Last earnings season, I wrote a scathing piece on nearly every big bank earnings release that came across the wire. My criticism primarily stemmed from the fact that bank earnings are largely meaningless given the multitude of ways the numbers can be massaged. The following passage is from a piece published last quarter entitled "Bank of America's Report Betrays Uselessness of Big Bank Earnings Releases":
"This quarters' results from America's largest banks have truly shown how many different ways earnings can be manipulated and massaged to come out with "net income" that meets analysts' expectations. In fact, bank earnings now appear so malleable, it is difficult to imagine how any competent big bank CEO could ever allow his/her firm to miss on an earnings report."
Not surprisingly, this quarter's releases from JPMorgan (JPM) and Citigroup (C) are more of the same. JPMorgan reported a quarterly profit of $5.7 billion last week, a record, and a 34% year-over-year increase. This equates to $1.40 per share, well above Wall Street's consensus estimate of $1.21. As expected, the results were helped by several "significant items".
Notably, a $900 million reduction in loan loss reserves accounted for 14 cents of the firm's quarterly earnings, a miracle considering that
"...the Firm's nonperforming assets totaled $12.5 billion at September 30, 2012, up from the prior-quarter level of $11.4 billion" (emphasis mine)
Those interested in knowing how the bank is actually doing minus the smoke and mirrors need only consult the firm's figures for net interest margin (net interest income divided by average interest earning assets). This metric fell to a new all time low of 2.92%.
Citigroup's earnings are similarly devoid of any real meaning. The firm actually 'earned' only 15 cents per share in the quarter but Citi would prefer investors pretend that the real figure is $1.06 per share (a beat), a happy fantasy made possible by ignoring
"a pre-tax loss of $4.7 billion ($2.9 billion after-tax) from the previously announced sale of a 14% interest and other-than-temporary impairment of the carrying value of Citi's remaining 35% interest in the Morgan Stanley Smith Barney (MSSB) joint venture"
Excluding this little detail, Citi's net income was $3.3 billion during the quarter. Of course the gimmicks don't stop there. The $3.3 billion adjusted net income figure includes a
"...$1.5 billion net release of loan loss reserves"
So half of the firm's already inflated net income came from putting aside less for bad loans. This is an even bigger fudge than last quarter when reductions in loan loss reserves accounted for a third of the bank's earnings.
The idea behind investing is to own a portion of companies which generate real profits -- more money coming in the door than money going out the door. There are so many adjustments -- so many 'significant items' -- to take account of when evaluating the results of many of America's largest financial institutions that one wonders if analyzing the reports is an exercise in futility. There simply is no straightforward way to determine how much money is coming in and how much money is going out. As such, investors should steer clear of these firms until such a time as their results become more transparent and less open to charges of manipulation.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.