As the recession deepened, market watchers began obsessing about banks' capital ratios to figure out who might fail next. With a recovery on the horizon, they've latched on to another somewhat obscure financial metric: pretax, pre-provision earnings.
Unprofitable institutions like Synovus Financial Corp. and Huntington Bancshares Inc. have touted consistent and growing PPE as evidence that they can thrive on the other side of the crisis. Others, like Fifth Third Bancorp, have been releasing more details on their PPE to cater to market interest.
The emphasis on PPE is an important shift for banks that has also been reflected in surging share prices: a sentiment that the industry's loan losses are easing. As credit concerns diminish, investors and analysts are turning their attention to how much money banks will be able to make when they stop setting aside massive amounts of capital to charge off bad real estate and commercial loans.
PPE has emerged as the de facto barometer of normal earnings. It essentially indicates a bank's profits on loan spreads and fee income by excluding credit costs and taxes. Taxes are often tied to credit costs because a bank may have to delay a tax payment to another quarter if it doesn't have enough taxable income due to loan losses.
"Tangible common equity was really important if you were worried about a bank's ability to survive — now looking at PPE, you're looking at a bank's ability to grow its earnings," said Jamie Cox, managing partner at Harris Financial Group in Colonial Heights, Va.
David Dietze, chief investment strategist at Point View Financial Services Inc., likens PPE to an imperfect snapshot of what a bank's profits might look like if it weren't weighed down by batches of bad loans.
"It shows the earnings power … if you strip away the long, ugly shadow of their prior bad loans and assume those won't be [made] going forward and the economy keeps getting better," he said. "It's all about looking forward — not looking back. We know what's happened in the past."
To be sure, PPE can't be viewed in a vacuum, as it hardly presents a full picture of financial health. It doesn't indicate when a company's nonperforming loans will start falling, for instance. While there is a broad assumption that banks won't resort to the questionable lending practices that helped caused the recession, Dietze said there is no guarantee history won't repeat itself.
Still, Dietze said PPE is the best tool that market watchers have for understanding how strong a bank's core business is. It tells how much the banks may have earned from fee income in asset management, as well as profits from loan margins. Banks' loan problems may be easing, as indicated by a slowdown in nonperforming asset growth, but their sizable portfolios of troubled assets cloud their profit potential, he said.
"As long as you have this massive overhang of bad loans from the past, I think people are going to be caring about PPE," he said.
Banks care about it, too.
Kevin Kabat, the chief executive of Fifth Third, said during an investor conference this month that the Cincinnati lender included a slide on pretax pre-provision because "a lot of you ask us about [PPE] to get a better feel for our future."
Fifth Third posted $562.3 million in PPE in the fourth quarter, up from negative $540.4 million a year earlier.
"We've continued to generate strong pre-provision profitability and remain focused on executing our strategic plans across all of our businesses," Kabat said.
Richard Anthony, the chairman and CEO of Synovus, said at the same conference that consistent PPE is one of the reasons the Columbus, Ga., company may be on track to turn a profit sometime this year.
It had $144 million in PPE in the fourth quarter, up 2.8% from the prior quarter and up about 13% from a year earlier.
With Synovus' bad-loan growth falling, Anthony said the second half of the year is an "opportunity for us to return to profitability … it gets down to that pretax, pre-provision earning number."
Huntington Bancshares CEO Steve Steinour said at the conference that the Columbus, Ohio, company's PPE growth was one of its bright spots in 2009 and figures strongly in its aim to return to profitability this year. Steinour has also taken the unusual step of giving investors guidance on where its PPE is going, saying it will reach $275 million by the third quarter.
Huntington had $242 million in PPE in the fourth quarter, up 2% from the third quarter and about 8% from a year earlier.
The PPE numbers paint a much different picture of the three banking companies than their bottom lines. In the fourth quarter, Fifth Third lost $98 million, Synovus lost $249.9 million and Huntington lost $368.7 million.
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