This Day On The Street
Continue to site
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Bank of America Faces Major Earnings Dip When Reserve Releases End

NEW YORK (TheStreet) -- Large-cap bank have seen a major boost from the release of loan-loss reserves over the past several years, and a return to typical provisioning for reserves could have quite a negative effect on earnings.

Banks typically set aside money for loan loss reserves each quarter based on their loan-loss expectations. For commercial loan portfolios, provisions are decided upon on a per-loan basis. Banks take a statistical approach for mortgage loans and other types of consumer loans. The trend -- it's human nature really -- is for banks to under-reserve during "good times" and over-reserve during and immediately after recessions.

This is in part because regulators don't want banks to use their reserve provisioning activity to smooth out earnings increases, and have traditionally frowned upon high levels of loan loss reserves when net charge-off rates are low. Investors also frown upon high levels of reserves, because they lower banks' returns on equity.

But this counterintuitive habit makes the bad times really bad, as we saw in 2008 and 2009 at the height of the real estate crisis, when banks really took it on the chin while adding to reserves.

Must Read: New York Community Bancorp Downgraded by KBW

During the fourth quarter of 2013, Bank of America's (BAC - Get Report) provision for loan loss reserves -- the amount added to reserves, thus lowering pretax earnings -- was $336 million, while the company's net charge-offs -- loan losses less recoveries -- totaled $1.582 billion. So the company saw a $1.246 billion boost to pretax earnings from setting aside less for reserves than it charged-off for nonperforming loans. This is appropriate at this stage of the economic recovery, considering that the bank's annualized ratio of net charge-offs to average loans was 0.68% during the fourth quarter and its $17.428 billion in loan loss reserves covered 1.88% of total loans as of Dec. 31.

Bank of America has plenty of excess reserves right now. But the reserve releases can't go on forever, and at some point the bank is likely to return to making provisions for reserves at similar amounts to its loan losses.

With this in mind, KBW's analyst team put together two sets of numbers to estimate what effect "normal" provisioning levels would have on earnings for 11 large-cap U.S. banks. Based on fourth-quarter numbers, if the banks were to make provisions for loan loss reserves matching median levels for the past 23 years, Bank of America would see its earnings lowered by 37 cents a share, or 37% of its core fourth-quarter earnings of a dollar a share.

With the understanding that the above analysis could be overly aggressive, KBW put together another set of numbers showing the effect on earnings if the banks made provisions for loan losses that matched their fourth-quarter net charge-offs. In this case Bank of America's fourth-quarter core earnings-per-share would decline by 31%.

The big bank that would see the second-largest declines under the first scenario is JPMorgan Chase (JPM - Get Report), with KBW estimating an earnings decline of $1.04 a share, or 19% of core fourth-quarter EPS of $5.60. Under the second scenario -- provisions for reserves matching fourth-quarter net charge-offs -- JPMorgan's earnings decline would be 91 cents a share, or 16% of core EPS.

1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
SYM TRADE IT LAST %CHG
BAC $17.03 -1.10%
JPM $67.52 -0.81%
AAPL $126.44 -0.13%
FB $87.28 0.43%
GOOG $523.40 0.30%

Markets

DOW 17,730.11 -27.80 -0.16%
S&P 500 2,076.78 -0.64 -0.03%
NASDAQ 5,009.2140 -3.9090 -0.08%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs