Jonathan Weil has an illuminating piece on the way in which the accounting standard setters have caved in to politcal pressure to abandon fair value accounting for financial instruments and the mess than has resulted as a result.
How can investors make sense of bank balance sheets where the same assets are accounted for differently by different banks without some kind of restatement? Basically they can't. They shouldn't.
Saturday, September 17, 2011
Wednesday, August 31, 2011
Don't let bank accounting fool you
Look, its simple: the way that banks account for their assets and therefore the profits they declare is not something that any serious investor or bank analyst should pay any attention to - at least not the reported stuff.
The IASB letter to the European securities regulators, objecting to the use of mark to model accounting by some banks (notably French bank BNPP) for sovereign Greek debt held on the balance sheet as Available for Sale is just the tip of a very large iceberg. (Note that oher banks marked valued Greek debt at market values (50% of par) and yet others at the estimated value of the bond to be issued under the haircutting arrangements - 79% of par). All this of course makes a nonesene of the comparability of reported bank earnings.
But even the IASB has skirted around the elephant in the room, which is the valuation of so called Held To Maturity loans and receivables. So a bank can ignore market values of loans and receivables, such as sub-prime loans, Greek debt, even Argentine debt, provided that it "intends" to hold the loans to maturity, it has the financial resources (i.e. the liquidity) to enable it to do so and it has made provisions against any permanent impairment of the loans in question. Yeah right.
So what's the objective evidence of an intention to hold to maturity? You ask the management. And yes, the management can change its mind. What about the liquidity condition? Well if there's a real problem Uncle Ben will lend you money. That's what the Central Bank is there for.And the provisions? Well you can just argue that any market price you don't like the look of reflects an illiquidity discount and decide on provisions based on a model where you determines the cashflows and where the discount rate is not changed for market risk and ignore credit risk.
So why should this matter if all banks do this? Because not all banks do this.
A tranche of an asset - sub-prime MBS for example - held on the balance sheet as Held to Maturity at one bank may be held by another in the trading book (valued at market with gains and losses treated as part of the current year's profits), or Available for Sale (valued at market supposedly, but see IASB letter referred to above, with the profit not treated as current year's profit).
Confused? Then don't invest in banks but since they represent more than 20% of the market and are the main drivers of market volatility, stay away from the market altogether.
UPDATE
As if on cue, Bloomberg reports that Danish regulators are to restrict flexibility that banks have to calculate write downs under IFRS. Doesn't help investors much I am afraid. The whole thing is a mess.
The IASB letter to the European securities regulators, objecting to the use of mark to model accounting by some banks (notably French bank BNPP) for sovereign Greek debt held on the balance sheet as Available for Sale is just the tip of a very large iceberg. (Note that oher banks marked valued Greek debt at market values (50% of par) and yet others at the estimated value of the bond to be issued under the haircutting arrangements - 79% of par). All this of course makes a nonesene of the comparability of reported bank earnings.
But even the IASB has skirted around the elephant in the room, which is the valuation of so called Held To Maturity loans and receivables. So a bank can ignore market values of loans and receivables, such as sub-prime loans, Greek debt, even Argentine debt, provided that it "intends" to hold the loans to maturity, it has the financial resources (i.e. the liquidity) to enable it to do so and it has made provisions against any permanent impairment of the loans in question. Yeah right.
So what's the objective evidence of an intention to hold to maturity? You ask the management. And yes, the management can change its mind. What about the liquidity condition? Well if there's a real problem Uncle Ben will lend you money. That's what the Central Bank is there for.And the provisions? Well you can just argue that any market price you don't like the look of reflects an illiquidity discount and decide on provisions based on a model where you determines the cashflows and where the discount rate is not changed for market risk and ignore credit risk.
So why should this matter if all banks do this? Because not all banks do this.
A tranche of an asset - sub-prime MBS for example - held on the balance sheet as Held to Maturity at one bank may be held by another in the trading book (valued at market with gains and losses treated as part of the current year's profits), or Available for Sale (valued at market supposedly, but see IASB letter referred to above, with the profit not treated as current year's profit).
Confused? Then don't invest in banks but since they represent more than 20% of the market and are the main drivers of market volatility, stay away from the market altogether.
UPDATE
As if on cue, Bloomberg reports that Danish regulators are to restrict flexibility that banks have to calculate write downs under IFRS. Doesn't help investors much I am afraid. The whole thing is a mess.
Monday, August 29, 2011
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