Get Started for Free Contexxia identifies hard-to-find pieces of information in SEC filings. No more highlighters, no more redlining, no more poring over huge documents. Discover Financial Services (1393612) 10-Q published on May 02, 2019 at 4:52 pm
Reporting Period: Mar 30, 2019
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The guidance requires lessees to capitalize most leases on their balance sheet whereas under previous GAAP, only leases previously identified as capital leases were recognized on the lessee's balance sheet. Leases previously identified as capital leases are generally identified as financing leases under the new guidance but otherwise their accounting treatment remains relatively unchanged. Leases previously identified as operating leases generally remain in that category under the new standard, but both a right-of-use asset and a liability for remaining lease payments are required to be recognized on the balance sheet for this type of lease. The manner in which expenses associated with all leases are reported on the income statement remains mostly unchanged. Lessor accounting also remains substantially unchanged by the new standard. The new guidance became effective for the Company on January 1, 2019 and, as permitted by the standard, management elected to recognize a cumulative-effect adjustment as of the effective date without adjusting comparative prior periods. Additionally, management elected the package of practical expedients to not reassess prior conclusions related to (1) contracts containing leases, (2) lease classification and (3) initial direct costs. Management also made an accounting policy election to exclude short-term leases of one year or less from the balance sheet. As a result of adoption, the Company recorded immaterial adjustments to other assets and accrued expenses and other liabilities to recognize operating lease right-of-use assets of $49 million and operating lease liabilities of $56 million, respectively. Leases are not material to the Company or its consolidated financial statements.
Current Expected Credit Loss
In June 2016, the Financial Accounting Standards Board issued Accounting Standards Update No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which is effective for us on January 1, 2020. The standard alters accounting principles generally accepted in the United States by replacing the incurred loss model with the current expected credit loss (“CECL”) approach. The CECL approach requires our allowance for loan losses to be based on an estimate of all expected credit losses over the remaining contractual term of all of the loans, as opposed to an estimate of incurred losses as of the balance sheet date. We are currently refining loss forecasting models and technological solutions, and advancing processes and controls in support of the new standard.
To enhance investors' understanding of the potential impact of CECL, we are providing a preliminary estimate of the impact on the allowance for loan losses assuming the standard had become effective for us on March 31, 2019. That estimate, which is subject to further refinement, would have resulted in an increase in the allowance for loan losses of approximately 55% to 65%. The ultimate extent of the impact upon adoption will depend on the characteristics of our loan portfolio and economic conditions at that date, as well as forecasted conditions thereafter.
Under Basel III rules for regulatory capital, DFS and Discover Bank are classified as "Standardized Approach" entities, defined as U.S. banking organizations with consolidated total assets over $50 billion but not exceeding $250 billion and consolidated total on-balance sheet foreign exposures less than $10 billion. The Basel III rules revised minimum and "well-capitalized" risk-based capital and leverage ratios, effective January 1, 2015, and refined the definition of what constitutes "capital" for purposes of calculating those ratios of which certain requirements were subject to phase-in periods through the end of 2018; as of January 1, 2019, thresholds within the Basel III rules are fully phased-in with the exception of certain transition provisions that were frozen pursuant to regulation issued in November 2017. For additional information regarding the risk-based capital and leverage ratios, see Note 10: Capital Adequacy to our condensed consolidated financial statements.
Under rules in effect in 2018, DFS was required to publish company-run stress tests results twice each year and Discover Bank was required to publish bank-run stress tests annually. Certain statutory changes under the EGRRCPA and proposed changes to regulatory rules, if adopted, would substantially change the stress testing and capital planning requirements applicable to us for 2020 and beyond. During the first quarter of 2019, we were notified that we are not required to participate in CCAR or submit to supervisory stress tests for the 2019 stress test cycle. However, our capital distributions for the period between July 1, 2019 and June 30, 2020 will be limited based on a formula that is largely based on results from the Federal Reserve's 2018 supervisory stress test. In April 2019, we submitted our planned capital actions for the period between July 1, 2019 and June 30, 2020 to the Federal Reserve. Moreover, we remain subject to certain capital stress testing requirements, including the development and maintenance of a capital plan approved by our Board of Directors. However, Discover is not required to disclose the company-run stress test results in 2019.