Two months ago Bloomberg's Jonathan Weil brought up the very relevant topic of fair value divergences on bank balance sheets courtesy of SFAS 107 and lax accounting firm standards (some more lax than others). Zero Hedge immediately followed up on this theme and presented a comparative analysis of various bank asset shortfalls, speculating that certain accounting firms are doing their best to do an Arthur Andersen redux for Generation Bailout. On October 15 we said: "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." Today, finally, after a two month delay, these two articles seem to have finally made the inbox of the financial gurus at the Wall Street Journal, which, in an article named "Accounting for the bank's value gaps," says: "can investors count on consistency when it comes to bank accounting? As many banks struggle with piles of bad loans, it appears some auditors are being stricter than others when assessing their true value." Way to be on top of that ball WSJ/Mike Rapaport. Nonetheless, we are happy that this very critical topic, is finally starting to get the due and proper, if largely delayed and uncredited, attention it deserves.
Among the top-25 U.S.-owned commercial banks, those five Ernst and Deloitte clients accounted for five of the six biggest gaps between fair value and cost as of Sept. 30. The average gap among Ernst and Deloitte clients in the 25-bank group was about 6%; among clients of PriceWaterhouseCoopers and KPMG, it was about 2%.
Those differences can affect how investors view a bank's loan portfolio, and could have a concrete effect on regulatory capital in the future. The Financial Accounting Standards Board is considering changes in banks' accounting for loans and may require them to carry loans on the balance sheet at fair value instead of cost.
If that happened, the current fair-value declines could reduce shareholder equity and regulatory capital—in some cases, to levels regulators would find troublesome. At Regions, the $16.9 billion gap between its loans' fair value and carrying value would wipe out its $13 billion in Tier 1 capital using a fair-value balance-sheet standard. Huntington, Key and M&I would see Tier 1 capital slashed to low levels. SunTrust would see a major Tier 1 reduction also.
Rapaport even provides a fancy graphic, which is eerily reminiscent to the one posted on ZH 10 weeks ago.
On the other hand you have Pimco (see prior post) claiming that investors can't go wrong by throwing their money at banks and their thoroughly mismarked balance sheets (and facing massive debt rollover risk: if rates really skyrocket as MS expects, we wish banks the best of luck as they face a maturity crunch. Has it occurred to anyone that banks are hording cash simply to be able to repay debt as it matures instead of refinancing? We will have quite a bit more to say on this topic very shortly). In the meantime, we lament the complete ignorance by the investing public of anything that is based on fundamentals (the government will bail them out after all), with only momentum and mass melt-up hysteria determining investing decisions.