Tuesday, February 27, 2007

no worries, loan loss reserves..../minyanville

this questions once more the earnings quality. this will hit the banks very very hard! you can see the impact now in the subprime segment were they went from record profits in 2005 to mid 2006 to record losses in just a 2 quarters. looks like the rainy days are coming back.......don´t get blinded from their low pe and the dividend yield........that´s the same mistake the new, cfi, etc investors were making.

dieses beispiel zeigt einmal mehr wie dürftig es teilweise um die gewinnqualität der banken bestellt ist. wir müssen hier nur zur hypovereinsbank mit den ostimmobilien blicken um zu erahnen was kommen wird. und das komplette subprimesegment ist von rekordgewinnen bis mitte 2006 zu rekordverlusten in nur 6 monaten gekippt. man sollte sich also nicht von den niedrigen kgv´s und divrenditen locken lassen.sieht so aus als wenn die regnerischen tage zurück sind.

That's the headline from today's WSJ on banks keeping less money in reserve.

We've noted the selloff in financials over the past week on the Buzz & Banter, remarking a number of times on the increasing number of technical breakdowns in Banks, Real Estate, Insurance and Finance stocks.

Perhaps this is the reason for the breakdowns in certain financials: over the past few years banks have dramatically lowered the level of their reserves.

Bank reserves are established to handle the percentage of their loan portfolios exposed to potential

According to the Journal article, investors in financials have benefited greatly from the sharp falloff in bank reserve levels since that helps boost profits.

"From 2004 to 2006, the nation's biggest banks received 37% of their earnings growth from reductions in their loan-loss reserves, (WOW!!!!!!!!!!!!!)

Meanwhile, problems building in the subprime lending segment are awakening regulators to the possibility that perhaps banks are overestimating the quality of their loan portfolios.

..., a number of banks have drawn down their reserves for bad loans to "apparently unsustainably low levels."

The common refrain in defense of the current low reserve levels is that banks are more sophisticated at measuring default risk and that current repayment problems are isolated to the weakest segment of borrowers.

Sounds good. Except that, according to the FT, late payments and defaults in the so-called Alt-A market, catering to consumers with slightly better than subprime credit, are running at four times the historical rate.

FT: Treasury prices rose on Monday as fixed income investors sought a safe haven amid fears that repayment problems involving “subprime” US mortgage borrowers could have knock-on effects in the broader $8,000bn mortgage market and beyond.

The latest concerns centre on the Alt-A market, in which consumers with slightly better credit than the weakest subprime borrowers can obtain loans with loose terms - such as no proof of income. Late payments and defaults on such loans are running at four times the historical rate.

“The delinquency numbers for the 2006 Alt-A originations are materially worse than a lot of people would have expected,” said Charles Sorrentino, mortgage analyst at Merrill Lynch.

The annual cost of credit protection on the ABX index of mortgage bonds rated BBB- rose to 14 per cent, up from 13 per cent at the start of the day and just slightly off last week’s record of 15 per cent. Three weeks ago, the price of such protection was 2.5 per cent.(end ft)

We could also point out that late payments and defaults are understated since a "readjustment" of the loan provisions keeps them out of the reporting criteria, but why spoil a solid case of denial?

more on this topic from calculated risk

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Blogger Adamchik said...

It is important to realize that (in the US) the SEC puts pressure on banks so that they do not "manage earnings." So, when banks have been setting aside large reserves in the past few years, the SEC has complained that banks are going to use those reserves for earnings management in the future, since the banks cannot show recent losses. There are a number of banks that have had few losses to speak of over the past few years, so it is hard to defend an increasing level of reserves. You can usually do it, by explaining that your economic outlook has changed, and trends are at work. But it is not so easy, and not every regulator listens.

In the banking industry, the folks in charge of credit risk usually have long memories, and are paid to think about worst-case scenarios. However, you should appreciate the pressure that the SEC brings, where it does not like large reserves, if you have a very low loss history.

The FDIC (deposit insurers) would love you to have high levels of reserves, so there is a struggle between regulators here, as well as just trying to figure out the right level of future losses.

2:03 PM  
Blogger jmf said...


thanks for the comment/insight.

have hear this argument multiple times on conference calls from subprime lenders.

i think with the housing slump and the recession coming they have to "change" their outlook.

the last few years the banks have tried to manage their earnings only/exclusively to the upside... :-)

9:12 AM  

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