Banks continue to get a lift in earnings from lower quarterly loan loss provisions relative to previous quarters, as credit quality continues to improve. This is the continuation of a trend that has been ongoing for the last two years.
TUTORIAL: Stock Basics

Loan Loss Provisions
The quarterly loan loss provision reflects an ongoing estimate by the management of a bank regarding the extent of possible losses in a loan portfolio. The provision is used to calculate the overall allowance for loans losses that is available to cover losses in that portfolio.

A bank will typically report total interest income in its financials and then deduct interest expense to come up with a net interest income figure. The bank will then subtract a provision for loan losses. Here is how Independent Bank Corp (Nasdaq: INDB) calculated its net interest income after the provision for loan losses in the first quarter of 2010 and 2011:

($ in millions) Q1 -2011 Q1 - 2010
Interest Income $ 49.0 $ 50.8
Interest Expense $ 7.5 $ 10.6
Net Interest Income (NII) $ 41.5 $ 40.2
Loan Loss Provision $ 2.2 $ 4.7
NII after Loan Loss Provision $ 39.3 $ 35.6

When a bank reports a lower quarterly loan loss provisions relative to prior quarters, it has the effect of increasing net interest income.

Trend Continues
Quarterly loan loss provisions for the industry peaked in the fourth quarter of 2008 at $69.4 billion, according to the FDIC, and have been declining over the last eight quarters. The latest data from the agency indicates quarterly loan loss provisions of $31.6 billion in the fourth quarter of 2010.

In 2010, the industry reported total net income of $87.5 billion, with the FDIC reporting a $92.6 billion benefit from a decline in loan loss provisions.

Citigroup (NYSE: C) benefited from a lower provision for loan losses in the quarter ending March 31, 2011. The bank reported loan loss provisions of $2.9 billion, compared to $8.4 billion in the first quarter of 2010.

This decline in the provision for loan losses was caused mainly by a net release of $3.3 billion in reserves during the quarter as the bank felt more comfortable with its portfolio. Citigroup said that approximately $2 billion of this release was related to the bank's Consumer loan portfolio.

Citigroup still has a large total allowance for loan losses set aside to cover possible losses. This allowance totaled $36.6 billion at 3/31/2011, or 5.79% of total loans for the bank. In the same quarter in 2010, Citigroup reported a total allowance for loan losses of $48.7 billion.

Other large money center banks also benefited from lower provisioning in the first quarter of 2011. JPMorgan Chase & Co. (NYSE: JPM) reported a $2 billion pre tax benefit from lower credit card loan loss reserves. Bank of America (NYSE: BAC) reported a $3.8 billion provision for credit losses, a $6 billion year over year decline from the $9.8 billion reported in the same quarter of 2010.

The Bottom Line
The banking industry has been the beneficiary of lower loan loss provisioning over the last eight quarters, and should see a continuation of this trend. This is reflected in the earnings of the large money center banks. (For related reading, also take a look at Analyzing A Bank's Financial Statements.)

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