Outlook 2021

US Banks May See 4Q Upside as Reserves Fall on Improved Outlook

Increased stimulus, vaccine mass-distribution boost forecasts

Fitch Ratings-New York-14 January 2021: Some U.S. banks may report reserve releases in their upcoming 4Q20 results under the current expected credit loss (CECL) accounting standard, as the increased stimulus and the expected mass distribution of vaccines have improved the economic forecasts, says Fitch Ratings. As a result, negative provision expenses could benefit earnings, despite the expectation of an increase in net charge-offs in 2H21.

Provision expenses may be a tailwind for 4Q results following the massive buildup in loss reserves that were a significant drag on earnings through the first three quarters of 2020. Provision expenses through 3Q20 YTD were up over 3x from 3Q19 YTD on expectations of higher credit losses stemming from the pandemic. Reserves under CECL are based on a “reasonable and supportable” forecast period, and economic forecasts have improved from those incorporated into 3Q20 earnings results, driven by vaccine developments that occurred during the quarter, as well as recently passed stimulus and better prospects for additional stimulus.

Fitch recently revised its 2021 and 2022 U.S. GDP and unemployment rate forecasts, which improved on the view that the vaccine provides a path to recovery but noted a delay in the rollout as a key downside risk. Fitch currently expects an additional stimulus package of $700-$800 billion to pass following the results of the Georgia Senate run-off election.

Qualitative Adjustments

The magnitude of banks’ potential earnings benefit from reserve releases is highly dependent on the economic assumptions incorporated into 3Q20 results, and to what extent banks will make qualitative adjustments to override the rosier economic outlook. Any potential earnings benefit is likely to be minimal if vaccine developments and stimulus expectations have already been factored into their reserves at 3Q20.

Although the economic outlook has generally improved, new cases are reaching record levels and continue to rise, which may cause banks to make qualitative adjustments to justify their current level of reserves...

Although the economic outlook has generally improved, new cases are reaching record levels and continue to rise, which may cause banks to make qualitative adjustments to justify their current level of reserves. Banks may choose not to release reserves until they have more clarity around loss expectations from the pandemic to minimize earnings volatility.

The sensitivity of earnings to changes in the economic outlook will also depend on the length of reasonable and supportable forecast periods used in their allowance calculations, loan mix and loan growth/shrinkage. The largest banks tend to incorporate longer reasonable and supportable forecast periods, which will be more sensitive to changes in economic assumptions than smaller banks. Furthermore, banks with exposure to loan types with longer lives and/or higher loss rates, such as credit cards, will be more sensitive to changes in economic assumptions and may see more earnings benefit especially if loan balances shrink or remain flat.

Delinquencies and net charge-offs have remained relatively benign through the first three quarters of 2020 due to forbearance programs and unprecedented amounts of government stimulus, although Fitch expects that credit losses will begin to manifest in 2021. However, the recently passed $900 billion stimulus package, which extended accounting relief for pandemic-related loan modifications through 2021, and expectations of further stimulus may result in losses being pushed out further.

Fitch’s 2021 Sector Outlook for U.S. banks is Stable. While downside risks remain in the form of second or even third wave of infections and renewed lockdown measures, optimism around vaccines for COVID-19 are expected to be supportive improvements in economic conditions in the latter half 2021.