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MARKETS FEBRUARY 3, 2012
The rainy-day funds that U.S. banks have been tapping
to boost their earnings could soon begin to dry up, and
that doesn't bode well for bank profits. Colin Barr
reports on Markets Hub.
By MICHAEL RAPOPORT
The rainy-day funds that U.S. banks have been tapping to boost their earnings could soon begin to dry up, and
that doesn't bode well for bank profits.
Many banks have been "releasing" reserves against bad loans since the worst of the crisis passed and the
economy began recovering. That money flows to the bottom line, helping some banks boost earnings at a time
when lending and trading profits have been soggy.
But with loan-loss cushions now receding toward precrisis
levels, some analysts doubt banks can afford to keep up the pace
of reserve releases. Lowering reserve releases could increase
pressure on profits that are being hit by slow economic growth,
low interest rates and tighter rules.
The releases are "masking some horrible operating
performance," said Mike Mayo, a banking analyst for Crdit
Agricole Securities. "The bottom line is your earnings power is
decreasing."
As banks write off bad loans as uncollectable, they are releasing
reserves they no longer need to cover those loans. When those
charge-offs exceed new funds being added to reserves, there is a
net release of reserves. That money is booked as income.
The top 10 U.S.-owned commercial banks released $4.3 billion
in reserves in the fourth quarter, according to an analysis by The
Wall Street Journal, boosting after-tax earnings by $3.5 billion.
The analysis assumes that the income generated by the reserve
releases was taxed at the same rate as the banks' net income for
the period. The latest-quarter releases accounted for nearly a
quarter of the banks' earnings, up from about 15% in the third
quarter. For 2011, these companiesthe biggest U.S. banks, excluding securities firms Goldman Sachs Group
Inc. and Morgan Stanleyreleased $26.7 billion of reserves on a pretax basis.
Citigroup Inc.'s fourth-quarter after-tax reserve release, at $1.3 billion, exceeded its $1.2 billion in net income.
Bank of America Corp.'s $906 million after-tax reserve release was 46% of its $2 billion fourth-quarter profit.
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Banks Depleting Earnings Backstop
Days Numbered for Using Reserves to Increase Profit
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Reserve releases also contributed significantly to profits at regional banks including SunTrust Banks Inc., Fifth
Third Bancorp and KeyCorp.
Banks say the reserve releases are justified by declines in bad loans and the economy's improvement. The
releases are permissible under accounting rules.
At Bank of America, nonperforming loans are down to 2.74% of total loans, from 3.75% two years ago. A Bank of
America spokesman said the Charlotte, N.C., company is "better able to release reserves" because of a stronger
economy and tighter underwriting standards, which should mean fewer loan losses in the future.
Citi follows standard accounting practices in handling reserves, a spokesman said. The New York institution's
reserve as a percentage of loans, at 4.69%, is "at the high end of our peers," the Citi spokesman said. A KeyCorp
spokesman said the Cleveland bank's improving credit quality "results in a need for lower levels of reserves."
SunTrust, based in Atlanta, and Cincinnati-based Fifth Third declined to comment.
But analysts note the releases aren't high-quality contributors to earnings, because they aren't generated by the
banks' core businesses and can't be repeated indefinitely.
"It's cotton candy," said Matt McCormick, a portfolio manager and banking analyst with Bahl & Gaynor
Investment Counsel in Cincinnati. "It looks good, but it's not going to be substantial for you."
Some banks say accounting rules and regulatory guidance essentially force them to release reserves when losses
are easing, because the rules use past and current loan losses as the criteria for determining the proper level of
reserves. But critics say that model led banks to be too late in recording loan losses during the crisis. Accounting
rule-makers have tentatively agreed to shift to a new model based on future projections of losses, which could
prompt banks to show losses and add to reserves more quickly.
To complicate matters further, regulators sometimes differ among themselves on what banks should do about
reserves. Bank regulators, focused on banks' safety and soundness, want them to keep reserves relatively high.
But the Securities and Exchange Commission wants them not to be too high, so that banks don't amass
"cookie-jar" reserves they can release into earnings when it suits them.
Banks now have released much of the reserves they added in the wake of the financial crisis. Citi, for instance,
released about $14 billion of reserves in 2010 and 2011reversing most of the $18 billion it added to reserves
between the start of the crisis and the end of 2009.
Citi's current loan-loss allowance is well off its high of 6.8% of total loans in 2010, and its lowest level since the
end of 2008, when the allowance was 4.27% of loans and the bank was ramping up its large reserve buildup.
The Citi spokesman said the mix of the banking firm's portfolio has changed significantly, with a decline in
nonperforming corporate loans.
Reserve releases don't drop directly to the bottom line, because they become income that must be taxed. But the
earnings contribution at some banks is substantial. For all of 2011, Citi released $6.3 billion in reserves on an
after-tax basis55% of its net income of $11.3 billion.
Release trends are worth watching because "it's difficult for these guys to make money the old-fashioned way,"
Mr. McCormick said, referring to banks in general.
Write to Michael Rapoport at Michael.Rapoport@dowjones.com
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