In the first quarter, JPMorgan Chase (JPM 1.14%) released $5.2 billion it had been reserving for potential loan losses back into its earnings, which helped juice profits. It's one of the main reasons the bank reported a blowout quarter of $14.3 billion in profits and a return on tangible common equity of 29%, far surpassing analysts' estimates.
JPMorgan also released $2.9 billion in reserves in the fourth quarter of 2020, meaning the bank has now released a total of $8.1 billion over the past two quarters. While that is a massive amount, the nation's largest bank is likely not done and could actually release billions more in reserves later this year. Here's why.
The reason for such big reserve releases
The pandemic hit at an interesting time for the banking sector. After many years of debate and delays, the Financial Accounting Standards Board finally implemented a new accounting standard at the beginning of 2020 called the current expected credit losses (CECL) method.
To make a long story short, CECL requires banks to reserve for losses on the life of a loan as soon as it hits the balance sheet. This so far has resulted in many of the big banks front-loading reserves because CECL requires banks to reserve for loans even if there is not yet a reason to believe that they will sour. CECL reserving is based on historical experience, current conditions, and "reasonable and supportable forecasts," according to Moody's.
Then of course, right as CECL was going into effect, the coronavirus pandemic hit, shutting down broad swaths of the economy for weeks at a time and making it much more difficult for people to travel, go out, and essentially spend money. With so much uncertainty in the air, banks braced for heavy loan losses simply because they had no idea how long the pandemic could last or what was going to happen, and again, CECL by its very nature results in banks front-loading reserves.
But as last year progressed, trillions of dollars in stimulus went into the economy and scientists around the world made significant progress on coronavirus vaccines. At the end of the year, it began to look like the U.S. would be able to recover from the pandemic much quicker than previously thought. It also began to look like the stimulus money could support borrowers until the pandemic ended, providing the time they needed to get back into better financial health and keep making loan payments.
With the situation trending much better than the doomsday scenarios many banks initially planned for, JPMorgan felt that it could safely start releasing its massive buildup of reserves at the end of last year.
How much more will JPMorgan release?
After the $5.2 billion reserve release this past quarter, JPMorgan still has roughly $25.5 billion left in its total reserves for losses. On the bank's recent earnings call, CFO Jennifer Piepszak noted that at this level, JPMorgan is still reserved roughly $7 billion above its base case. Think of the base case as an economic scenario that the bank actually expects to happen.
However, Piepszak also noted that the bank is unlikely to release $7 billion in reserves because it always reserves with downside scenarios in mind, just in case things don't go as planned. But that still leaves a lot of room left for reserve releases -- potentially billions.
One area where there will likely be more reserve releases is in the bank's credit card portfolio. Of the bank's $25.5 billion total reserves, $14.3 billion is specifically slated for potential losses in the credit card portfolio. However, the bank in the first quarter of this year only reported $983 million in credit card net charge-offs (debt unlikely to be collected and a good representation of actual losses).
If this were the run rate for the rest of the year, which is unlikely, that would mean JPMorgan would lose $3.93 billion in its credit card portfolio in 2021, or the equivalent of 2.97% of its total current credit card loan portfolio. However, Piepszak said she expects the bank to see a net charge-off rate for the year of 2.5%, which would mean even less credit card losses than what the first quarter indicated. Although banks always reserve more conservatively for credit card loans because of their higher loss rates, with $14.3 billion of reserves and only $3 billion to $4 billion in expected losses, there should be plenty of room to release some of these reserves.
While the economy is trending much better and we can all but rule out a doomsday scenario, there is still some degree of risk that the economy will not grow at the pace many economists are now projecting if the pandemic isn't fully brought under control.
But assuming vaccine efforts and cases keep trending positively, the economy reopens, and U.S. economic growth is strong, I do think it's possible that JPMorgan could release as much as another $4 billion or even $5 billion of reserves later this year, which would significantly boost earnings.