Loan loss reserve : an impact on bank future return and stock price

Abstract

Loan loss reserve is an accounting adjustment made by banks in order to reflect the actual performance and reveal the appropriate value of loan portfolios. This study would apply the ordinary least square methods (OLS) to examine an impact of unexpected loan loss reserve, on bank stock price and future cash flow, using the semi-annual data of 10 Thai commercial banks during 1997-1999. The reason to substitute unexpected loan loss reserve as independent variable is because current stock price should reflect all available information or any expected information. Therefore, the change in stock price is related only with unexpected, not anticipated information. Empirical result finds that unexpected loan loss reserve has no impact on bank stock price or future cash flow. Consequently, the paper extends the study by replacing unexpected loan loss reserve with total amount of loan loss reserve. The result suggested that total amount of loan loss reserve hassignificant negative impact on bank stock price and has positive impact on bank future cash flow. Reasons for the negative impact on stock price are that investors view an increase in loan loss reserve as an expense that reduce current earnings and increase the risking of a bank's capital structure. These reasons affect the confidence of investors, which result in a drop in stock price. The positive impact of loan reserve on bank future cash flow is occurred from the ability to deal with troubled debts more effectively and the ability to finance new projects to generate revenue.