One thing that’s great about being a TBTF bank is that generally speaking, no one (including employees) really has any idea what all is on your balance sheet let alone how much all of it may or may not be worth at any given time. Between that ambiguity and fun accounting tricks like taking loan loss reserve releases when it suits you (sometimes while simultaneously reporting increases in non-performing loans) and booking DVA gains (because it certainly makes sense that becoming less creditworthy should somehow generate “profits”), you can pretty much just goal-seek the bottom line in any given reporting period. Given this “flexibility,” one smart thing to do as the Fed prepares to embark on a rate hike cycle is figure out the best way to shield your available-for-sale book from damage. Fortunately, this turns out to be remarkably straightforward. You simply reclassify everything as held-to-maturity. Here’s more from WSJ:
Banks are shuffling big chunks of their securities portfolios around the balance sheet to shield capital levels from rising interest rates.
The moves, also encouraged by recent changes by regulators in bank-capital requirements, mean that billions of dollars in bonds and other debt held by banks have gone from being available for sale at a moment’s notice to being parked in an area of their books where they can’t easily be traded.
In the 18 months ended Dec. 31, U.S. banks moved $293 billion of their securities investments to the “held to maturity” bucket on their balance sheets, according to data from the Federal Deposit Insurance Corp. that covers more than 6,500 banks.
That 84% increase since June 30, 2013, means that about $640 billion, or one in five dollars in banks’ securities portfolios, can’t be sold easily, up from about one in nine dollars in mid-2013.
So that’s a quarter of a trillion dollars in interest rate sensitive securities that banks get to shield from rising rates simply by calling them something different today than they did yesterday. Nice trick, right? What this does is allow banks to simply ignore changes in the market value for those securities when it comes to calculating capital levels.
Now you would certainly think that there would be something that prevents banks from simply shifting these things around when it’s advantageous and ostensibly there is:
Once banks put securities into the held-to-maturity bucket, they generally aren’t permitted under accounting rules to take them out and sell them.
It is “not in the best interests for the bank,” to move securities into the held-to-maturity bucket, said Gerard Cassidy, an analyst with RBC Capital Markets. “They’re just going to restrict themselves” and leave themselves “handcuffed.”
Of course this is just a charade. Does anyone really think that the same accounting regime that allows banks to generate profits with gimmicks like DVA gains is going to keep the very same banks from reclassifying held-to-maturity securities as available-for-sale in a bind? Of course not. This is just a way for banks to delay marking their book to market when the market mark is likely to get unfavorable.
The problem with this approach — besides the fact that it makes a complete mockery of the idea that GAAP is supposed to be somehow be useful — is that the conditions that would cause a TBTF firm to have to suddenly raise cash will be the very same type of conditions that would cause the market value of its available-for-sale book to decline.
So in the end, be wary of attempts to postpone M2M because all of those billions in securities carried at par may one day be subject to the old maxim that things are worth exactly what someone is willing to pay you for them.