The nation's top 50 banks could forfeit a year's worth of earnings growth if the economy turns down and more loans go sour, warned a Wall Street analyst who has studied the industry's loss reserves.

"For most of the past five years, banks have accelerated their loan growth while reducing, in absolute terms, their loan-loss reserves," said Richard X. Bove of Raymond James & Associates, St. Petersburg, Fla.

"Banks do not appear to be reserving against the next economic downturn," he said. "They seem to believe that good times are here forever."

Several weeks ago, the analyst advised bank stock investors to secure profits from last year's big run-up by selling shares of all but selected companies into any market rally.

"Basically, reserves are now about 2% of total loans, which is the average over the past 50 years," Mr. Bove said. "If present trends continue for several more quarters, however, we will be below that level, and not prepared for a change in the economy."

He said he had been "particularly struck by the fact that every bank (management) we have interviewed in the past year claims they are capable of growing at rates that are two to three times the rate of the local economies they serve."

At the same time, he said, bankers complain that their competitors are pricing loans at unprofitable levels in order to achieve growth while they, of course, are not.

"Clearly, not all of these bankers can be correct," he said. In particular, "not every competitor can be a loser."

The analyst also wondered how growth claims can be made by major banks, notably those operating in Florida, when they are losing deposit share to smaller institutions.

"It is unclear whether this is due to the introduction of new policies that make big banks eliminate unprofitable customers, or whether the big banks' new pricing and marketing policies are making them lose ground," he said.

"Whatever the reason," Mr. Bove pointed out, "the loss of deposit market share may not be consistent with growing at rates two to three times the rate of the local economy."

More than the growth issue, however, the analyst questioned current loan pricing. Banks, he said, "do not appear to be taking into account future loan losses when they price loans in the present."

That could quickly create the need for higher reserves if the economy falters, he said. And most banks have not been building reserves at a sufficient rate, he said. He cited data that, from 1992 to now, the nation's top 50 banks have increased loans by 9.98% annually and reserves by 2.12%.

There are some exceptions, of course. Most notably, New York's Citicorp, burned during the industry's last outbreak of bad loans, has maintained its reserves, as have First Chicago NBD Corp., U.S. Bancorp., SouthTrust Bancorp., and several others.

But if Citicorp's numbers are excluded, the Florida analyst said, the nation's top 10 banking companies increased loans by 10.33% per year during the past five years, while reserves fell by 0.73%.

Mr. Bove is not the only Wall Street banking industry watcher to raise questions about banks' reserve-building activity.

Raphael Soifer of Brown Brothers Harriman & Co. has noted the phenomenon of falling reserves since 1995. In a study of yearend results, released in March, he said, "our U.S. banking universe is continuing to withdraw money from its aggregate reserve for credit losses and is taking those withdrawals into pretax income."

The result is overstatement of earnings. Among banks he follows, Mr. Soifer calculated that fourth-quarter aggregate return would have fallen to 15.3% from 16.7% if reserves had been added at a pace "sustainable over an entire credit cycle."

In his broader study, Mr. Bove estimated that the top 50 banks may be overstating earnings by 10.5%. Excluding Citicorp, the overstatement is probably 13.2% for the top 10 banking companies.

The analyst said there's nothing new about banks cutting reserves in good times when stimulation of earnings is not really necessary. But the result is that when loan chargeoffs rise, banks must increase reserves quickly and artificially penalize earnings, thus spawning the extreme swings in reported profits that have bedeviled the industry.

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