Early signs of economic recovery are putting US banks under growing pressure to slash funds they held for potential loan losses, but banks fear a hasty markdown could hurt their credibility.
Investors and analysts have started questioning banks on when their reserves will go back to pre-pandemic levels. But the financial institutions worry that lowering reserves too quickly and then needing to rebuild them could damage their credibility and reduce their income.
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Banks bulked up their loan reserves this time last year to prepare for potential defaults during the onset of the pandemic, cutting into profits.
Lender’s provisions for credit losses totalled $61.91bn in the second quarter of 2020, compared with $12.84bn during the prior-year period.
A complicating factor: new accounting rule CECL
Banks and other financial institutions are devising how to release large loan reserves under an accounting rule that complicates the task of calculating them.
To do so, executives at companies including JPMorgan and Citizens Financial are scrutinising metrics such as credit quality and loan growth to help estimate the level of future reserves amid the continuing economic uncertainty.
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By GlobalDataUnder US accounting standards, companies are required to forecast expected losses as soon as a loan is issued.
The rule, known as Current Expected Credit Losses, or CECL, went into effect for large public firms in January 2020, with some of them choosing to delay implementing it for a year because of the pandemic.
Private and smaller public companies have until 2023 to adopt CECL.
Companies previously didn’t have to book losses until they had evidence—such as the default of a borrower—that the losses had actually occurred.
CECL particularly impacts financial institutions because loans comprise a large portion of their assets.
The standard also affects nonfinancial companies with financial assets ranging from loans to debt securities.
Bankers say the rule makes company earnings more unpredictable.
The Financial Accounting Standards Board, which sets US accounting standards, however, has said the rule more closely aligns companies’ accounting with actual credit risks and provides investors with more transparency.
Banks remain uncertain about the direction of the economy
The improved economic outlook and soaring markets are leading banks to slash the funds they held for loan losses, thus boosting profits.
JPMorgan on April 14 said it freed up $5.2bn in funds it had allocated to cover soured loans, bringing its reserves to $25.6bn. The bank’s loan assets totalled $1.01trl as of March 31.
The bank released most of the $5.2bn in its consumer credit-card division because certain mortgage delinquencies remain low and US. employment levels have improved.
Executives are careful about the amount of reserves they hold because they are unsure about where the economy is headed.
