Bank loan

U.S. Bank Loan Loss Projections Exceed Allowance Levels

As banks begin to report second quarter profits, they are largely expected to post staggering credit costs. But an optimistic view believes that a second round of large loss provisions could be enough to put the bulk of the pandemic’s damage behind them.

To get a sense of where the industry is going, S&P Global Market Intelligence analyzed how much banks have already set aside for loan losses compared to stress test loss projections. For the historical context, this analysis also looked at the actual charges during the last deep recession.

Overall, the build-up of loan loss reserves in the first quarter raised the credit provisions of the major banks to levels roughly comparable to those at the onset of the 2008-2009 recession. Banks are better capitalized now. But with actual cancellation rates during the 2008-2009 financial crisis higher than what was projected in recent stress tests, the idea that further and significant increases in loan loss reserves are needed to reconcile banks plausible losses over the entire cycle looks good. based.

Among a group of 17 banks with more than $ 100 billion in assets, reserves as of March 31 represented a median of 32.4% of projected loan losses over the nine quarters considered by the most recent stress tests of the Federal Reserve, under the hypothetical “severely adverse” scenario. . In this fiscal year, the clock begins to run in the first quarter of 2020, when the recession caused by the pandemic began. At the end of the first quarter of the previous recession on March 31, 2008, this ratio was 30.4%, based on actual loan losses.

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Projected loan losses for the group in nine-quarter stress tests typically range from around 4.5% to 7% of total loans at the end of 2019. This may prove to be too low. For eight of the banks, the actual charge rates between 2008 and early 2010 were higher. In addition, accrued liabilities remained high for at least a few additional years during this time.

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Loan underwriting could be more conservative overall than in the last cycle, but the speed and depth of the actual recession triggered by the pandemic appears to have exceeded the severely adverse stress test scenario. The parameters for the stress tests were formulated before the extent of the COVID-19 threat was clear.

Additional analysis designed by the Fed to incorporate conceivable pathways for the pandemic found that the impact on capital levels of the severely adverse case would be roughly equivalent to a full V-shaped rebound, even though the recent surge in infections threaten to interrupt a strong initial rebound that appears to have started in May. A double-dip recession, on the other hand, would exhaust the capital levels of several stress-testing banks to near-minimal requirements, the Fed said.

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Several banks benchmarked themselves against their peers using previous stress test results in Q1 earnings reports and subsequent presentations. Bank of America Corp. said its relatively low estimated loan losses reflect its cautious underwriting and focus on credit card customers with very high credit scores.

Truist Financial Corp. said its ratio of reserves to projected losses in 2018 stress tests – the most recent figures available to the company when it released its first quarter results – fell from 35% to 58% after including fair value marks on SunTrust Banks Inc.’s portfolio. resulting from the recognition of the merger. Its standard reserves at March 31 represent 34.1% of the estimated loan losses in the extremely adverse scenario of 2020.

Massive amounts of federal pandemic assistance have so far eased the pressure on borrowers. Notably, in the consumer sector, stimulus checks and improved unemployment insurance kept personal income higher in April and May than in February. In addition, strong bond issuance and trading, supported by the Fed’s interventions, is expected to bring billions of dollars in additional trade benefits to big banks in the near term, helping to offset the costs of credit.

But much of the government’s pandemic aid money is expected to run out in the coming weeks without additional legislation, and the path to normalcy looks increasingly uncertain as COVID-19 cases continue to mount. spread rapidly across much of the country. Another round of large reserve build-ups should bring banks closer to the potential losses estimated in stress tests.

JPMorgan Chase & Co.’s provision of approximately $ 10.5 billion in the second quarter increased its stress-testing reserves-to-loss ratio from around 36% to around 50%, helping it to approximate the potential costs of credit for the full cycle, as expected.