The specifics of bank reserves, generally
Glenwood Springs, CO Colorado
The recent announcement by Alpine Bank of a $22 million first quarter loss has prompted a lot of questions by the citizenry. What does this mean? Is the bank stable? How does any business sustain that kind of loss?
Addressing those questions will tell us a lot about banking in general as the world claws its way out of the Great Meltdown.
First, so we can move on to the interesting stuff, Alpine is, in fact, stable. It’s got a good capital base, and a fairly strong core income stream (income from regular banking business, like the spread on deposits and investments). You can check this out for yourself by logging on to the FDIC website that shows financials for every bank in the country: www2.fdic.gov/idasp.
Much of the loss, but not all, was a result of reserves set aside for problem assets. We bankers get pretty good at making this reserve thing sound pretty arcane, and the regulators are even better at it. But the process is pretty simple. Banks have two major reserve categories, general and specific. The former, general reserves, are built up over time and relate to the bank’s overall asset base, loans, investments, and any other things that they own. The amount in this account is controlled by the perceived risk in the bank’s portfolio, and based on historical losses. General reserves are not paired with any identified loss, and they count as capital. In short, they’re quite benign.
The fun starts with specific reserves. These do affect income and capital. Banks are required to periodically review all of their assets, good and bad, including delinquent loans and foreclosed real estate, to determine if losses are anticipated. When they are, then the amount of that potential loss is determined, and that amount is assigned to the specific reserve. This comes right out of income.
One of Alpine’s executives was quoted as saying that “The money’s not gone”. True, so far as it goes. But there is an assumption, in this calculation that, given present conditions, it very well could be. In a bank, if the bad assets that have specific reserve allocations were sold today, the reasonable presumption is that the money would in fact be gone, because of the decrease in value of the asset. Alpine, because of its current strong capital base, can be, and is, proactive in assessing potential losses and reserving for them.
This process of writing down assets can be interesting to watch, as long as you’re not an executive, board member or stockholder of the bank in question. Many banks don’t have the luxury of overly high capital ratios going into the process. Consequently, a lot of man hours of executive time are spent on putting a favorable spin on problem asset reviews with the goal of mitigating the immediate hit on capital, which could trigger regulatory sanctions. The most optimistic appraisals are selected for documentation of the review. Historical trends and dynamics, which may no longer be all that relevant, are cited for the loss assessment.
Then the examiners come in. Whoa, Nelly! To say that the regulators are not optimists is something of an understatement. They take the most pessimistic view, and in this recently declining economy, they’re more often right than not. When the regulators get done with a bank, the capital account may have taken a stomach-turning nosedive, and regulatory enforcement actions are in the offing.
The other day I was strolling down 17th Street in Denver, the financial center of the city. There was this street musician strumming his guitar and singing, “Mamas, don’t let your babies grow up to be bankers. …”
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