Increased its loan loss reserve recording a provision

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increased its loan loss reserve (recording a provision for loan losses) by $2 billion in the third quarter of 2007. This loan loss provision expense was recorded in recogni- tion of expected losses on mortgages and loans tied to corporate buyouts. As a result, Citigroup’s third-quarter 2007 profit fell 60 percent. As mentioned earlier, the size of the provision is determined by management, and in the United States it is subject to a maximum allowable tax deductible amount set by the Internal Revenue Service. 16 A bank can recognize income for at least 90 days after the due date of the interest payment.
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Appendix 2B Commercial Banks’ Financial Statements and Analysis 19 At the beginning of the month, a bank has $1 million in its loan portfolio and $50,000 in the allowance for loan losses (see Panel A of Figure 2B–3). During the month, management estimates that an additional $5,000 of loans will not be paid as promised. Accordingly, the bank records an expense to loan loss provision (which reduces net income and thus retained earnings and equity of the bank) and increases the allowance for loan losses to $55,000 on the balance sheet (see Panel B in Figure 2B–3). Notice that the loan is still listed as an asset on the bank’s balance sheet at this time. After another month, management feels there is no chance of recovering on the loan and writes the $5,000 loan off its books. At this time, loans are reduced by $5,000 as is the allowance for loan losses (see Panel C in Figure 2B–3). Notice when the loan is considered unrecoverable and actually removed from the balance sheet, there is no impact on the bank’s income or equity value. Noninterest Income Noninterest income (item 30) includes all other income received by the bank as a result of its on- and off-balance-sheet activities and is becoming increasingly important as the ability to attract core deposits and high-quality loan applicants becomes more difficult. Included in this category is income from fiduciary activi- ties (for example, earnings from operating a trust department—item 26), service charges on deposit accounts (generally the largest source of noninterest income— item 27), other gains (losses) and fees from trading assets and liabilities (from marketable instruments and OBS derivative instruments—item 28), and other EXAMPLE 2B–1 The Relationship between Allowance for Loan Losses, Provision for Loan Losses, and Loan Balances Panel A: Beginning of Month 1 Assets Liabilities and Equity Securities $ 250,000 Deposits $ 700,000 Gross Loans 1,000,000 Common Stock 200,000 Less: Allowance for Loan Losses $ 50,000 Ret. Earnings Total Equity Total 300,000 500,000 $1,200,000 Net Loans $ 950,000 Total Assets $1,200,000 Panel B: End of Month 1 Assets Liabilities and Equity Securities $ 250,000 Deposits $ 700,000 Gross Loans 1,000,000 Common Stock 200,000 Less: Allowance for Loan Losses $55,000 Ret. Earnings Total Equity Total 295,000 495,000 $1,195,000 Net Loans $945,000 Total Assets $1,195,000 Panel A: End of Month 2 Assets Liabilities and Equity Securities $ 250,000 Deposits $ 700,000 Gross Loans 995,000 Common Stock 200,000 Less: Allowance for Loan Losses $ 50,000 Ret. Earnings Total Equity Total 295,000 495,000 $1,195,000 Net Loans $ 945,000 Total Assets $1,195,000 FIGURE 2B–3
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