A Very Positive Sign for Banks

Here's one reason to be positive about the ongoing economic recovery: Banks are setting aside less money in expectation of future loan losses than they have since the second quarter of 2006.

According to data supplied by Standard & Poor's Capital IQ, the nation's 12 largest banks by assets (excluding investment and custodial banks) recorded a total of $4.75 billion in loan loss provisions last quarter. That's down an impressive 90% from the peak of $45.8 billion in the second quarter of 2009.

Source: Standard & Poor's Capital IQ.

Regional lenders KeyCorp , SunTrust Banks , and PNC Financial provide representative examples of this. KeyCorp saw its provision expense decline by 97% from its peak during the crisis, while SunTrust and PNC have notched comparable declines of 87% and 86%, respectively.

In addition to simply clearing out bad loans dating back to the financial crisis, this trend reflects the quality of loans that have been underwritten over the last five years. You can see this in the chart below, which was included in a recent presentation given by the chief financial officer of Wells Fargo .

Source: Wells Fargo Investor Relations.

The worst loan vintages were from 2006 and 2007 -- that is, just as mortgage originators doubled down on subprime mortgages. As things progressed, however, this started to change. And by 2009, the loss rate on residential real estate loans had dropped to nearly zero.

It should come as no surprise, in turn, that industry analysts expect this trend to continue. In the same presentation cited above, for example, Wells Fargo's chief financial officer noted that "the favorable conditions that drove the [reserve] release in the second quarter have not dissipated, and we currently expect our reserve release in the third quarter to be greater than what we experienced in the second quarter" -- for the record, a reserve release is the counterpoint to an increase in loan loss provisions.

For current bank investors, this is very good news, as it suggests that an increasing share of profits will be passed onto shareholders in future quarters. But for those just looking to get into the industry, it may mean \valuations will continue to climb, making a profitable entry point harder to come by.

To help those of you in the latter group, our analysts have put together a free report which shows that bargains of a lifetime are still available. The catch is that you need to know where to look. The Motley Fool's new report "Finding the Next Bank Stock Home Run" will show you how and where to find these deals. It's completely free -- click here to get started.

The article A Very Positive Sign for Banks originally appeared on Fool.com.

John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of KeyCorp, PNC Financial Services, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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