Loan-loss reserves may represent too much of a good thing at many banks.

Since 1990, banks have built up huge reserves for loan losses -- in some instances equaling four times the sizes of bad loans.

Regulators, skittish after congressional criticism of the handling of the thrift crisis, ordered the heavy reserving at some banks in the face of growing real estate lending problems.

But the reserves may now need to come down after two years of strong performance by the nation's banks. If banks don't cut reserving, they may understate earnings and book value.

"I think [falling reserves] will have a huge impact on 1994 and 1995 earnings," said Thomas Hanley, banking analyst at First Boston Corp.

He said that 29 of the 35 large banks he tracks were overreserved by a total of $9.9 billion at the end of the first quarter.

At these 29 banks, net income could rise a total of $6 billion next year and in 1995 if quarterly provisions fall to bring reserve coverage of loans to 80% of nonperforming loans from 180% at March 31.

Book Value Seen Rising 6.7%

And the book value of these 29 institutions would increase an average 6.7% from the first quarter.

Some large banks may even be able to take money out of reserves in future quarters, Mr. Hanley added.

He said regulators are starting to reassess their previous insistence on heavy reserving and have asked banks to lower their reserves in the next year.

Where Reserves Are Highest

Mr. Hanley said some of the banks with the biggest surplus reserves are J.P. Morgan & Co., First American Corp., Nashville; Norwest Corp., Minneapolis; First Chicago Corp.; Fleet Financial Group, Providence, R.I.; and First Interstate Bancorp, Los Angeles.

Donald Coonley, chief national bank examiner at the Office of the Comptroller of the Currency, said examiners have been issued no new marching orders regarding loan-loss reserve levels.

Mr. Coonley acknowledged that he has received more questions lately from field examiners about how to judge whether a bank's reserve is excessive or not.

But he said the overall number of inquiries is still small -- less than 10 requests in the past two months, mainly involving banks in the Northeast.

"Two years ago, we were getting comments from examiners -- they don't have enough reserves," Mr. Coonley said. "Now we are getting the question, Do they have too much reserves?"

He said he plans to talk to OCC district managers to ensure that the issue is addressed properly.

"You want to be sure you have a fair balance-sheet presentation, and when times get bad you don't want reserves currently at hand to be used to mask deterioration," he said.

He declined to comment on individual banks.

Orders to Cut Provisions

But executives at small banks said the Comptroller's office has already begun ordering their institutions to cut quarterly provisions or take money out of reserves.

Ron Edwards, president and chief executive officer of First National Bank and Trust Co. of Ardmore, Okla., said that OCC examiners last summer ordered his bank to put $180,000 from the reserve back into income.

"When I heard about it, it blew my hat into the creek," he said. "We wish we didn't have to do it. It flies in the face of everything we've seen in Oklahoma."

Threat of a Suit

Michaux Nash Jr., chairman and chief executive officer of EastPark National Bank in Dallas, said he reduced the bank's provision after examiners said they could sue his bank's directors.

"We said we can't believe this," Mr. Nash said. "Three or four years ago they came blasting in here and said we were underreserved. Then they come in and say we are overreserved. We said it is prudent for us to be a little overreserved. We have been taught all our lives to save for a rainy day."

Off the Record

Big banks, too, have started to notice a change among regulators.

"It's interesting that we in the industry are starting to hear the regulators change their tune a little bit, not exactly on the record, but a little bit in conversation," said Malcolm Murray, chief credit officer at First Union Corp.

Mr. Murray said regulators started to get "itchy" when reserves that are not allocated to specific loans hit 20% of loans at First Union. However, he said that regulators have not specifically told the bank to reduce its reserves.

"They are raising the issue, and I think they are feeling a little funny suggesting that reserves may be high," he said.

First Union's reserves equaled 98% of nonperforming loans on March 31.

Slow Loan Growth

Mr. Murray said that in past economic recoveries, loan growth "essentially absorbed any excess reserves."

In the current recovery, weak loan growth means it will take longer to absorb reserves, he said.

Lower provisions in the industry will reflect both the lower levels of nonperforming loans and decreasing chargeoffs.

"I think we and other banks will see provisions declining over the next four to six quarters," he said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.