Nancy Bush, a bank analyst for whom I tend to have a lot of regard, spouted an unfortunate piece of conventional wisdom this week in a piece she published on SNL:
While I know that the SEC mandates pretty stringent parameters on the formulation of loan loss provisions and they their utterly insane pro-cyclical bias on this subject continues to hold sway, I also have been around long enough to know that there is some latitude for the building of reserve to account for future expectations of loan growth. I would hope that banks would take full advantage of those expectations to start minimizing loan loss reserve releases, lest poor earnings quality continues and the industry sows the seeds of the next credit crisis. [Emph. added]
Nonsense. I’m hearing a lot of blather like this lately-one always does at this point in the cycle-about how reserve releases somehow constitute “low quality” earnings for banks. I don’t buy that. What’s “low-quality” supposed to mean, anyway? The earnings are only worth 80 cents on the dollar? Seventy? That must be some new accounting rule I haven’t heard about. Earnings are important because they build capital and there is no sliver of capital deemed “low-quality” because it was created via reserve reversals. Capital in turn can be used for shareholder-friendly actions such as dividends and share buybacks.
Besides, back when the banks laid on those reserves during the recession and suffered huge losses as a result, no one questioned the quality of the losses or dismissed them as somehow figments of the accountants’ imagination. They were real enough at the time-so real that hundreds of banks became collapsed as a result. Why shouldn’t the reversal of those reserves be just as real?
Bush herself admits that reserving rules have an “utterly insane pro-cyclical bias,” which is the same thing has saying that the banks had no choice but to over-reserve for years during the slowdown. But if that’s so, why should they be shy about reversing that built-in redundancy now?
As I say, Nancy Bush isn’t the only one spouting this line. It’s standard on among sell-side bank analysts now, most of whom seem to want to come off as no-nonsense tough guys. Why, I can’t say. In any event, don’t believe them. The banks’ earnings recovery is real-and very high quality.
What do you think? Let me know!