JPMorgan Chase and Wells Fargo made a lot of money last quarter. JPMorgan’s investment bankers closed a lot of deals, and Wells Fargo’s mortgage lenders stayed fairly busy. But what really made the difference for each bank—pushing them both over Wall Street expectations—was a quirk of accounting called a loan-loss provision.
Here’s how it works: When a bank makes loans, it puts them on the balance sheet as an asset, but it also acknowledges that not all loans will be paid off. The estimate of that shortfall is recorded as a loss reserve on the liability side of the balance sheet. When bank executives think businesses and consumers have become more likely to pay off their loans, they can draw down the loss reserve and record that amount on the income statement as a benefit, commonly known as a “release.”
The whole process is akin to an individual’s rainy-day fund. Say a person with $5,000 under the mattress suddenly feels more confident that he won’t be fired, or that the zombie apocalypse is not, in fact, nigh. He might take $1,000 of that stash and go shopping. Or he might take $2,000, or $500. It depends.
Similarly, it’s up to each bank to decide how much to set aside for loan losses. The American Bankers Association said the process involves “a significant amount of discretion” and a sober read of economic conditions, borrowers, and a bank’s historical experiences.
So how confident are JPMorgan and Wells Fargo that deadbeat borrowers will turn into solid, sound credit vessels? In a word, very. Drawing down loan-loss provisions in its real estate and credit card divisions accounted for almost 15 percent of JPMorgan’s earnings of $1.60 per share. JPMorgan marked just a $47 million expense on credit losses in the quarter, down from $247 million a year earlier.
At Wells Fargo, the credit-loss expense shrank from $1.8 billion to $652 million.
Profit is profit, but analysts and investors would rather see big operational wins—the kind that come with cash—than income based on optimism. Charles Peabody, an analyst with Portales Partners in New York, calls loan-loss gains “non-quality” profit and says they aren’t sustainable.
On the banks’ part, it doesn’t seem unreasonable. Delinquency rates have been falling in almost every category of borrowing. Most notably, missing credit card payments haven’t been as low since the first Bush was in the White House.
JPMorgan Chairman Jamie Dimon and his compatriots are simply (and happily) acknowledging those gains, as they have since 2010. Here’s a look at how U.S. banks have handled loan-loss provisions since the mid-1980s.