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5 Bank Stock Red Flags

NEW YORK ( TheStreet) -- It can pay for bank investors to look a little deeper at financial statements.

While you are not able to see everything going on behind the scenes at a bank holding company, there are some items that can serve as red flags for trouble down the road.

We've selected five areas for bank stock investors to consider that can distort the bottom line, lead to future write-downs or -- in the worst of cases -- a dreaded restatement of financial results.

Provisions for Loan Losses

Over the past several quarters, many of the largest U.S. banks have seen a direct boost to earnings through the release of loan loss reserves. This is no surprise, since the obvious reaction to a souring loan portfolio is to sock away extra reserves. Then, after working through a significant portion of the problem loans, most of the large players have found that they had more reserves than they needed.

Each quarter, a bank will typically add to its allowance for loan losses by making a provision for loan loss reserves, which lowers its earnings. If the provision outweighs a bank's net charge-offs -- its loan losses less recoveries on previously charged-off loans -- its allowance for loan losses increases.

Since messing with the quarterly provision is an obvious way for banks to manage earnings, regulators frown upon banks "over-reserving" when the economy is strong. This, of course, is counter-intuitive, because a period of strong economic growth is when a bank will be better prepared to build reserves. No matter. What happens is they scramble to build reserves in the midst of a recession, thus front-loading their net losses, leading to the large release of reserves we are seeing now.

During the second quarter, JPMorgan Chase (JPM - Get Report) reported net income of $5.4 billion, partially fed by a $1.2 billion reserve release.

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