U.S. banks to lose profit cushion of releasing bad-loan reserves

Reuters
JP Morgan Chase & Co sign outside headquarters in New York
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A sign outside the headquarters of JP Morgan Chase & Co in New York, September 19, 2013. REUTERS/Mike Segar

By Peter Rudegeair

NEW YORK (Reuters) - A popular way for big U.S. banks to boost profits may have run its course.

The practice of dipping into funds set aside for bad loans, known as releasing loan-loss reserves, has helped the industry weather weak loan demand and lower fee income. But it is expected to have a smaller impact on banks' second-quarter earnings, which will start being unveiled on Friday, because loss rates and reserves are nearing their lower limits.

"This could be the first quarter where credit doesn't bail out most banks," Goldman Sachs analyst Richard Ramsden wrote in a recent report.

Analysts at Credit Suisse expect JPMorgan Chase & Co, the largest U.S. bank, to report $300 million worth of loan-loss reserve releases, down 80 percent from $1.5 billion in the second quarter of 2013. They expect releases to drop 40 percent at Bank of America Corp and Citigroup Inc and 30 percent at Wells Fargo & Co.

The decline in income from reserve releases is the latest obstacle for banks to increase earnings in an environment of slow economic growth and low interest rates.

Bankers have been able to justify large reserve releases as the economy gradually recovers from the financial crisis. As more borrowers make payments on time, banks can set aside less money for losses.

Though banks have released reserves for years, the practice has become more crucial in recent quarters. Revenue from a boom in mortgage refinancing dried up since the second quarter of 2013, and legal and regulatory costs have ballooned.

Most big banks have already cut loan-loss reserves for some products, like credit cards, as low as they can, said Charles Peabody, a banking analyst at Portales Partners. Although there is still some room to reduce mortgage reserves, it will be difficult for bankers to justify large releases because home prices are now rising more slowly, he said.

Moreover, U.S. regulators are more closely scrutinizing banks' loans to indebted companies, which could result in an increase in commercial reserves, Peabody said.

"There's no way the banks are going to release the same amount in the second quarter as they did in the first," Peabody said.

As the jolt from reserve releases fades, revenue stresses remain. Mortgage volume is half of what it was a year ago, after a rise in rates caused refinancing activity to plummet, according to the Mortgage Bankers Association.

Banks' trading revenues are also expected to suffer. Executives at JPMorgan and Citigroup have warned second-quarter trading profits will be down about 20 percent.

Wells Fargo will report earnings on Friday, followed by Citigroup on Monday, JPMorgan and Goldman Sachs on Tuesday, Bank of America on Wednesday and Morgan Stanley on Thursday.

(Reporting by Peter Rudegeair; Editing by Tom Brown)

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