Drip
Portfolio Report
Citicorp
by Dale Wettlaufer ([email protected])
Alexandria, VA (June 26, 1998) --Thursday, we left off looking at the direction of Citicorp's loan loss provisions and net charge-offs. Before we go on (we're not in a hurry to finish Citicorp, as it has suspended its DRIP while putting together the merger with Travelers Group), let's quickly review the components of net charge-offs.
When a loan has been charged off, the bank or finance company (or, say, a manufacturer, retailer, or professional that extends credit to customers) believes that the likelihood of collecting the principal amount of the loan is low. There are also rules-based systems for charging off a loan, such as when a credit card balance has been delinquent for 180 days. Other types of consumer loans are charged off when they have been delinquent for 120 days.
A nonperforming loan is seen on the balance sheet until it is charged off. Even as it is delinquent, you see it in "Loans, Leases, and Factored Accounts Receivable," or just "Loans, Net of Unearned Income." However, there is an account just below that line on the balance sheet called "Reserves for Loan Losses" or "Reserves for Credit Losses." That is called an "asset contra account" because it is set up against, or "contra," an asset account and adjusts the value of those assets. So, on the balance sheet, we see:
Period 1
Loans, net of unearned income�.$53,380
Less: Allowance for loan losses�.900
Net loans�.$52,480
Period 2
Loans, net of unearned income�.$54,900
Less: Allowance for loan losses�.900
Net loans�.$54,000
The company's reserves for loan losses amount to 1.6% of gross loans, down from 1.7% in the prior quarter. That means that the composition of loans has changed from quarter to quarter or the bank's management believes credit quality is improving.
To get from the first period to the second, we have to look at charge-off activity and recovery activity, which net out to give us net charge-offs. Then we look at the quarter's provision for loan losses. All of these impact the income statement in one way or another, because net charge-offs influence the company's provision for loan losses, but only the provision for loan losses is an income statement item.
THREE MONTHS ENDED MARCH 31
Balance at beginning of period�.$900
Charge-offs�.(100)
Recoveries�.23
Net charge-offs�.(77)
Provision for loan losses�.77
Balance at end of period�.$900
So, to get from one period to another, we start with last quarter's reserve for loan losses of $900. Then deduct charge-offs of $100 from the reserve (and from gross loans), add back recoveries (which may or may not increase gross loans) of $23. At this point, net charge-offs for the quarter were $100 minus $23, or $77. So, the reserve for loan losses has been reduced by $77. We then have to add back to the reserves any addition to the reserves that we made through the income statement (where the addition to loan loss reserves shows up as an expense). From the income statement:
NET INTEREST INCOME�.$664
Provision for loan losses�.77
Net interest income after provision for loan losses�.$587
The company's provision for loan losses for the quarter was equal to its net charge-off rate. When credit quality is deteriorating, provisions for loan losses should be larger than net charge-offs. And when credit quality is improving, loan loss provisions will decrease, as recoveries of previously written off loans bolster the loan loss reserves.
When looking at credit quality trends, you need to look at the company's current reserve position and its charge-offs and recoveries, and then compare the company's loan loss provisions to net charge-offs to ascertain what's going on.
Touchstone Friday. Over the past week we continued to cover Citicorp, beginning Tuesday with a look at the company's business lines. If you don't know the business lines, you can't very well know the business. (Remember last Thursday that we initiated this study by providing the overall numbers for Citicorp.) Next, on Wednesday this week we discussed Citicorp's return on assets by business line. What is working best in making money for the company? And, again, this Thursday we discussed the company's credit quality.
In the Drip Port, we added our most recent Intel (Nasdaq: INTC) dividend and Johnson & Johnson (NYSE: JNJ) purchase and dividend to the transaction page. Also, we recently sent three checks to invest in our three companies for next month. Those details are on that page as well.
Have a good weekend!
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