Inside Financial Services

No, Reserve Releases Don’t Count As ‘Number-Fudging’

A Bloomberg columnist hints at a scandal where there is none

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Some events are as predictable as the sunrise. Sure enough, Bloomberg’s accounting scold, Jonathan Weil, has taken to carping that banks’ earnings lately are of “low-quality” or worse because–and you hear this every cycle–they contain a significant amount of loan-loss reserve releases. He’s just sure he’s on to something. Commenting on a recent a speech by OCC head Thomas Curry, Weil writes that “[Curry] cautioned that some banks seemed to have been ‘scrimping on their allowances against their loan losses,’ which is a fancy way of saying they are fudging their numbers.”

Oh, please. First, I don’t recall Weil or anyone else complaining in 2008 and 2009 that the big reserve additions the banks were booking at the time meant that the resulting reported losses were somehow not real. Come to think of it, my recollection is that the Jonathan Weils of the world took those mid-crisis loss-reserve additions as evidence the banking industry was at risk of collapse. Which, in fact, it was. Five years on, we now know that that banks over-reserved at the bottom the way they always do, and are making adjustments. As I say, it happens every cycle.

More to the point, if Weil believes the problem is bad as Curry seems to think (“fudging their numbers”!), why doesn’t simply pontificate that Curry should do his job and tell the banks to cut out the monkey business. Curry is the Comptroller of the Currency! Bossing banks around is what he does.

Except that on this issue, the regulators will stand pat. Reason: banks have a lot less discretion in setting (or releasing) their reserves than most people, even Bloomberg columnists, seem to realize. The accounting rules on reserving are pretty clear, and don’t leave a lot of wiggle room. Meanwhile, I’ve never quite understood what people mean when they say that certain types of earnings are “low-quality.” One hundred cents on the dollar counts as 100 cents on the dollar, after all. And considering what the banking business was going through when those reserve additions were put on the books, their release now should be seen as something of a triumph. But number-fudging? No way.

What do you think? Let me know!

24 Responses to “No, Reserve Releases Don’t Count As ‘Number-Fudging’”

  1. fraudster

    The point is that these are non-recurring earnings that disappear as the reserves are tapped. They are not a predictable component of the bank’s operations.

  2. peterh1

    There was a time; think 50′s&60′s, that some miscreant banks tended to over reserve. They promptly got their knuckles rapped by the National bank examiners and the problem seemed to be solved. Not aware that this was
    still on the radar to the extent that Mr. Curry would miss an opportunity to read the riot act.

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  3. fraudster

    The point is that these are non-recurring earnings that disappear as the reserves are tapped. They are not a predictable component of the bank’s operations.

    • Controle

      Wonderful story, reckoned we could conibme a few unrelated data, nevertheless really worth taking a look, whoa did one learn about Mid East has got more problerms as well

  4. chico

    non-recurring, fraudster! it’s called being at a certain point in the cycle. the credit cycle gets bad and LLPs impact earnings negatively; conversely, the credit cycle heals, and credit becomes a tailwind…it’s not complicated and it’s not fudging #’s. it’s basic accounting as it relates to banks taking on credit risk…which by the way is what they do.

    • Caroline

      Wonderful story, reckoned we could cniombe a few unrelated data, nevertheless really worth taking a look, whoa did one learn about Mid East has got more problerms as well

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  5. chico

    non-recurring, fraudster! it’s called being at a certain point in the cycle. the credit cycle gets bad and LLPs impact earnings negatively; conversely, the credit cycle heals, and credit becomes a tailwind…it’s not complicated and it’s not fudging #’s. it’s basic accounting as it relates to banks taking on credit risk…which by the way is what they do.

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  6. Retired Banker

    I am so glad you are around to call attention to and spread some rationality on an off-track commentator who clearly does not understand his subject matter.

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  7. JRG

    Is it ok to pay incentive comp on earnings from reserve releases? Bank stock prices have historicaly not been positively affected by reserves releases. Investors reward sustainable earnings growth not one time gains.

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  8. c smith

    As long as the Fed is cranking out the free money, the banks can cut the LLPs to zero and it won’t matter a lick!

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  9. Abby Normal

    The point is that as an analyst you need recurring consistent earnings to asses bank profitability and do ratio analysis, in addition to estimating the ratings migration on the loan portfolio and the direction on release or accumulation of loan loss reserves to determine where we are at in the credit cycle. It is stupid that you get a jump in price when earnings are “good” because they released the loan loss reserve, and newbie analysts are creaming their jeans on the conference call but it happens every time like clockwork. Like you say they are a cyclical and that’s why value guys have liked them over time so much. It’s the whole point of why you bought them if you did your homework.

    Ordinarily you could say that better quality earnings had more cash component than accrual, but since you can’t asses cash flow all that well with a bank you have to use the above to do it. Of course there’s no sense in telling Tom that because he knows it and wrote a whole bunch of articles on it.

  10. Pat O'Brien

    I agree that a lot of comments about banks in the past seven years sound as if the writers just graduated from high school. In my mind though, the earnings that count are those using a “normal” level of reserving. Now, “normal’ is slippery concept but any cyclical like a bank or an auto manufacturer reports earnings that swing widely up and down over a cycle and you need to have an idea of what the central tendency is of those swings. Every dollar is worth 100 cents but you ought to be willing to pay more at the bottom than you would at the top.

  11. Frank

    Over 30 yrs ago when I was working for the OLD Wachovia Bank ( pre First ‘Onion’ merger) Wachovia would always aggressively take losses in their bond portfolio and add to reserves during the ‘good’ times so they could draw them down during the inevitable bad times. I always thought that this was the way to run a bank. Can banks still do this, or are these more ‘conservative’ moves precluded by current accounting/SEC rules/regs?
    Thanks,
    Frank

  12. Rus

    Suntrust is a perfect example in that it was forced to lower it’s LLR in 2004 by the SEC. Reserves that would come in handy in 2007-2008!

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