Banks release $41B in reserves this year as CECL amps earnings volatility

The banking industry, in aggregate, posted a negative provisioning figure in the second quarter for only the second time in history. The first instance occurred in the first quarter.

Banks typically book a positive provision in their earnings, essentially setting aside funds for potential loan losses but taking a hit to net income to do so. But with loan growth scant and a mountain of reserves built earlier in the coronavirus pandemic, banks have released reserves by the billions so far this year, boosting earnings in the process. While the unique nature of the pandemic economy played a central role in this earnings whiplash, some bankers and analysts have said the current expected credit loss accounting standard played a significant role in the volatility.

Lenders have excess reserves because they set aside massive sums near the onset of COVID-19 only to see credit performance improve through the pandemic as government stimulus checks and forbearance programs kept borrowers current. In 2020, the industry's aggregate provisioning totaled more than $114 billion in the first half. That weighed on bank earnings, pushing several banks into the red.

This year, those provisions are having the opposite effect, providing a tailwind that is pushing bank earnings beyond consensus estimates. Over the first two quarters, negative provisioning has totaled nearly $25 billion — money that has flowed directly to banks' bottom lines. After accounting for net charge-offs that further drew on credit loss reserves, banks have released more than $41 billion of reserves in the first half.

JPMorgan Chase & Co. CEO Jamie Dimon said the accounting standard has made the bank's earnings figures less meaningful. Dimon said he focuses on items such as debit card activity, trading flows and the bank's market share in key businesses to gauge the bank's success, not net income.

"That's what I look at much more than what are the ups and downs to the earnings this quarter because of CECL. I don't think that means anything for the future of the company," Dimon said during the bank's second-quarter earnings call.

JPMorgan and its megabank peers experienced even greater volatility than the rest of the industry. JPMorgan itself booked negative provisioning of $2.76 billion in the second quarter, pushing its aggregate negative provisioning in the first half over $7 billion. Reserve releases contributed $1.75 billion or more in earnings to each of the second-quarter reports for JPMorgan, Bank of America Corp., Wells Fargo & Co. and Citigroup Inc.

Large regional banks similarly built more reserves a year ago and are releasing more cash now, wrote Jake Civiello, an analyst for Janney Montgomery Scott, in an Aug. 9 note. And it is not only on a nominal basis: provisioning at banks with $50 billion to $100 billion in assets equaled 1.07% of average loans in the year-ago quarter, compared to 0.56% for banks with $3 billion to $10 billion in assets, according to Civiello's analysis. Similarly, larger banks' negative provisioning was greater, relative to average loans, than the negative provisioning at smaller banks in the second quarter.

Looking ahead, several bankers and analysts believe banks can draw down reserves to the levels around CECL day 1, when banks adopted the standard, just before the pandemic.

"That's the end point in peoples' minds. The question is, how many quarters does it take to get there?" said Jeff Harte, an analyst for Piper Sandler, in an interview. Harte said he expects banks to return to reserve building by the second half of 2022.

Banks still have billions in reserves above CECL day 1 levels. And some bankers, including Bank of America management on their earnings call, have said companies could release reserves below day 1 levels, arguing credit performance is currently stronger than it was in January 2020 when many were predicting a turn in the economic cycle. For the coming quarters, analysts expect to continue seeing billions of dollars flow to the bottom line from reserve releases. While the unprecedented nature of the pandemic economy contributed to the earnings volatility, Harte said he thinks CECL also played a role.

"One thing [CECL] did, which we kind of expected, was make bank earnings more volatile," Harte said. "Everyone seems to be functioning fine, but it did seem to increase volatility."