Is Citi Back To Its Old Accounting Tricks; And Are Accountants Papering Over A $735 Billion Valuation Hole?
A piece today by Bloomberg's Jonathan Weil focuses on ongoing accounting gimmicks, this time in the realm of Fair Value definitions as determined by SFAS 107. Weil compares the difference of Book (Carrying) Value to Fair Value which several banks hold their assets at, primarily consisting of loans. As a reminder, "Fair value is supposed to represent the price at which an asset would change hands in an orderly, arm’s-length transaction." Weil has noticed that for several banks the accountants have stretched so much that they are in fact holding FV at a higher value than book value. How that is conceivable in the current loan-impaired environment is a major question mark, especially since Weil goes off June 30th balance sheets, before the stock market bubble bonanza was in full force.
In the article, the primary focus is on banks such as Midwest Banc Holdings, which despite being unable to pay scheduled TARP dividends, somehow marked its loan FV at $2.53 billion, $35 million more than the book value of these loans. Other banks highlighted by Weil include Seacost Banking Corp, First Bancorp, BB&T as well as Commerce Bancshares, all of whom seems to suffer from accountants who have yet to be introduced with the concept of a calculator. Conveniently, Weil provides just who these accountants are: PWC in the case of Midwest, BB&T, and First Bancorp, and KPMG in the case of Seacoast and Commerce.
Yet what caught our attention is the FV action at the big 4 banks: Citi, BofA, Wells and JPM. What is most notable is that while the three firms ex Citi have taken a decent haircut to their Book-to-FV margin, Citi is now down to a mere 0.2% difference between loan Carrying Value at Q2 ($602.6 billion) and loan Fair Value ($601.3 billion). What is more notable is that on average the margin has increased over the past 2 quarters: while the average FV-to-Book spread was 3.2% at year end 2008 for the non-Citi banks, it grew by 1.5% to 4.7% at Q2 (non weighted). And in this environment where banks have been getting more cautious and applying an increasing discount to their loan book values, Citi has collapsed the differential from 2.8% to 0.2%!
Just what about the economic environment has given Citi auditors KPMG the flawed idea that the bank's loan can be easily offloaded with virtually no discount? And just how much managerial whispering has gone into this particular decision.
If one assumes a comparable deterioration for the Citi loan book as for the other big 4 firms, and extrapolates the 2.8% getting worse by the average 1.5% decline, one would end up with a 4.2% Book-to-FV deterioration. On $602 billion of loan at Q2, this implies a major $25 billion haircut. Yet this much more realistic number is completely ignored courtesy of some very flexible interpretation of fair value accounting rules at KPMG. Maybe Citi and its accountants should take a hint from Regions Financial CEO Dowd Ritter who carries the FV of his $90.9 billion loan book value at a 25% discount.
“We and our accountants interpreted that in the strictest manner,” Ritter said at a Sept. 15 investor conference, referring to the FASB fair-value rules. “I don’t think we’ll hear anything probably from the SEC. But I’d be surprised if some other banks don’t, or else we and our accountants missed something.”
And as usual the SEC is completely out of yet another regulatory picture. What is very frightening if Ritter is the correct one of all bank execs: if a 25% discount to the combined carrying loan value at just the Big 4 banks is truly appropriate, it would mean that the nearly $3 trillion in loans on the "asset" side of the big banks deserves a whopping $734 billion haircut! This is almost the size of the entire TARP rescue package. And, unfortunately, a 25% discount is probably right in line with where banks should be calculating "Fair Values" for their holdings which likely include massive amounts of CRE exposure, which as everyone knows is the next big shoe to drop, and will likely flood the banks' balance sheets once refi time comes around.