Accounting maneuvers muddy bank earnings this quarter

Banks are reporting fourth quarter earnings and, while they look like a mixed bag, a big reason for the variation has to do with accounting moves related to past financial scandals. 

Deutsche Bank and Morgan Stanley both posted losses for final quarter of last year because of how much they had to pay to cover litigation costs. At the same time JPMorgan Chase, Bank of America and Wells Fargo were all able to report profits thanks to an accounting maneuver related to loan-loss reserves.

On Sunday night, Deutsche Bank reported an unexpected loss of $1.3 billion for the fourth quarter. Legal settlement costs accounted for nearly half of that. The report, released 10 days before the bank was scheduled to announce earnings, was a shock to analysts who had expected $270 million in profits. Last week, Morgan Stanley said its profits dropped to $192 million for the period from October to January from $661 million for the same period the year before. The drop was largely due to $1.2 billion in legal bills related to its trades of mortgage-backed securities.

However, last week JPMorgan Chase was able to report a profit for the quarter of $5.3 billion -- despite paying $1.1 billion in legal costs related to its role in the Bernie Madoff Ponzi scheme. For the year, its profits were $17.9 billion, which is especially impressive given that its legal bill for 2013 was nearly $23 billion. Shortly after JPM’s report, Wells Fargo announced $5.6 billion in earnings for the quarter and later in the week Bank of America reported $3.4 billion in earnings and $2.3 billion in legal costs for the same period.

All of this would suggest it’s a good time to be in the banking business, but a lot of those profits weren't actually earned in 2013 at all. Nearly a third ($5.6 billion) of JPMorgan’s earnings, $2.2 billion – about 10 percent – of Wells Fargo’s earnings and $1.8 billion of Bank of America’s came from their loan-loss reserves. This is money banks set aside at the time of the financial crisis to cover future losses if the economy didn’t improve.

Because people are currently doing a better than ever job of paying off consumer debt like credit cards, auto loans and mortgages, the banks have moved this money from the loss side of the ledger to the credit side. This has bulked up their reported revenue at a time when caps on fees and tighter loan standards make it hard to increase actual revenue. In addition to these one-time cash infusions, banks have also managed to show profits thanks to very aggressive cost cutting – mostly through lay-offs.

As many analysts have noted, accounting maneuvers and slashing expenses aren't a sustainable strategy for growth. Plus, there’s a lot of litigation still to come.

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    Constantine von Hoffman is a freelance writer and writing coach. His work has appeared in outlets such as Harvard Business Review, NPR, Sierra magazine, Brandweek, CIO, The Boston Herald,, CSO, and Boston Magazine.