Loan Loss Provisioning and Differences of Opinion

Abstract:     
Prior research suggests that differences of opinion of professional forecasters are indicative of risk and uncertainty. This study investigates whether different attributes of loan loss provisions influence the likelihood and magnitude of disagreement between the two major credit rating agencies. Focusing on a sample of bank issues from 1994 to 2009, I find that Moody’s and S&P disagree on the initial ratings of 66% of the issues and that S&P is the more conservative rater who gives a lower rating 89% of the time when there is a disagreement. I also find that S&P is more likely to give a lower rating during periods of higher economic uncertainty. In addition, I hypothesize and find that lower timeliness and validity of loan loss provisions exacerbate the likelihood and magnitude of initial credit rating splits between the two major credit rating agencies. Furthermore, discretionary loan loss provisions are positively associated with the likelihood and degree of differences of opinion. Finally, I find bank bondholders demand a yield premium on split rated bonds. The findings in this paper suggest that accounting information quality influences the perceived risks and uncertainties in banking industry and is useful in facilitating bondholders’ market discipline of banks’ risk exposures.

Number of Pages in PDF File: 53

Keywords: Rating disagreement, Loan loss provisions, Accounting quality, Rating agency, Banking

JEL Classification: G21, G24, G32, M41

working papers series