With the recession retreating, at least seven large lenders surprised market watchers last quarter by clawing back some loss reserves.
Releases at Bank of America Corp., JPMorgan Chase & Co. and KeyCorp, among other banking companies, helped jolt profits while delivering more evidence that loan losses are ebbing.
Reserving has been among the most complicated and controversial topics in banking since the start of the recession, as investors and regulators worried that the country's top banks would become insolvent because they lacked enough money to cover losses as the mortgage market collapsed.
The issue of reserves remains divisive now that it looks as if they are plateauing and poised to shrink industrywide.
Wall Street welcomed news that banks with big reserves were comfortable enough with their loss projections to start releasing some. Skeptics, meanwhile, questioned the wisdom of doing so this early in the recovery.
Richard K. Davis, the chairman and chief executive of U.S. Bancorp in Minneapolis, for one, said last week in discussing why his company keeps building reserves that the number of banks releasing reserves caught him off guard.
"I think it's prudent to continue to have strong reserves," he told analysts. "It's a surprise to me."
He was not alone.
Banking analysts said they had not anticipated reserves falling until later this year, though they said this first round of releases was not rash, given signs that loan losses are stabilizing.
"I was a little surprised to see it happen in the first quarter," said Terry McEvoy, a regional banking analyst at Oppenheimer & Co. Inc. "I would also add that the overall credit trends showed greater improvement, stronger improvement than I was looking for … allowing these banks to release the reserves."
Banks build reserves by setting aside more loss provisions than chargeoffs. They shrink them by doing the opposite.
"The reserves are there to anticipate chargeoffs — the chargeoffs are happening," McEvoy said. "Why do you need to refill the reserve? You don't."
The seven large banking companies that have released reserves — which include Huntington Bancshares Inc., Capital One Financial Corp., First Horizon Corp. and Citigroup Inc. — are well above the industry average when it comes to key ratios like allowances-to-total-loans and allowances-to-nonperforming-loans.
Bank of America, for instance, has an allowance-to-loan ratio of 6.8%, among the highest in banking.
The average ratio for banks with at least $10 billion of assets was 3.66% at yearend, according to federal data. The other six lenders' ratios are all higher than that.
U.S. Bancorp, meanwhile, has allowances covering 3.6% of loans, so it does not have as much freedom as the others to release reserves. Its reserves rose 3.3% from the prior quarter, to $5.44 billion.
"We're still in the midst of a downturn, and the evidence of an economic recovery is still pretty mixed," said Todd Hagerman, an analyst at Collins Stewart LLC. "You're seeing reserve release at those [banks] with the most cushion against their portfolios and, more specifically, those with reserves allocated against commercial portfolios."
He said commercial credit is "holding up better than expected." Reserves, for the most part, are a bank's best guess — based on math and professional judgment — of how much money it will need to cover eventual losses on bad loans. Banks rely on hard data like past chargeoff and delinquency rates as well as on subjective outlooks about the economy's direction.
Loss forecasts eased dramatically during the first three months of the year, as banks across the board said fewer consumer and commercial borrowers had missed at least one loan payment. Rates of new delinquent borrowers are also falling to pre-recession levels. These are key gauges of prospective losses.
Brian Moynihan, the chief executive of Bank of America, said in a conference call with analysts on April 16 that "decreasing chargeoffs" and "potential reserve releases" would be ongoing trends as "modest growth in the economy through the rest of 2010 will continue."
A reserve release of nearly $1 billion on better consumer credit performance helped return Bank of America's credit card business to profitability.
JPMorgan Chase shrank its credit card reserves by $1 billion. That, coupled with some better-than-expected loan sales in its investment bank, prompted a reserve release of $919 million.