Capital One's management recently increased loan loss reserves after it underestimated the severity of unemployment and housing declines.
Not until page 111 of the 2010 10-K does one see details on how the companies loan loss reserves, aka valuation allowances change.
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Citigroup (NYSE:C), audited by KPMG for the last forty-one years, posted a profit for its third consecutive quarter after cutting its loan loss reserves.
While the bottom lines are being cushioned with loan loss reserves releases and accounting maneuvers like debt valuation adjustments the revenue number tells a more honest story.
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In the financial sector, despite weak trading volume in Q2, results are likely to top consensus expectations on improving credit quality and large releases from loan loss reserves.
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Allowing loan securitizations, derivatives, and swaps to be taken off bank balance sheets was an important element in this, as were the procyclical rules on capital and loan loss reserves.
In 1998 the SEC forced SunTrust Banks to restate three years of financials by claiming it had used overly generous loan loss reserves as a cookie jar to smooth earnings.
Moreover, the SEC impeded creation of adequate loan loss reserves by banks during the boom years, allowed Wall Street firms to reduce significantly their capital cushions and eliminated regulations on abusive practices by short-sellers.
The results will contain estimated losses by exposure category, pre-provision net revenue, changes in loan loss reserves, total assets, aggregate loan balances and anticipated capital distributions over the time horizon.
Reliance on market forces and models led the SEC to challenge the judgmental approach to establishing loan loss reserves and to the creation of procyclical models that understate reserves in good times and overstate them in bad times.
David Trone, bank analyst at JMP Securities, says traditional banking like making loans to consumers and businesses should be relatively flat as loan growth remains muted and the impact of releasing loan loss reserves continues to peter out.
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Mitigating Considerations: It is a matter of public record that the major German banks (who hold somewhere between DM 6-10 billion in uninsured Soviet debt) have with the possible exception of Commerzbank already established loan loss reserves which cover 100 percent of Soviet debt exposure.
The accepted practice in bank accounting is to set up significant loan-loss reserves only when the commitment is availed of and the arrangement becomes an on-balance-sheet loan.
And the banks can tap funds set aside for loan-loss reserves and call them profits.
What has been strong for banks has been their almost 18 month run of reducing loan-loss reserves.
Capital One said second-quarter profit fell 90 percent as an acquisition forced it to set aside loan-loss reserves.
Heymann of Sterne Agee notes that GE's loan-loss reserves are around 2.36% of receivables, compared with 3% at comparable banks.
Now, Tokyo will probably have to write off almost all the Sogo debt that it holds, while banks must increase their loan-loss reserves.
Spain's financial regulators took the smart move nearly a decade ago of requiring banks to boost their loan-loss reserves (see "Reserves Saved Spanish Banks").
Singapore's banks were relatively cautious in this regard, but even they are having to boost loan-loss reserves to account for the increasing number of non-performing loans.
But selling non-core assets and reducing loan loss risk and the reserves for potential losses was ostensibly part of their federal bailout deal.
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