The Securities and Exchange Commission made big waves recently when it required SunTrust Banks to reduce its loan-loss reserves and restate earnings. A meeting was hastily convened between the SEC and bank regulators.
The confab produced nothing but a reassuring press release. Bank regulators, it said, are still in charge of overseeing bank reserving policies. The SEC's sole concern is protecting investors from attempts to manipulate earnings.
The truth is that the SEC is continuing to challenge reserve levels at banks even when they're complying with mandates from their regulators. The SEC contends that banks create larger than necessary reserves in good times (thereby understating earnings) and tap into reserves in bad times (thereby overstating earnings).
Based on a faulty premise that banks are managing earnings through reserving policies, the SEC imposes "solutions" that could damage the banking system. The SEC hasn't conducted a rulemaking process; engaged in meaningful consultations with the regulators who have responsibility for maintaining stability in the banking system; or requested public comments from bankers, accountants, or the investment community. Instead, the SEC has chosen to bully individual banks that have the misfortune of needing to get a registration statement through the agency.
The SEC has offered no evidence that using reserves to manipulate earnings is a practice in the banking industry. It can't, because there is no such evidence.
Bank loans increase in good economic times. Banks know through experience that a certain percentage of those loans will sour when the economy turns down, so they build reserves.
When a recession hits, loan growth slows and loan losses rise. During these periods, banks absorb most of their loan losses out of current income. Some draw down some of their reserves to help cover loan losses. Their reserves are used as intended, with considerable oversight from bank regulators and industry analysts.
The SEC's decision to go after SunTrust is particularly egregious. SunTrust is widely recognized as one of the most prudent and reputable banks in the country. I haven't spoken with SunTrust about its encounter with the SEC, but the facts are readily available from public records.
SunTrust, along with most banks, came out of the nation's worst banking crisis since the Great Depression with relatively high loan-loss reserves. During the years challenged by the SEC (1994-96), SunTrust added to reserves at a slower rate than it grew its loans, reducing reserves from 2.22% of loans to 2.05%.
The SEC required SunTrust to reduce its loan-loss provision during the three years by $25 million, $35 million, and $40 million, thereby increasing net income by somewhat over 3% per year. The amounts involved are trivial and unworthy of attention from the SEC or investors.
The confusion the SEC has created, however, is considerable. Bankers across the land are wondering, "Who's in charge and what are the rules?"
Everyone agrees that banks shouldn't manage reserves to manipulate earnings. Banks are required to have objective methodologies and procedures to set reserve levels. Every bank of any consequence does.
If the SEC believes it has more expertise on bank reserves than banks, bank regulators, and the accounting profession, it should commence a public rulemaking process. Once it has developed standards and methodologies, it should announce them so everyone will know what the rules are and that the SEC is responsible for enforcing them.
Then when the next major economic downturn occurs, the SEC should stand accountable for any resulting inability of banks to weather the storm. If the SEC is not willing to accept public responsibility for its actions and policies, it should stop meddling in matters over which, in my opinion, it has little or no expertise.