provision vs net charge offs

http://www.fool.com/investing/beginning/2007/04/09/whats-the-deal-with-bank-reserves.aspx Loan loss provisions When a bank makes 1,000 loans during the quarter, it knows from experience that, say, 1% of those loans will go bad. It doesn't know which ones will go bad -- it just knows from statistical experience that 10 of those loans will not be repaid, or will become slow-paying loans. Rather than waiting for the credit loss to occur, a bank uses its best judgment to account for those losses through the provision for loan losses, a non-cash charge to earnings. Here's a simplified income statement for Ohio-based KeyCorp (NYSE: KEY), highlighting the provision for loan losses. KeyCorp FY 2006 Net Interest Income 2,815 Provision for Loan Losses (150) Noninterest Income 2,127 Noninterest Expense (3,149) Earnings Before Taxes 1,643 Numbers in millions of dollars. Again, the $150 million loan loss provision is not a cash expense. Instead, that $150 million charge builds the loan loss reserve on the balance sheet. The reserve provides a cushion if and when customers don't repay their loans. Without this cushion, there's a chance the bank could be caught with little or no capital. Think of the reserve as a bucket of water that should stay full. Water leaks out of the bucket when the bank abandons hope of collecting on a loan (called a charge-off). Every charge-off causes the reserve to shrink. If this reserve gets too low, the bank replenishes the reserve with the provision for loan losses. Over time, provisions for loan losses should be about equal to charge-offs, ensuring that the reserve doesn't get too low. The bank can also recover previously charged-off loans, which adds to the reserve. On the way out of a recession, a bank can frequently lessen its loan loss provision on the income statement because recoveries of charged-off loans build up the loan loss reserve. Putting it all together The important things to remember are that the provision for loan losses builds the reserve, and charge-offs deplete the reserve. For example, KeyCorp's reserve fell in 2006, as net charge-offs outpaced the provision for loan losses: KeyCorp FY 2006 Reserve at beginning of year 966 Net charge-offs (170) Provision for loan losses 147 Reserve at end of year 943