The first-quarter earnings season was marked by historic reserve releases by the U.S. banking industry, and more could come in the quarters ahead.
With the economic backdrop improving, banks released a record amount of reserves and posted a negative figure for credit loss provisioning, funds set aside to cover the cost of loans that are expected to go bad. This was the first time on record that the banking industry in aggregate reported a negative credit loss provisioning figure, according to S&P Global Market Intelligence and Federal Deposit Insurance Corp. data, which go back to 1990 and 1984, respectively.
"That would be a first as far as I'm concerned," said James Barth, a finance professor at Auburn University who studies financial institutions. "Maybe the uniqueness of that is the uniqueness of the pandemic."
Trillions of dollars worth of government stimulus payments helped keep U.S. businesses afloat and kept the level of net charge-offs — loan losses banks have written off — relatively low, making many in the industry comfortable with releasing reserves by the billions. Banks have amassed a huge pile of reserves due to significant provisioning in 2020, as well as the adoption of the current expected credit loss accounting standard, which requires banks set aside reserves sufficient to cover all expected losses over the life of a loan. Some analysts expect more reserve releases in the quarters ahead, potentially extending into 2022.
In the first quarter, banks combined to report negative provisioning of $13.38 billion. That is a stark difference when compared with the first part of 2020, when banks were worried the pandemic would trigger significant loan losses. In the first quarter of 2020, banks posted a positive provision figure of $52.40 billion and the figure rose to $61.73 billion in the second quarter of 2020.
Across the industry, banks released $22.34 billion of reserves in the first quarter, the largest reserve release on record in S&P Global's database. The previous peak came in the 2011 first quarter, following the Great Recession, when banks released $12.96 billion of reserves.
The FDIC has annual reserve data back to 1948. Prior to the Great Recession, the largest reserve release for a full year was $4.76 billion in 2005.
As a percentage of total reserves, the first-quarter release is also the highest on record. It represented a release of 9.4% of the banking industry's reserves, compared to a 5.6% release in the 2011 first quarter. Going back to 1948, the largest full-year reserve release came in 1976 when the industry released 28.5% of its reserves, according to the FDIC data.
In the first quarter of 2021, JPMorgan Chase Bank NA, the nation's biggest bank by assets, posted the largest negative provisioning figure at $4.28 billion. Even Sallie Mae Bank, the bank with the largest quarter-over-quarter increase in provisioning, still posted a negative provision of $135.1 million, compared to a negative provision of $311.6 million in the 2020 fourth quarter.
Despite the optimism, banks may still see credit deterioration. Some have expressed concern that the effects of the pandemic have not fully been felt yet and certain borrowers could soon face greater hardships. But even after the first-quarter reserve releases, banks still have a huge buffer to absorb loan losses.
The banking industry increased its credit loss reserves, in aggregate, by nearly $120 billion between the 2019 fourth quarter and the 2020 second quarter thanks to adopting CECL and heavy provisioning at the onset of COVID-19. Following the 2021 first-quarter reserve release, the industry still has $214.27 billion in reserves, representing 1.98% of gross loans. Before implementing CECL, reserves stood at 1.18% of gross loans.
CECL drew the ire of many bankers who argued the standard would be pro-cyclical, reducing banks' income in recessionary times and boosting it in recovery. This can increase volatility in banks' earnings results, requiring massive builds as the economic outlook deteriorates and significant income boosts when the forecast improves.
"I think the numbers speak for themselves," said Joe Stieven, chairman and CEO of Stieven Capital Advisors, an investment firm focused on financials. "There are things that we had warned about with CECL, and the pro-cyclicality was one of the biggest problem areas."
Looking ahead, banks will likely continue to release reserves, though possibly not at the same velocity as in the first quarter, said Gerard Cassidy, a bank analyst with RBC Capital Markets. Analysts at Fitch Ratings also project reserve release continuing in the quarters ahead.
On earnings calls and in analyst notes, many in the industry have noted that they expect reserves returning to "CECL Day 1" levels — the total when many banks adopted CECL on Jan. 1, 2020. Cassidy said he thinks banks could release reserves below Day 1 levels since CECL requires the use of economic forecasting models, and outlooks may have improved compared to 2020.
"The outlook was still positive in 2020, but it was late in the cycle," Cassidy said. "It was the end of the cycle whereas today we're at the beginning of an economic expansion."
