Something's Not Right With Report's Loan Loss Data

Quarterly Earnings Are Highest in Almost Three Years

Reductions in loan-loss provisions underscored improvement in asset quality indicators during second quarter 2010. The industry’s quarterly earnings of $21.6 billion are up dramatically from the year-ago loss of $4.4 billion and represent the highest quarterly earnings since third quarter 2007. Almost two out of three institutions (65.5%) reported higher year-over-year quarterly net income. The proportion of institutions reporting quarterly net losses remained high at 20% but was down from more than 29% a year earlier.

Reduced Loan-Loss Provisions Boost Net Income

Insured institutions added $40.3 billion in provisions to their loan-loss allowances in the second quarter. While still high by historic standards, this is the smallest total since the industry set aside $37.2 billion in first quarter 2008 and is $27.1 billion (40.2%) less than the industry’s provisions in second quarter 2009. Fewer than half of all institutions (41.3%) reported year-over-year reductions in quarterly loss provisions. Only 40% of community banks (institutions with less than $1 billion in assets) reported year-over-year declines. Reductions were more prevalent among larger institutions. More than half (56.2%) of institutions with assets greater than $1 billion had lower provisions in the second quarter.

Charge-Offs Fall for First Time Since 2006

Net charge-offs totaled $49 billion in the second quarter, a $214-million (0.4%) decline from a year earlier and the first year-over-year decline since fourth quarter 2006. Charge-offs were lower than a year ago in most major loan categories except for credit cards and real estate loans secured by nonfarm nonresidential properties. Charge-offs on loans to commercial and industrial (C&I) borrowers were $3.1 billion (37.0%) lower than a year ago, while charge-offs on real estate construction and development (C&D) loans were $2.7 billion (34.6%) lower. Charge-offs of one-to-four family residential mortgage loans were down by $1.4 billion (16.0%). Credit card charge-offs were $8.6 billion (86%) higher than in second quarter 2009. Most, if not all, of this increase was attributable to the inclusion of charge-offs on securitized credit card balances, which were not included in reported charge-offs in previous years. The change in reporting was the result of the application of FASB 166 and 167. In contrast, the $1.8 billion (107.2%) year-over-year increase in charge-offs of nonfarm nonresidential real estate loans reflected further deterioration in commercial real estate portfolios. Almost half (49.1%) of insured institutions with more than $1 billion in assets reported lower net charge-offs, while only 43.6% of community banks reported year-over-year declines.

Noncurrent Loans Post First Decline in More than Four Years

The amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) declined by $19.6 billion (4.8%) during the second quarter. This is the first quarterly decline in noncurrent loans since first quarter 2006. Noncurrent levels declined in most major loan categories during the quarter. The sole exception was nonfarm nonresidential real estate loans, where noncurrents increased by $547 million (1.2%), the smallest quarterly increase in three years. The largest reduction in noncurrent loans in the quarter occurred in real estate C&D loans, where noncurrents fell by $5.9 billion (8.3%). This is the third consecutive quarter that noncurrent C&D loans have declined. Noncurrent C&I loans also declined for a third straight quarter, falling by $2.7 billion (7.3%), while noncurrent residential mortgage loans declined by $4.7 billion (2.5%) and noncurrent credit cards fell by $4.2 billion (19%). Slightly fewer than half of all institutions (48.9%) reported declines in their noncurrent loan balances during the quarter. Noncurrent loan balances fell by 5.3% at institutions with more than $1 billion in assets and rose by 0.3% at community banks.

Reserves Fall as Large Banks Reduce Loan-Loss Provisions

Total loan-loss reserves of insured institutions fell for the first time since fourth quarter 2006, declining by $11.8 billion (4.5%), as net charge-offs of $49 billion exceeded loss provisions of $40.3 billion. Almost two out of three institutions (61.7%) increased their loss reserves in the second quarter, but a number of large banks reduced their loss provisions, producing net declines in their reserve balances. In particular, some institutions that converted equity capital into reserves in the first quarter in accordance with the requirements of FASB 166 and 167 reported lower provisioning in the second quarter. Although the industry’s ratio of reserves to total loans fell from 3.51% to 3.40% during the quarter, it's still the second-highest level for this ratio in the 63 years for which data are available. The industry’s “coverage ratio” of reserves to noncurrent loans improved for a second consecutive quarter, from 64.9% to 65.1%, as the reduction in noncurrent loans slightly outpaced the decline in loss reserves.