New Threat: Loan Losses
Apr 22nd, 2008 at 6:55 am by Susie
The next earnings nightmare for banks has begun.
Until now, losses at many banks have come from multibillion dollar write-downs on toxic debt. But analysts believe the costs of building bad-loan reserves could cause just as much pain — and for a lot more banks.
Banks establish bad-loan reserves as a cushion against expected losses on defaulted loans. Additions to these reserves, called “provisions,” get booked as an expense in a bank’s income statement and reduce earnings.
Now, as the economic downturn starts to bite, rising defaults are prompting banks to add larger sums to the reserves, a development that has hurt first-quarter earnings at some lenders.
Bank of America Corp. is the most recent victim. The bank’s first-quarter earnings, reported Monday, were worse than expected because of a $6 billion addition to its loan-loss reserve. That expense dwarfed the bank’s $1.31 billion of trading-related losses in the quarter — an indication that reserve building is taking over from write-downs as the newest big threat to earnings.
To be sure, investors have been expecting bank earnings to get whacked by bad-loan reserves. But, as Bank of America’s first-quarter numbers show, that expense can cause a lot more pain than the market anticipates. And, if defaults continue to rise, banks may have to make large, earnings-depleting additions to their reserves for several quarters.
