The common theme of bank results this earnings season is the adoption of the current expected credit loss (CECL) methodology and big coronavirus-related loan loss reserves. The CECL requirements started at the beginning of the year, and they’re about to get a real-world test.
At this stage of the COVID-19 pandemic, earnings estimates carry less weight than usual; however, we still have to make sure companies aren’t trying to beat the number by gaming the provision for loan losses. It is important to look at the provision as a percent of assets and loans and compare it to the company’s competitors. It is also helpful to compare the total allowance for loan losses. This can help an investor feel more comfortable that there aren’t more shoes to drop later.
Just looking at the headlines, U.S. Bancorp‘s (NYSE:USB) quarterly reserve in its latest update seems low compared to the competition. But that’s why it’s important to look at its overall provisions. Let’s dig into the report.
U.S. Bank reported first-quarter earnings of $0.72 a share, which was down 20% from the fourth quarter and 28% from a year ago. Assets increased 10% as businesses took down lines of credit in anticipation of liquidity needs. Return on assets fell from 1.21% in the fourth quarter to 0.95%. Return on equity fell from 11.8% to 9.7%. Like most banks, U.S. Bank has suspended its share buyback program; however, it still pays a dividend. Note that some regulators are encouraging the Fed to insist that banks stop paying dividends and bonuses, similar to European banks.
The provision for loan losses is on the low side, but overall provision is high
The incremental provision for loan losses was $600 million, or about 0.11% of assets and 0.19% of loans. The complete provision was just under $1 billion. Compared to some of the other banks reporting last week, this is on the low side as a percentage of assets and the loan portfolio. JPMorgan Chase built reserves by $6.8 billion, which was 0.25% of assets and 0.71% of loans. Wells Fargo increased by $3.1 billion, which was 0.16% of assets and 0.31% of loans.
However, U.S. Bank’s total allowance for loan losses is $6.2 billion, or about 2% of the loan portfolio, which is a bit higher than some of the competing banks as a percentage of loans. Of course each bank’s loan portfolio is somewhat different, but the smaller quarterly provision is offset by the already higher provision. Total provision for loan losses at U.S. Bank was about 2% of the loan portfolio compared to 1.1% at Wells, and 1.4% at JPMorgan. So it appears U.S. Bank isn’t underestimating losses compared to its competition.
Mortgage delinquencies are headed up
Residential mortgages account for 31% of U.S. Bank’s assets between loans held in the balance sheet and agency mortgage-backed securities. Based on the CARES Act and the potential for borrowers to skip mortgage payments, we should expect to see an increase in delinquencies. It looks like delinquencies did trend up marginally in U.S. Bank’s residential mortgage portfolio, but the crisis really didn’t get going until the second half of March. Home equity loans also saw an uptick in delinquencies. U.S. Bank reported stronger mortgage banking revenue on higher production and improved gain on sale.
U.S. Bank also had a positive mark on its mortgage servicing rights (MSR) portfolio, which put it at 3.7 times the servicing income. This is a high multiple relative to where servicing is trading in the market, and where competing banks marked their servicing portfolios. No two servicing portfolios are alike, and the models are highly sensitive to inputs.
Payment services feels the squeeze
Noninterest income slid as well, as the payment services business was affected by the slowdown in business. Payment services revenue fell 17% from the fourth quarter, on lower credit and debit card revenue, slower corporate processing, and lower merchant processing services revenue. Investment management revenue decreased and general banking fee revenue declined as U.S. Bank waived some fees as part of its COVID-19 relief to consumers. Overall, the payment services business is going to suffer a bit going into the downturn, so those hoping for fee income to mitigate increased delinquencies will be disappointed.
This is going to be a difficult time for banks. The CECL framework will have the effect of front-loading some of the reserves, which means further writedowns may not be as bad as, say, 2009 was. The banking system is entering this crisis with a lot more capital, and we don’t have a collapsing real estate bubble to deal with. U.S. Bank is confident that it has the capital to weather the upcoming storm.