Loan-Loss Reserves Are Slowing at Banks

By MATTHIAS RIEKER The tide of problem loans is still rising, but bankers believe they need fewer sandbags to stem the flood. In the second quarter, many of the nation's largest banks added less than in the first quarter to their loan-loss reserve, which is the capital banks set aside to cover loans written off because borrowers can't pay them back. Banks have taken their medicine early, analysts say; now they can pace themselves. Reserves, particularly for mortgages, could prove strong enough to sustain them through the crisis, J.P. Morgan Chase & Co. Chief Financial Officer Michael Cavanagh told shareholders recently. Further, the slower second-quarter reserve build reflects the impression that things "are getting worse at a slower pace," U.S. Bancorp Chief Financial Officer Andrew Cecere said in an interview. That doesn't mean banks are done adding to their reserves, but levels are in much better shape than at the beginning of the year. If the trend holds, future reserve additions won't strain banks' painstakingly rebuilt capital levels. In the second quarter, SunTrust Banks Inc. added $161 million to its loan-loss reserve, compared with $384 million in the first. Wells Fargo & Co. added $700 million, compared with $1.3 billion in the first quarter; U.S. Bancorp put $466 million into its reserve, $64 million less than in the first quarter. At J.P. Morgan, KeyCorp, SunTrust, Capital One Financial Corp. and American Express Co., provisions, the money banks set aside each quarter to cover loan losses and what they add to the reserve, declined from the first quarter. Delinquent loans have hurt earnings badly and will continue to do so for some time. But banks' loan books have been shrinking; that is one argument that less reserving will be required for potential losses. Moreover, early-stage consumer delinquencies -- where loans are less than 60 days overdue -- are declining, say bankers such as Tom Freeman, chief risk officer of SunTrust. Mr. Freeman said the slower increase in reserves "is largely due" to that trend. Some bankers and analysts warn that seasonal improvements and the impact of President Obama's economic stimulus might be behind the improvement in early-stage delinquencies, rather than a turn for the better in the economy. Barclays analyst Jason Goldberg noted that some banks, including SunTrust and Fifth Third Bancorp, "highlighted improvement in early stage delinquencies" in the first quarter of 2008, "which turned out to be misleading. "No one appeared ready to declare victory" just yet, he wrote. As unemployment continues to climb and businesses struggle, the slowdown in reserves runs the risk of being premature. The percentage decline in loan-loss reserves, FBR Capital Markets analysts wrote in a research report, is "increasing our concerns" about bank profits in the second half. For some banks, like KeyCorp, loan-loss reserves and capital are strong, giving analysts such as Gerard Cassidy of RBC Capital Markets little concern even when loan losses are higher than expected. The loan-loss reserve ratio at the Cleveland bank was 3.5% of total loans, compared with 4.3% at J.P. Morgan and 5.6% at Citigroup Inc. "North of 3% is strong," Mr. Cassidy said. In the last banking crisis in the 1990s, the reserve climbed to 2.7% of loans for banks overall, and Peter Winter of BMO Capital Markets expects banks to exceed that ratio by the end of this year. "We expect banks to build loan-loss reserves as long as charge-offs rise," he said. But the reserve ratio might also continue to improve simply because banks make fewer loans. As Fifth Third Chief Financial Officer Ross Kari told investors recently, "It's too early to say we're ahead of the game, but we're certainly on top of it." Write to Matthias Rieker at matthias.rieker@dowjones.com