American banking sector’s lackluster results: why won’t they keep the story straight?

Maybe I’m not the financial analyst I should be, but I noticed that the market took a hit today, primarily due to earnings reports from Bank of America and Citibank. JPMorgan reported results yesterday.

In all three cases, the banks reported profits. But the stocks went down anyway because the banks also reported reduced revenues. The chattering classes on the topic of banks are saying, “how can they ever be expected to be more profitable if their sales are going down???!!!” (Notice the excessive punctuation at the end.)

I just wish people would keep the story line straight, which I guess is hard to do if you’ve never studied a bank’s balance sheet.

Last year, people were saying that the banks were so full of bad loans that their actual capital was zero. Even as the considerable amounts of TARP emergency capital were being repaid to the government (at a high profit to the government no less), people were predicting more major bank failures. It didn’t happen.

There was the argument out there that loans on the books weren’t being properly analyzed, and that not enough were being “written off” as uncollectable. But what appears to have happened in JP Morgan’s case is that the bank has taken some of this earlier write-off back onto the asset side of the balance sheet. Meaning: the bank now thinks these won’t be as bad as what they thought even a few months ago. Remember, a bank first builds a “reserve account” which represents the loans they don’t think will be paid back. It’s a figure that represents something like a “minus loan” on the asset side of the balance sheet. Only when the loan is really, in fact, not paid back, is it “charged off” against the reserve account. They are two different things, and the hit to profits comes when the reserve account is increased—not when the loan is in fact charged off.

So if the bank has taken its hits already on whether the loan will be collected, and things turn out better than expected, some of that reserve account comes back into profit. That’s what happened with JP Morgan.

Other people go on the government for not “cracking down on bad bank lending!!!!”, which would mean, what? That the banks should only make prudent loans. So the amount of revenue would be down if the bank made fewer loans than it had before. But it would also be down if the interest they charge on the loans is lower than it used to be. One reason it might be lower is because the borrower refinanced, or the bank got cheap money from depositors, since now most checking and money market accounts pay zero.

The real test of whether the bank is actually shrinking is whether the number of actual, performing loans, is going down (including loans to the government in the form of U.S. government bonds). There’s a lot of silence on this today.

So there are countless reasons why bank results are no surprise, but also no social crisis.

They were supposed to all be bankrupt. Then, in years of marginal profitability, if that. Now, the earnings exceed analysts’ expectations, but somehow everything is still “bad”.

What quarter will a straight forward story be told?