US bank provisioning slowed significantly in the third quarter, but reserve levels remained high as the industry prepared to face the potential for further economic turmoil.
Banks increased their credit loss reserves when the COVID-19 pandemic first hit, racking up more than $ 100 billion in loan loss provisions in the first two quarters of the year. In the third quarter, provisioning returned to pre-pandemic levels as banks set aside $ 14.25 billion, down 77% from the second quarter. The drop helped ease what had been one of the biggest hurdles to bank profits.
Bankers are hopeful that the large reserve cushion they built in the first half of 2020 can absorb any loan losses that may arise from the pandemic. But the spread of the virus in the United States could complicate that outlook, as another drop in economic activity could lead to more widespread business failures and deterioration in lending.
For now, most banks are holding onto their reserves rather than releasing them. “It’s a lot easier to be conservative at this point and hold reserves … instead of being too quick to let the reserves go and then see a reversal of the improving economy and have to build up again. reserves, “William Losch III, chief financial officer of First Horizon Corp., told analysts during the bank’s earnings call. The bank continued to build up its reserves with $ 230 million in provisions during the quarter.
HomeStreet Inc. executive chairman and CEO Mark Mason told analysts his bank would opt for an “abundance of caution” until the bleak outlook becomes brighter. “Everything is very uncertain at this point, and that is why we hold these reservations against this uncertainty.”
Bank reserves stood at $ 244.27 billion at the end of the quarter, nearly double the level of a year ago and hovering around levels that followed the 2007-09 financial crisis. Industry accounting methods for accounting for reserves have changed considerably since then, with major banks adopting the new accounting standard for current expected credit losses which prompts them to recognize reserves on all loans up front rather than when individual loans start showing signs of stress.
Small banks that did not adopt the CECL standard continued to increase their provisions during the third quarter. Diane Ellis, who heads the insurance and research division of the Federal Deposit Insurance Corp., told reporters on Dec. 1 that this trend was not surprising and that future funding figures could be volatile as outlook changes quarterly.
Jennifer Demba, regional and community banking analyst at Truist Securities, says the potential for an improving economic outlook as a COVID-19 vaccine becomes available makes it more likely that reserve levels could decline by the end of 2021.
“Advances in vaccine development give us more confidence than [loan loss reserve] levels have peaked and risk is skewed toward more stable or lower dollar loan loss reserves in 2021 and 2022, “she said in a Dec. 4 report.
Yet banks face difficulties in determining their reserves under the CECL because impending economic uncertainties, such as whether Congress will agree on another fiscal stimulus package. As a starting point for their models, many banks use Moody’s Basic Economic Forecast, which assumed Congress would approve another round of tax relief for individuals and small businesses.
But the lack of progress in budget negotiations has made the basic economic outlook a bit bullish for many banks. In October, executives at Valley National Bancorp said they had changed their CECL model to weigh a little more heavily on Moody’s adverse and protracted recession scenarios, a move that ultimately led to higher provisioning.
Jay Sidhu, chairman and chief executive of Customers Bancorp Inc., said his bank was also taking a more conservative approach and booking at levels “above what Moody’s models would show.” The bank has benefited from “qualitative” reserve adjustments that banks can apply to parts of their loan portfolios that they believe may be under more stress.
“We could have justified the lack of reservations this quarter, but we chose to be more conservative,” Sidhu said during an investor call in October.
Qualitative overlays of CECL models are an “art, not a science,” with each bank making different assumptions that ultimately make it difficult for analysts to make precise comparisons, said Michael McTamney, vice president of DBRS Morningstar.
Even with rising reserves, actual credit losses remain moderate in large part due to the fiscal stimulus Congress approved this year and other relief measures to help distressed borrowers. Credit losses are expected to increase eventually, but the ‘timing is so hard to predict’ McTamney added.
“It’s going to take a long time to play,” he said.