No wonder US banks are on the nose and the Occupy Wall Street groups are slowly making headway in winning over public opinion.
Not only are they greedy, unable to see the damage they have caused and continued to generate, earn too much money, they can’t see the debt they owe to American taxpayers.
Take the latest wheeze showing up in the September quarter earnings reports from two of the country’s biggest banks, Citigroup and JPMorgan Chase. It will feature heavily in the reports this week from two other big banks, Bank of America and Morgan Stanley who has already been a prominent user of this new rule.
Only in America can something you have to repay, a debt, become an asset, but that’s what US accountants are now allowing the country’s banks to claim.
It’s been a feature of bank profit statements since last year when the Federal Accounting Standards Board allowed banks to write down their debt to “market value”. That saw JPMorgan last week reveal a $1.9 billion gain and overnight Citi revealed a similar gain, There was no gain signalled by another bank, Wells Fargo, in its third quarter results overnight.
But the rule change means that if a bond issued by a bank is valued at $US100 is trading for $US90 that’s a $US10 gain for the bank — even though the bank is responsible for paying back $US100 to buyers. So we are faced with the absurd situation of the value of the bank’s debt falling, while the amount actually owed, remaining unchanged, and interest payments continuing on the face value of the debt.
This is only happening thanks to the attempts by the US Federal Reserve to drive US interest rates lower, especially those rates longer than three years, which is where a lot of the bank debt is to be found. In other words, these banks are using an accounting rule to “leverage” the Fed’s attempts to lower interest rates, to protect and improve their profits. Sounds a lot like a “Through The Looking Glass” situation. No wonder the protesters on Wall Street have a case.
The impact on the profits were stunning: Citi reported a 74% increase in profit and it seems from the report that $US1.9 billion of Citi’s $US3.77 billion profit was tied to the gains. JPMorgan reported a profit of $4.26 billion last week, and the $US1.9 billion of gains helped Morgan report a slightly better than forecast result.
The move last change by the accounting standards body is the second gift to the banks from the accounting profession (got to look after these big clients). In 2009 they changed the rules on marking asset values to market.
That change allowed securities that had no value in the market (there weren’t any buyers) to be marked to an estimated value by the banks. And of course they did it and ended the big quarterly write-downs of dodgy assets such as CDOs, home loan mortgages, commercial mortgages and loans to weak businesses.
For example, Citigroup said that the percentages of mortgages that were 90 days delinquent rose for the first time in almost two years — up from 3.87% in the second quarter to 3.88% in the three months to September.
Last week, JPMorgan increased its provision for losses on consumer loans to $US2.3 billion from $US1.9 billion in the June quarter and overnight Wells Fargo said early-stage delinquencies in its retail business remained flat quarter-on-quarter at 6.13%. The bank, which is America’s biggest home lender, lifted the amount of cash it set aside for credit losses in its community banking unit, the first increase since 2009.
JPMorgan said it had also increased delinquencies of $US9.5 billion on government-insured mortgage loans that are more than 90 days past due, compared with $US9.2 billion a year ago.
So how does revaluing a liability to its market value result in an asset? Thats not what the changes do and I think the fourth para and title are wrong? All that can happen is the carrying value of the liabilities will become more volatile.
Analysts will just ignore the non-cash increments/decrements on these fair value adjustments anyway so it doesnt do the banks any favours.
Let me see if I understand what you are saying: if the value of a liability goes down a bank should not record the associated gain? Is that because you don;t think it’s a gain? Would you also suggest an asset who’s value has gone up should not be recorded as a gain? Sounds like you prefer good old historical cost accounting to anything based on market values.
And I’m not sure you describe it as ‘absurd’ when the value of a liability with a fixed face value declines. That’s just straight forward valuation. If I owe you $100 payable in say 5 years time with fixed interest payments at, say $10 per year (i.e. a nominal interest rate of 10% on the face value) and interest rates go up, then the value of that liability to me now goes down. Why? Because I only have to pay you at the nominal rate of 10% – the present value of all those payments is less. That’s a gain in anyone’s words. That’s not absurd. (For the same reason that it would be an economic loss to you.)
Have I got this right?
Bank borrows $100 via a traded note.
Market value of bank’s note drops to $90. Buyers are only prepared to pay $90 for the bank’s promise to repay the original ($100+interest).
The bank still owes the $100+, but is able to buy back this liability by standing in the market and offering $90.
So, the book value of the debt is revalued to $90 instead of its starting value.
Fair enough, provided that the bank is actually able to pull this off.
Now consider what will happen to the value of the bank’s notes once the market finds that the bank is buying them back at $90. Does the market decided that the bank considers this to be a bargain, and revalue accordingly?
Does that mean the $90 is unachievable and thus unrealistic?
My guess is that the new rule will be permitted to stand, at least until a regulator decides that it is unacceptable to allow a note issuer to gamble against its own notes, essentially rewarding the bank for running its business badly, but who would disallow a bank from repurchasing its own notes? That would be strange, indeed, because isn’t that what is supposed to happen? The bank is expected to eventually buy all of its notes back, because that is the basis on which they were issued.
It’s not as silly as first appears, so I disagree with the basic thrust of the headline and the article.
These bits of paper are worth only what the market says that they are worth. Get used to it.