Off-Balance-Sheet Exposures WFC, PNC: I Did It My Way

rc whalen's picture

Reading through the Qs for this quarter, a picture starts to emerge of utter chaos when it comes to how banks are implementing -- or not -- the changes by the FASB as to how organizations account for off balance sheet ("OBS") exposures. Let us take two examples:  Wells Fargo and PNC Financial.

In the case of WFC, the bank has taken the position that NONE of its conforming residential exposures should be brought on balance sheet despite the FASB rule change.  As we discussed in The Institutional Risk Analyst this week, "Why? Because the loans inside these securitization vehicles are insured by FHA, so goes the thinking of WFC and its auditor, thus the bank has no liability to these entities or the securities they have issued to investors. Pretty neat trick, eh?"

Thus WFC is basically saying that none of the bank's $1.1 trillion in conforming OBS exposures need to be represented or reserved against.  My problem with this is two-fold:  First, the FHA and/or GSEs will return some portion of the securitized loans, so WFC should explicitly disclose this cost and reserve against it.  Second, it seems to be pretty arrogant for WFC to take such an aggressive positions with respect to these OBS vehicles, even with a third party guarantee, especially given the intent of the FASB rule change.  BTW, WFC has another $0.6 trillion in non-conforming exposures we have yet to hear about.  That is next quarter presumably.

Then we go to PNC, which has much smaller OBS exposure than WFC, smaller by several orders of magnitude.  PNC spends a good bit of time in its most recent 10-Q describing its OBS exposures, the primary vehicle for which is a an unconsoldiated  multi-seller asset-backed commercial paper conduit that is owned by an independent third party.  After spending most of a page explaining that the vehicle is owned by a third party and guaranteed by another third party, PNC concludes that the full amount of this previously unconsolidated entity should come on balance sheet.

Start to see the problem? As we review the banks in Q3, there seems to be no consistency in the way in which banks are implementing the FASB rule.  As we go into the end of Q4 2009, the fun will really start.

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sun's picture

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sun's picture

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Anonymous's picture

Wells is planning to layoff tens of thousands of employees company wide because of their financial situation, this was from a reliable source within the company close to the CEO.

CombustibleAssets's picture

This should lead to some interesting blackmail

Hephasteus's picture


Didn't see that comment coming. You stole that from the Supplies closet didn't you?


Missing_Link's picture

Someone tell me why GS is shorting PNC?  They seem rock-solid to me.

Lux Fiat's picture

Thanks for an interesting article.  Bank balance sheets are not my forte, but articles such as this one have been very interesting and educational.  It sure looks like we are setting ourselves up (in the US at least) for a repeat of the fall of 2008 in the not so distant future.

Anonymous's picture

I thought only mobsters and tax cheaters had 2 sets of books. I wonder, would the IRS let me do the same?

Mark Beck's picture

Obviously, the goal of accounting for a public company, is to give a fair assessment of the health of the corporation to enable investors to understand the corporations earnings potential and risks.

However, depending on the type of business, especially BHCs and other large multinational corporations, the approach to your accounts, for financial reports and taxation, is a planned out strategy, to increase profit and reduce tax expense.

Tax law is interesting in that the accountants know, that unless there is precedence, you can push the plausible. There really is no "new" law unless it is upheld through a ruling or a determination. Sometimes, it really looks like the IRS lawyers just shoot from the hip, and cross their fingers.

Its interesting to contemplate how the IRS would enforce some of the newer green book concepts, without a massive increase in investigative and legal staff. Which in the end, could cost more than any tax collected.

So how do you handle Derivatives? on balance sheet? off balance sheet? what are the tax implications? I view derivatives as a complexity shield against recognizing loss and reducing tax expense. Although, they are not the only off balance sheet or "Goodwill" accounting gray area.

Every time I formulate a tax strategy, and/or use of an approach for a tax question, I cannot help but get this strange feeling that all of this complexity is essentially a substantial hidden cost. Meaning, by removing tax complexity the IRS would actually increase net tax revenues, offset by the relative reduction in costs. 

Mark Beck

Anonymous's picture

they can't all be insolvent for the same reason now!

bokapita's picture

""Why? Because the loans inside these securitization vehicles are insured by FHA, so goes the thinking of WFC and its auditor, thus the bank has no liability to these entities or the securities they have issued to investors. Pretty neat trick, eh?"

I have a question: Were the FHA insurance needed, would not the FHA have a requirement to seek redress from WFC for any losses? (As would be normal practice for a commercial insurer).

Anonymous's picture

I don't think the government has legally backed FNM/FRE guaranteed bonds. If the banks' protector/criminal gets fired and Elizabeth Warren gets the job the landscape will dramatically change. Wells will in deep trouble.

Bruce Krasting's picture

As of 2006 The shadow banking system was $15 trillion. About equal to the assets held by the banks. It was central to our near demise. It was unregulated and there were abuses.

So regulating it and forcing the banks to more rigorously disclose it make a lot of sense.

I find it amusing that while that process is unfolding the D.C. crowd is doing everything they can to revitalize the ABS market through TALF.

I have looked at TALF deals as an investment. I did not like what I saw. Basically you put up the equity and the Fed lends cheap Senior debt. The idea that I was 'beneath" the Feds was a non starter. My guess is that TALF accomplishes very little.

From Mr. Whalen's comments I have to conclude that more and more of this stuff is coming back on the bank's BS. As soon as it does they will hate it. It will blow up balance sheets and suck up capital. Bad business. The banks will wind it down. (WFC would be dead if the FHA stuff came back at them)

I am left with the question, "Where the hell is the debt capital going to come from to support  3-4% GDP growth?"  The shortfall has to be near $5 trillion....


Anonymous's picture

One man's debt capital is another man's printing press issue.

Anonymous's picture

To be fair, FASB was basically forced to change fair market rules by threat of the Legislature. I distinctly remember Barney Franks saying that if FASB didn't "so something" the congress would. The SEC has authority over publicly traded companies, not the FASB. If the SEC, and by extension congress, decides to ignore the standards-setting body they can. I think FASB did what they had to in order to remain relevant...

deadhead's picture

FASB was clearly strong armed, you are correct.  The strongest threats to FASB came from Gary Ackerman, D-NY who also coincidentally voted against Paul/Grayson.

Anonymous's picture

speaking of fas 166/167 does anyone know for a fact whether mark to market will be required in 2010 and if so when?

Rainman's picture

I believe it is still in the commentary period. ABA is fighting it like hell.

I suspect it will be killed outright, contain delayed implementation or be so watered down as to become a modified extension of 157 . But I hope I am wrong.

deadhead's picture

FASB 166/167 is already the rule.

It was originally to go into effect Nov 15 2008 but was delayed one year to Nov 15 2009.  the ABA did fight like hell but lost the battle on that particular end.  it is now the rule and implementation is required for Q1 2010.

The FDIC comment period in regards to capital requirement matters in regards to the implementation of 166/167 is now closed and a decision is pending (i don't know when). 

naturally, the banks have requested that necessary capital increases be postponed or phased in. 

in my view, the necessary increased capital will be phased in over a several year period and let's not forget that the banks can still mark these "new" assets to their balance sheet under the "liberalized" FASB 157 standards.  this will only further zombify our banks and continue the false accounting that is currently the paradigm.



spekulatn's picture

Well done, rc whalen. 


delacroix's picture

I seem to remember a story, that revealed that wachovia underwrote some of their own hedges. talk about risky, thats gonna surface sooner or later.

Anonymous's picture

reggie, what will change in q4? do they have to have everything on the books then?

Anonymous's picture

Whalen is a smart and useful analyst, and I am grateful for this report. But I have not forgotten his vehement defense of the now-defunct Downey Savings and Loan in August of 2008: "Why Downey Financial is not Indymac." At that date it was already completely obvious that Downey WAS Indymac, or at least an equally involvent piece of $&+#, This leads me to wonder what Whalen had at stake when he defended Downey.

blackebitda's picture

just because WFC will not acknowledge it does not mean investors have to ignore it. once FASB started getting gimmicky with FMV, i decided to value the stuff on my own. just because WFC is in denial and trying to wait things out, does not mean investors need to play into their games. furthermore, i refuse to lend any cash to these banks, as they are now high risk borrowers and without new deposits, how could they operate in the future. in God we trust, all others pay cash, and the cash the bankers will pay. with pitchforks coming at them to boot soon enough. 

Anonymous's picture

count me in the pitch fork brigade....

and the point about pay to play is precisely what
the hand wringers need to implement....instead
of whining about big banks and their wicked ways
as well as the ill behaving stock market, folks
need to pick up their marbles and go to stable
smaller banks - vote with their money....

fasb has single handedly destroyed the equities
markets by making financial state opaque and murky
with off balance sheet accounting and mark to
myth policies...those moves should have been a signal
to all but the most sophisticated investor to
get the fuck out of the markets....

Miles Kendig's picture

Chris, I suspect that the emerging condition of inconsistency is precisely what is being sought.  Thanks for this bit of texture from Q3 and the emerging dynamic within the banks balance sheets.

Fibozachi's picture

Fantastic insight from the very best out there !  Thank you Mr. Whalen, sir.

Rainman's picture

Gives new meaning to the Profit and Loss Statement.

Profit appears and loss disappears.

Ten more years of this kind of accounting and they'll be out of this mess altogether.

deadhead's picture

thank you for the insight.

hope to hear more about 166/167 as it unfolds.

taking the entirety of OBS that are coming home to momma, aren't credit card securitizations the majority?  thank you.

Anonymous's picture

Wow. Just wow.

This is first class investigative reporting. The kind you seldom get anymore from the "Big Name" media outlets. Well done indeed.

It was pretty obvious that Wells Fargo is cooking their books just from their public P.R. statements about what they were doing with the Stuy town and East Palo Alto foreclosures. I.e. "work" with the groups that declared bankruptcy rather than having these multi-million dollar bad loans be counted negatively on WFC's books.

But I had no idea that they'd would try to pull something like this.

This is going to be bigger than Enron. And that's not taking into account BofA or the other Banks.

No wonder their Troubled Asset Ratios are so low, just above the median. It sounds like if they were honest, the FDIC would be required by law to shut them down.

Orly's picture

That's the thing.  This has been huge from the get-go, at least to me.  Everybody has known for a ong time that WFC is a cluster-bomb waiting to go off.

I've never unsderstood, though, Uncle Warren's fascination with it.  Didn't he just buy more?

Which came first, the chicken or the egg?

Just askin'.

agrotera's picture

Uncle Warren doesn't care who thinks what about what he does and his purchase of GS and WFC are perfect PR ploys, and a bet on how wonderful it will be for earnings to borrow money at 0% and use that to gamble and provide loans...since Enron style OBS SPV's SPE's (and other handy acronyms) provide the perfect dumping ground to hide misdeeds, and now that our govenment chose to privatize all losses of the privateley held federal reserve corps babies, there is no end to how high their share prices will go...additionally Uncle Warren made a ton off of the puts he wrote knowing that the govenment would forever officially sanction this criminality and send out the plung protection team to ensure that the market won't go down below his puts.

Anonymous's picture

'Tis a sure fire bet that the Oracle is no oracle at all.

If any humanoid with an IQ above 100F had access to the guarantees, really great inside information, and special terms he does, they'd all be wealthy enough for several hundred years.

It's not investing when you already know the outcome is assured. It's more like counterfeiting with the blessings of government.

SDRII's picture

WFC is leading the syndicate for Buffet's BNSF buy. Also check out the Wells Fargo portfolio? You simply don;t get a sustained close to 200 bps premium NIM without taking inordinatly more risk. All the fancy language in the world doesn;t change gravity. See their Q suppliment - Loaded to the gills with Resid MBS and CMBS, at "nice" yields of course

Gimp's picture

The bankstas have made GAAP accounting procdeures totally irrelevant. Thanks FASB.

This is what happens when you let insolvent companies carry on as business as usual.

Question is "How long can it last?"

Anonymous's picture

I have Barney Frank and Larry Summers' addresses.

Karl Roves' too.

Argos's picture

These guys really need to relocate to anywhere in the American South.  A much more fertile crop awaits them.