According to a news release from Fitch Ratings, the firm believes that loan loss reserve releases by U.S. banks will continue, albeit at a declining pace as banks begin to approach normalized provisioning and net chargeoffs.
 
After building up reserves to very high levels as a result of the crisis, many banks have been releasing reserves given improving asset quality trends. This trend in declining levels of loan loss reserves is catching the attention of the regulators, who are sharpening their focus on the level and magnitude of reserve releases amid an uncertain economic environment.

U.S. Comptroller of the Currency Thomas Curry indicated in an Oct. 29 speech that regulators are monitoring the level of reserve releases closely, and that they are prepared to act if banks were judged to be releasing reserves solely for the purpose of boosting earnings. Reported earnings benefit when banks report provision expenses below quarterly net chargeoffs or even report negative provision expenses.

Data collected from 30 Fitch-rated U.S. banks show that the industry continues to report provision expenses less than net chargeoffs. However, reserve releases have exhibited an overall declining trend among the majority of banks over the past several quarters. Third-quarter releases totaled $6.2 billion for that group of 30 banks, compared with $8.8 billion a year ago. There have been some outliers to this general trend from quarter to quarter, most recently driven by clarified accounting guidance in third-quarter 2012.

Overall loan loss reserves for the entire banking industry continue to decrease from their peak. The level of reserves to loans has fallen from a post-crisis high of approximately 3.5% for all FDIC-insured commercial banks and savings institutions in first-quarter 2010 to 2.4% at June 30, 2012, though still above precrisis levels.

Prior to the crisis, reserves to loans hovered around 1%. Fitch assumes that the regulators will likely not permit reserve levels to approach 1% again, and they will likely settle at a higher level for the industry. Greater caution in the post-crisis period will likely keep regulators from allowing that ratio to fall to that level, in our opinion.

Reserve coverage of non-accrual loans is at a level (107% in second-quarter 2012) that could also cause concern for regulators in light of the scope of macroeconomic risks that still cloud the credit horizon. Comptroller Curry has recently cited weak economic growth and continuing softness in real estate markets in supporting the view that non-accruals are likely to remain an issue, even though they are well off of peak levels.

We expect reserve releases to taper off throughout 2013 when normal provisioning will need to occur to cover chargeoffs. Even if asset quality levels off or improve modestly from current levels, problem assets still remain relatively high for the industry. More substantial improvements in credit quality will likely require a brightening of the economic picture, sustained improvements in residential and commercial real estate, and clarity on fiscal policy.