Loan Loss Reserve, Loan Loss Provision and Net Chargeoffs I am Really Confused by Them
I read many articles that talk about loan loss reserve, loan loss provision and net chargeoffs. I don’t really understand what they mean and all of a sudden I want to spend sometime to dig into their meanings. One thing I am clear is that loan loss provision, is like cost of good sold on income statement, should be subtracted from revenue to calculate net income. I did some research and find the following from A Loan Loss Reserve Primer: Beyond Simplistic Ratios
The loan loss reserve (or allowance for loan losses) is a contra-asset account on a bank’s balance sheet that is netted against gross loans. Each quarter the loan loss reserve rises by the amount of the loan loss provision (an expense item;) and reduced by the level of net chargeoffs.
I still remember this general accounting principle: Asset = Liability + Owner’s Equity. So loan loss reserve can be viewed as negative asset sitting on the asset side. The increase of loan loss reserve will decrease the total asset value. And this loss of asset value is reported on income statement as loan loss provision. Loan loss reserve on the balance sheet is similar to the stocks a company holds. Its value can fluctuate from time to time. But the stocks a company holds is normal asset type and the increase of stock price creates a gain item on income statement whereas the decrease of stock price creates a loss item on income statement. Loan loss preserve may go down and when it happen it will create negative loan loss provision and bring up net profit. It can happen when the management decides that they are over reserved for loan loss. It was the number 4 arguing point of the quote in this post The Reasoning Behind Bank of America’s Upgrade. I think he really means BOA has over 100 billion loan loss reserve(not provision) and at some point in the future when the economic turns around Bank of America may find it is over reserved. We can see loan loss preserve is a pretty flexible item where every banks can make its own decision to increase it or decrease it base on its own view on its own loan portfolio although some general guidelines apply
Net chargeoffs are loan amounts considered absolutely not collectible. It shouldn’t change the total value of asset as far as my understanding. People can look at net chargeoffs to evaluate whether loan loss is over or under reserved.
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Hope you took advantage of BAC under 12 this am….
I was watching but I didn’t trade on BAC today. I bought some puts and loss again.
Really? What were you seeing when you decided to buy Puts? When earnings for MS and WFC came out BAC was down maybe 1% when the others where down 4 and 5 %…Led me to think BAC was going to rally. Technical trade seems to still be intact with BAC.
You were right about BAC looking back. What do you see going forward?
Seems like you’ve been on the wrong side of trades for a little while now because of bad luck so let’s do a little experiment. Look at BIDU (again) and OSK..
Everybody said BIDU is up too high and it should drop. 2 days ago, it posted stellar earnings and growth. I would bet it goes up higher in the coming days due to momentum and lack of bad news. In fact, momentum is usually the first thing I look at when trading, then I figure out what’s causing the momentum to see if it’s sustainable.
OSK has skyrocketed since they announced a $1B govt contract. There are rumors that they will receive another $1.8B for expansion of that contract in the coming days. While that may or may not happen, their earnings have been beaten down in recent quarters and thus have low expectations. I suspect that they will beat earnings and beat guidance. In case they don’t beat earnings, they will definitely guide higher with the contract. Do you think they’ll go up or down and why? Up because they are in a brighter place? or down because their prices have popped? Again, my money’s on going up because that’s the momentum and no foreseeable bad news to drag it down (except maybe earnings).
I’m not saying to buy either one of these, but just watch them to try to get a feel for what moves markets. If they go down, try to figure out why. Feel free to post a reply with what you think and we can discuss..
I wasn’t in good mood to check my blog in the past few days. But when I look back at BIDU and OSK you seem to be right on OSK but Bidu went down a bit. I didn’t follow OSK long enough. But for BIDU it seems going back to normal meaning it will just follow the general market for a while. I kind of feel the downside is more than the up side at this point. If the market tanks downgrade on Baidu might come. Baidu already reach the highest price target I heard in the past year.
That’s true, BIDU seems to be a loser for now, but trust me, momentum will more often than not, be your friend. Take a look at a couple others: STEC and MNI are both going up. STEC makes solid-state drives and will report earnings next Monday. That’s enough to continue its momentum, especially considering Western Digital and Seagate both reported earnings that beat expectations. MNI is a pretty big newspaper company that’s recently fallen on hard times. This quarter, newspapers started to post profits again. Though it’s not much of a trend yet, it’s still worth taking a look at.
I would -always- start by looking at the momentum and see if it’s sustainable and why. BIDU might or might not prove to be a loser, but it’s still too early. I suspect if we revisit in a few more weeks, BIDU might be up again because there’s really no credible information that says it’s over-priced, except for the fact that it climbed a little faster than normal (due to revenue growth and overreaction to bad news earlier).
In the meantime, you might want to try a little experiment: plot a daily close chart of any stock that has made a 52-week high (or any stock) with the end of day prices and a simple moving average (SMA) line based on the 10-day close. When the closing price crosses the SMA line on the way down, consider that a short-sell, and when it crosses the SMA line up, consider it buy. Take a look at how often it crosses. For most stocks, about 50% of the time, you will be taking a loss and 50% of the time, you will be winning. Now, try to figure out how much your $ wins vs $ losses are. It will surprise you!
This is the simplest momentum system I can think of with its own type of stop-losses.
By the way, as for OSK, they’re announcing earnings before the bell tomorrow. Depending on what is said, it might mean an end to the momentum.
As always, good luck!
Follow-up on the 7/25 comment recommending BIDU and OSK.. Let’s assume we have $2M and we allocated 50% to each stock, no commissions. We buy at market open on 7/27 and held to either it closed below the 10-day SMA (since neither closed below this, we will just use their closing prices on Fri) or let the profits ride until end of day Friday 7/31.
Let’s just see how we did.
By the way, for all those who didn’t follow OSK, they announced Friday after close of market that they received a $1.06B (that’s Billion!!) contract from the military. This will certainly boost their share price Monday, considering their market cap is only $2B.
For BIDU, we bought 2,776 shares (round down any decimals and assume that amount was used for transaction fees) at $360.12 and sold on Friday for $348.14. We return $966,436.64
For OSK, we bought 39,510 shares at $25.31 and sold Friday for $27.45/share–$1,084,549.50
We would have $2,050,986.14 (or, made a profit of $50,986.14 or 2.55%).
If we assumed a worst case scenerio that BIDU went below the 10-day SMA of $343.59 and we stopped out at that price, we would have returned $953,805.84 on the trade and total returned would have been $2,038,355.34 (profit of $38,355.34 or 1.92%–compared to Dow making 0.55%) for a week’s worth of trading.
Look at that! I just made you into a billionaire hedge fund manager!!
Hope this helps!!