a change in accounting standards that affects their bank partners.

Under the current expected credit loss (CECL) standard that went into effect for SEC filers for fiscal years beginning after December 15, 2019, banks are required to set aside reserves for their entire book of loans based on estimated losses for the full life of those loans. 

Previously, banks set aside their reserves on an incurred-loss basis. The reserves were only for loans showing signs of trouble and typically only for 12-month periods. 

The change has a potentially disproportionate impact. How much the banks set aside in their reserves determines how much, and at what cost, they make credit available, greatly affecting the amount of credit-related income retail partners with in-house cards can expect to generate. 

The rules-setting board that made the change, the Financial Accounting Standards Board (FASB), has said it expects the new standard to affect how banks calculate the timing of losses, but otherwise shouldn’t have any bearing on the amounts banks set aside for reserves. 

But analysts at Morgan Stanley say the impact is likely to be far more consequential. Banks will end up making less credit available, and at a higher cost, because of the increased volatility the change introduces in their reserve calculations. 

"We expect loan loss provision volatility to increase," the analysts said in a recently released research report. "This drives up cost to originate new loans, especially for the lower credit quality borrowers to whom many retail card portfolios skew."

What’s more, should the economy dip into a recession this year, as some are predicting, banks will recognize loan loss reserves at a much faster rate and in much higher amounts, which will slow credit availability. 

"On top of shoppers beginning to pull back on spend," the Morgan Stanley analysts said, "profits from the card portfolios would decline more rapidly."

The new standard took effect this year for big banks. It goes into effect for community banks and credit unions in 2023.  

Macy's, Kohl's hit hardest

Retailers Macy’s, Kohl’s and Nordstrom, whose sales depend disproportionately on their in-house card customers, will be most affected, the analysts said. 

Macy’s is expected to be particularly hard hit, because as much as 70% of its operating profit (earnings before interest and taxes) is projected to come from its in-house card sales, and that’s expected to grow to as high as 85% in 2021.

For big retailers in general, the average share of their operating profit from credit card sales is 50%, the analysts estimated. 

"Removing the credit growth engine from these stores could further weigh on [earnings per share] and valuations," the analysts said. 

Bank concerns

For years, banking trade groups have been trying to get FASB to rethink the CECL changes, but besides getting the effective date pushed back until 2023 for community banks and credit unions, they haven’t been successful. 

"A partial delay without a requirement for study or reconsideration does not reduce the ongoing data, modeling and auditing requirements … or address the increased procyclicality it will cause," Rob Nichols, president of the American Bankers Association (ABA), said last year.

In a move that could help banks in their battle against CECL, Rep. Blaine Luetkemeyer, R-MO, ranking member of the House Financial Services Committee, introduced legislation last year that would subject FASB to the same regulatory approval process as federal agencies. 

That process includes a review period in which Congress gets a chance to weigh in before regulatory changes are finalized and put into effect.

The legislation hasn’t moved forward, but it sends a message to FASB — a private, nonprofit group — lawmakers have it in their sights. 

"This bill will not take away FASB's independence, but it will force them to perform the due diligence they have proven unwilling to do," Luetkemeyer said. 

A spokesperson for FASB said the organization and its parent, the Financial Accounting Foundation (FAF), were ready to work with interested groups to allay concerns.

"FAF and FASB are committed to continue meeting with stakeholders on Capitol Hill and elsewhere to answer their questions, hear their concerns and discuss the time-tested benefits of the integrity of the standard-setting process," the spokesperson said.