More than a year ago, Sheila Bair warned that reductions in loan-loss provisions couldn’t drive bank earnings forever.
She was right, but reserve releases rebounded in the first quarter, and the decline in writeoffs of bad debt has continued to outpace drawdowns of allowances, suggesting more room to run.
Across the industry, reserve releases, or the amount by which chargeoffs exceed loss provisions, have accounted for 15% to 30% of quarterly net income since early 2010, assuming an effective tax rate of 35%.
Reserve releases jumped 32% from the fourth quarter to $8 billion in the first quarter, though growth in revenue meant that their contribution to the bottom line held even at about 14%. Still, without past set-asides running through income statements, the industry’s return on equity would have been more than a percentage point lower at 7.8% during the period, and that much farther away from the range of 11% to 13% that prevailed in the quarters leading up to the recession.
Chargeoffs peaked at an annual rate of $220 billion in the fourth quarter of 2009, or 96% of aggregate reserves at the end of the period. In other words, banks were on pace to burn through their allowance in about a year. They didn’t — chargeoffs eased and, at an annual rate of $87 billion in the first quarter this year, measured 48% of industrywide loss allowances. That’s roughly on par with levels during the first three quarters of 2007. (The recession officially began that December.)
Reserves were only 60% of a still-enormous pile of nonperforming loans in the first quarter, however, well below ratios of 130% or more before the crisis, a perspective that underscores the former Federal Deposit Insurance Corp. chairman’s point. Nevertheless, chargeoffs remain elevated too, eating through bad assets, and banks have shown comfort cutting provisions as credit improves.
Credit cards continue to explain much of the change in loss provisioning. JPMorgan Chase (JPM) boosted its card reserve release by 50% from the fourth quarter to $750 million in the first quarter, accounting for 45% of the allowance reduction across its entire loan portfolio.
Meanwhile, reserve releases dipped in the first quarter at companies like Wells Fargo (WFC) and U.S. Bancorp (USB), which have relatively small credit card businesses and never had swings in allowances comparable to competitors like JPMorgan, Bank of America (BAC) and Citigroup (NYSE:C).
Among the Big Six, reserve releases in the first quarter ranged from 5% of earnings per share at U.S. Bancorp to 330% at B of A.
Even if the apparent bottom in the credit cycle holds, and the reservoir contained by the gap between allowances and chargeoffs has not been depleted, executives continue to emphasize that reserve releases are transitory.
Echoing a note he has sounded before, JPMorgan CEO Jamie Dimon said in April that he does not expect big reserve reductions “in credit cards anymore.”