U.S. banks' loan losses soar, reserves don't

By Jonathan Stempel - Analysis

NEW YORK (Reuters) - U.S. banks proved correct in warning that many more borrowers would struggle to pay back loans. Yet those same banks are not setting aside more money to cover rising loan losses.

Most major banks posted large double- or triple-digit increases in loan losses and net charge-offs, or loans it doesn't expect to be paid back, when they reported second-quarter results last week. None, however, boosted loss reserves by more than a low double-digit percentage, and some even reduced them.

Keeping reserves down helps boost earnings, and banks' results met or surpassed investors' modest expectations despite a tough interest-rate environment. Yet disappointment may lurk if banks later find they didn't set aside enough for bad loans now.

"It's very relevant today," said Kevin Fitzsimmons, an analyst with Sandler O'Neill & Partners LP. "Over the last three to five years, taking the reserve ratio down was a nice catalyst for earnings. Not only won't you have that any more, but you have the necessity to build reserves."

The eight largest banks and thrifts by assets -- Citigroup Inc. (C.N), Bank of America Corp. (BAC.N), JPMorgan Chase & Co. (JPM.N), Wachovia Corp WB.N, Wells Fargo & Co. (WFC.N), Washington Mutual Inc. WM.N, U.S. Bancorp (USB.N) and SunTrust Banks Inc. (STI.N) -- reported average increases in loss reserves of just 3 percent from both June 2006 and March 2007.

Yet this came as a housing slump and what banks often call a "normalization" of credit led to big year-over-year increases in loan losses -- 75 percent at Citigroup, 80 percent at Bank of America, and roughly a tripling at JPMorgan and Wachovia.

Citigroup appeared to boost reserves most, increasing them 13.5 percent from a year earlier and 9.2 percent from March, to $10.38 billion. Reserves as a percentage of loans ranged from 0.73 percent at Washington Mutual to 1.64 percent at JPMorgan, according to the companies' quarterly earnings reports.

This reflects a long-term trend. According to Federal Deposit Insurance Corp. data, U.S. commercial banks set aside reserves covering 2.68 percent of total loans and leases in 1992, in the wake of the 1980s savings and loan crisis. This would drift lower. By the end of 2006, reserves bottomed at 1.16 percent of loans and leases. They were 1.17 percent in March.

Meanwhile, ratios of nonperforming assets, or assets on which income is not recognized, to reserves range from 0.26 percent at Bank of America to 2.58 percent at WaMu.

BANKS SAY ADEQUATELY RESERVED

Banks say they're well protected from a credit crunch.

Wachovia was criticized for shelling out $24.2 billion last year for mortgage specialist Golden West Financial Corp. More than half of Wachovia's $341 million increase from the first quarter in nonperforming loans related to Golden West. Reserves were little changed from the first quarter.

Yet Chief Financial Officer Tom Wurtz said Golden West loans are safer than many housing loans that have run into trouble in the last year. Reserves for loan losses rose 12 percent from a year earlier, but were little changed from the first quarter.

"We have a very strong cushion," Wurtz said in a July 20 interview. "The only reason we added reserves was we had growth in more credit-sensitive businesses, including credit cards and our indirect auto portfolio."

WaMu, meanwhile, now plans to set aside $1.5 billion to $1.7 billion this year for credit losses, up $200 million from its prior forecast. The thrift, a major mortgage lender, has been reducing risk in its home loan portfolio, including by selling most "subprime" loans it makes.