Just how seriously should we take the latest bank earnings?
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It’s a big week for the big banks. Bank of America beat expectations with its earnings report today, $3.4 billion last quarter. Earlier this week, Wells Fargo announced record profit. JP Morgan had better than expected earnings.
“You can tell that the banking industry is recovering, and that our economy is on a recovering path,” says Ken Carow, a finance professor at Indiana University’s Kelley School of Business.
But, turns out these banking numbers maybe smell a little sweeter than they really are. The effects of the housing crisis linger on these balance sheets. Banks are writing fewer mortgages. They’re facing lawsuits, government settlements.
One thing propping up these earnings reports—accountants. Big banks are adding billions of dollars from reserves that they’d set aside for loan-losses that never came to be. “Now they are reducing the reserve for the bad loans, and are going to have a positive income effect,” says Anne Beatty, an accounting professor at Ohio State University. But, be very clear, “there’s no cash flow associated related to this income being created. It is a pure accounting effect.”
So what’s a regular investor to do?
Fight back, with some math of your own.
“Do some accounting,” says David Stowell, a finance professor at Northwestern University’s Kellogg School of Management, “it’s not easy to do, and you have to look carefully at the financial statements.” But, he says, it’s worth it. There’s a lot of accounting noise in these earnings reports, obscuring the actual business of banking.
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