From the earnings quality file: When Alliance Data Systems reported earnings earlier this week, the credit card company reported that its “core” earnings of $1.38 per share, 6 cents ahead of expectations.
Here’s what it didn’t say: the $1.38 included 18 cents from the reversal or “release” of reserves tied to an accounting change. The accounting change, in essence, involves pulling securitized assets on balance sheet from off-balance sheet. As part of the change, which hit balance sheets on January 1, companies created reserves based on what they believed the risks were at the time.
Since then, as the credit environment has improved, many companies are realizing that they over-reserved. When a company over-reserves, it reverses the reserves.
The biggest impact is at credit card companies, and the biggest—such as Discover FinanceServices and JP Morgan Chase—openly discuss it and the impact.
But at Alliance Data , which was the focus of an item here June 28, analysts and investors are left to fend for themselves to figure it out.
And figure out is just what longtime Alliance Data critic Bill Ryan of Portales Partnersdid when he conjured up the number. According to Ryan, so far this year the release of reserves has added 54 cents (or 20 percent) to reported earnings.
“While the company presents this is core/cash,” Ryan said in a report, “we would note that reserve reduction is not a ‘cash’ contributor to earnings.”
Nor, I would argue, is it sustainable and therefore should not be included in so-called core results.
I’m not the only one who feels that way. Here’s what J.P. Morgan CEO Jamie Dimon had to say about reserve releases on his company’s earnings call: “You should assume we don't like to release loan loss reserves. It isn't like we should be saying, well, this company wants to do it to report its earnings. We don't consider that earnings. I always called that ink on paper. It means nothing.”
As for Alliance Data, it didn’t respond to my inquiry.