I Report U Decide Not "We Report You Decide": Saving for Banks Rainy Day

22.8.07

NuHa said...: As requested by a concerned citizen, here are some more details ... NuHa

With the financial sector under increasing stress, TheStreet.com Ratings checked two key ratios to measure the strength of big banks' balance sheets: loan-loss reserves as a percentage of nonperforming loans, and nonperforming assets as a proportion of core capital and reserves.

Banks and thrifts walk a fine line in setting their quarterly loan-loss provisions, which add to their reserves against future losses. If they reserve too little, they can be seen as taking on more risk in the event of a decline in credit quality and padding their earnings for the current quarter (since the loan-loss provision lowers net income). If they reserve too much, investors, analysts and regulators may see the institution as over-reserving -- so it can manage earnings by under-reserving at a future point when earnings would otherwise weaken.

A good benchmark for loan-loss reserve coverage is 100% of nonperforming loans, which are loans past due 90 days or more. If a bank is forced to charge off loans totaling more than its loan-loss reserves, the losses eat into capital. That can hurt earnings if loan quality continues to deteriorate.

Another thing to consider is headline risk. As we have seen with Countrywide, any bad news in this environment can cause depositors to flee -- every bank's worst nightmare.; August 23, 2007 at 11:25 AM

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