UPDATE:Rainy-Day Funds Account For Half Of Big Banks’ Earnings

NEW YORK (Dow Jones)–Call it steroids for bank profits.

The biggest U.S. banks virtually doubled their collective earnings in the third quarter just by injecting $8.1 billion into net income from funds they’d set aside to cover loan losses.

There are 18 commercial banks in the U.S. with at least $50 billion in assets, and together they earned an adjusted $16.8 billion in the third quarter. Of those profits, nearly half, or 48%, were from drawing down what bankers call loan-loss reserves, according to an analysis by Dow Jones Newswires. A year ago, the same 18 banks earned $6.2 billion in quarterly profits; at that time, they added more than $7.8 billion to the same reserves, a move that reduced their profits. The analysis omits a $10.4 billion noncash charge to earnings that Bank of America Corp. (BAC) disclosed during the third quarter.

Lenders are likely to disclose more releases from reserves for quarters to come. The reason: American banks set aside so much capital for loan losses during the financial crisis that they still hold bigger reserves than at any other time in modern history, according to Moody’s Investors Service Inc.

“Going back to 1948, banks’ reserves, as measured by total loans outstanding, are at the highest levels we’ve ever seen,” said Gerard Cassidy, analyst at RBC Capital Markets.

At the heart of the issue is a set of arcane corporate governance accounting rules that call for banks to release loan-loss reserves as soon as they don’t expect to need them, even against the protest of some bank officials. The sharp reductions in loan-loss reserves illustrate how starkly banks’ economic forecasts have improved in recent months, even as borrowers continue to face persistently high unemployment and a slumping U.S. economy.

For borrowers looking for capital, the shrinking loan-loss reserves at banks also show how lenders have pulled back from loans to riskier borrowers in the wake of the financial crisis.

J.P. Morgan Chase & Co. (JPM) earned $4.4 billion in the third quarter, in part because it released $1.7 billion from the bank’s loan-loss reserves. During a recent conference call with investors, Chief Executive Jamie Dimon told investors, “We don’t release reserves because we want [to hit] earnings targets or something like that. We release them because we have to.” He called the rules “silly” and said they promote the industry’s history of boom-and-bust cycles; banks are unable to build an extra cushion of reserves in good times, and then have to build such reserves when loan problems surface.

But as banks’ lending activity and revenue have fallen in the last two years from overheated levels before the financial crisis, the sharp reductions in reserves have been a great help to big banks’ earnings.

In fact, releases from reserves eclipsed earnings at two big banks. Fifth Third Bancorp (FITB) earned $238 million in the third quarter after the Cincinnati regional bank released $500 million from its loan loss reserves. KeyCorp (KEY), in Cleveland, earned $219 million after releasing $263 million from reserves.

At other banks, draw-downs from reserves accounted for the vast majority of third-quarter profits. Of Citigroup Inc.’s (C) $2.2 billion in earnings, 92% came from reserve releases. Similar releases accounted for 82% of earnings at Capital One Financial Corp. (COF) in McLean, Va., and 65% at Huntington Bancshares Inc. (HBAN) in Columbus, Ohio.

Two other regional lenders reported smaller losses after releasing reserves. Marshall & Illsley Corp. (MI) in Milwaukee lost $144 million in the quarter, but released $128 million. Zions Bancorp (ZION) in Salt Lake City, lost $47 million and released $51 million.

Banks’ moves to shrink their reserves are also a reflection of a decade-old fight between investor advocates and regulators.

The Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency want banks to set aside money based on expected losses over time–and they prefer banks use longer time horizons. Said Cassidy: “Regulators have never seen a reserve they didn’t like. In their view, more is better.”

The Securities and Exchange Commission, on the other hand, has in the past slammed banks for setting aside too much capital for loan losses and using the fat reserves to pad earnings. In the late 1990s, the SEC questioned the loan-loss accounting used by Atlanta-based SunTrust Banks Inc. (STI), and the bank agreed to cut provisions.

In the third quarter, SunTrust earned $153 million after releasing $75 million from its reserves.

Source:  WSJ


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