US Banks Underweight
Analyst(s): FPK US Bank Research Group 212-687-1105
Examining Loan Loss Reserves – Then and Now
• Versus The Early 1990s, Our Universe Of Banks Is Under-Reserved. The current credit cycle is
often compared to the early 1990s since real estate was the focus in both periods (CRE in the early
1990s and residential today). In this report, we compare and contrast the loan composition, credit
metrics, and loan loss reserve allocations for both periods.
• Our 2008 EPS Ests Would Decline 9% (To 26% Below Consensus) If Banks Built Reserves To
Median 1991-1995 Levels... We sensitized our current 2008 EPS ests for higher reserve levels
similar to those maintained during the early 1990s. We took the median industry level of residential,
home equity, C&I, CRE, construction, and consumer reserves in the early 1990s and applied it to
the current loan portfolio for each bank. This scenario resulted in a median shortfall in the LLR of 22
bps, a 9% reduction in our 2008E EPS, a 26% discount to Street estimates, and caused the bank
stocks to trade at 17x 2008E EPS. The banks with the greatest implied LLR build are TCB, SIVB,
NYB, CMA, HBAN, CFR, and PCBC, with reserve additions of 100 bps or more.
• …And Would Fall By 46% (54% Below the Street) If Peak 1991-1995 Levels Were Reached. We
performed the same analysis as above, but used peak levels, rather than medians. In this scenario,
the median bank would need an additional 70 bps of LLRs, have a 46% EPS reduction, trade at 21x
2008E EPS, and be 54% below the consensus. The banks with the greatest impact to EPS
estimates are FHN, TSFG, PBKS, CMA, STI, and HBAN, all of which would move from positive
earnings to losses and have swing of more than 100%.
• LLRs Rose Modestly in 2007 And We Expect Further Build In 2008. The median LLR ratio for
our banks increased 4 bps in 2007 to 1.21% and we expect 22 bps of additional reserve build in
2008. However, current reserves are 57 bps and 73 bps below 1991-1995 median (1.79%) and peak
(1.95%) levels. Banks with the highest absolute LLR ratios today include WABC, CPF, and BBX (all
> 2%), while BKUNA, TCB, PCBC, SBNY, TCBI, and CVBF have among the lowest (ex NYC thrifts).
PCBC, SIVB, STI, UB, WB, WTNY, and ZION stand out as banks that had LLR ratios well above the
industry median in the early 1990s, but are below the current median today.
• Construction Reserves Were The Lone Product to Increase Meaningfully In 2007. Median
construction reserves increased 59 bps to 158 bps in 2007, but remain well below the early 1990s
peak of 253 bps and median of 199 bps. C&I reserves were essentially flat in 2007 at 155 bps
compared to a median of 182 bps and a peak of 222 bps in the early 1990s. CRE reserves
surprisingly only increased 10 bps to 109 bps in 2007 and were 41 bps and 104 bps below the early
1990s median and peak, respectively. 13 of 36 and 31 of 49 banks reduced CRE and C&I reserves
in 2007, respectively. Residential mortgage reserve factors rose to 31 bps from 24 bps in 2006 and
were well below the early 1990s median 58 bps and peak of 80 bps. Consumer reserves were a
bright spot, with an increase of 39 bps to 175 bps and were about even with the 1990s peak.
• Banks Appear Under Reserved In Our View and We Remain Most Concerned About LLRs At
Our SE And Western Regionals. We would prefer if reserve coverage migrated closer to its
historical long-term 1.7-1.8% median at this point in the credit cycle. We note that our loss
assumptions in a more stressed credit scenario (4.2% median) resulted in only two of 41 banks
having adequate level of reserves (BOH and DCOM) and about half of these banks needed to raise
capital if our assumptions played out (see “Regional Banks: Frequency and Severity Analysis” from
3/20/08). Further, we believe higher reserves in the SE and the West are warranted given housing
pressures and coverage should be much higher, as potential loss content could reach as high as 5-
6% based on our frequency and severity analysis. We are most concerned about reserve adequacy
at STI, BKUNA, TSFG, PCBC, CBON, and WAL
TABLE OF CONTENTS
Today Vs. The Early 1990s..........................................................................................3
Assessing Loan Loss Reserves .................................................................................10
Assessing Loan Loss Reserves By Product...............................................................13
Scenario Analysis For Current Reserves ...................................................................25
Company Specific Reserve Allocations......................................................................31
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