Provisions for credit losses at U.S. banks shrank to their lowest levels in years, continuing their slide after lenders built up massive reserve cushions in the first half of 2020.
Banks set aside just $3.6 billion in provisions for credit losses during the fourth quarter, driven by the large amounts of reserves already in the system and muted loan growth prompting small build-ups of new reserves. Provisions were down from $52.4 billion in the first quarter of 2020 when new accounting standards kicked in and $61.73 billion in the second quarter of 2020 when lenders started to account for the impacts of the COVID-19 pandemic.
Credit costs "hit an inflection point" during the fourth quarter of 2020, according to Peter Winter, a bank analyst at Wedbush Securities. Most banks have now started to release some of their past reserves, as lenders grow more confident in the economic outlook and a fresh round of fiscal relief hits their customers' pockets.
"This massive fiscal stimulus has served as an important bridge for businesses to reopen and important financial support for consumers, which helped to keep credit costs manageable with no looming spike as the year unfolds," Winter wrote in a note to clients.
While banks are "not out of the woods just yet," particularly those with larger hotel exposures, Winter wrote the improved outlook has pushed most banks to start releasing some of their existing reserves.
The industry's reserves dipped to $236.56 billion during the fourth quarter of 2020, down from $244.26 billion in the previous quarter. Banks' reserves as a percentage of their total gross loans declined to 2.18% during the quarter, down from 2.24% in the third quarter of 2020.
Most of the largest banks in the U.S. saw declines in that ratio, with two exceptions: U.S. Bancorp and Truist Financial Corp.
Terrance Dolan, U.S. Bancorp's vice chairman and CFO, told investors in January that the bank wanted to wait for the outlook to clear up a bit more before releasing reserves. Daryl Bible, Truist's senior executive vice president and CFO, also hinted at future reserve releases, assuming the economic recovery progressed further and some of the uncertainty ebbed.
Banks' improved credit prospects have helped drive investors toward their stocks in recent weeks, as equity investors continue shifting away from tech stocks that boomed during the pandemic and toward banks and other "value" stocks. Investors have also been drawn in by the increase in longer-term bond yields, which bode well for banks' net income as interest rates on loans adjust higher.
The likelihood of a strong recovery and the additional round of relief checks for households should start to drive some reserve releases on the consumer front, said Cheryl Pate, a portfolio manager at Angel Oak Capital Advisors who focuses on the banking industry.
Hotels, restaurants and other sectors of the economy still face an uncertain outlook, but the trends in banks' credit books have been "very strong" with fewer businesses asking for loan modifications and loans continuing to come off deferral status.
"That gives us some comfort that credit losses this cycle are probably lower than anticipated" and more gradual, Pate said.
