“Accounting changes could force US banks to take thousands of billions of dollars back on to their balance sheets in the coming months in a move that is likely to curb further their lending and could push them into new capital raisings, analysts have warned. See Banks fear new $5,000bn balance burden.
Off-balance sheet vehicles have been used by financial institutions to keep some assets off their balance sheets, thereby avoiding the need to hold regulatory capital against them. A planned tightening of the rules regarding off-balance sheet vehicles would force banks to reconsider arrangements and could result in up to $5,000bn [ yes! That’s 5 trillion] of assets coming back on to the books.
Birgit Specht, head of securitisation analysis at Citigroup, said: “We think it is very likely that these vehicles will come back on balance sheet.
“This will not affect liquidity because [they] are funded, but it will affect debt-to-equity ratios [at banks] and so significantly impact banks’ ability to lend.”
Meanwhile the latest FDIC Quarterly Banking Profile, released last week had some dismal disclosures:
“Industry earnings for the fourth quarter of 2007 were previously reported as $5.8 billion, but sizable restatements by a few institutions caused fourth quarter net income to decline to $646 million.”
This means that the banking industry reported $5.8 billion in earnings to its investors, but restatements took that total down by 89%. In other words only 11% of the earnings that were reported by US banks to investors survived after the restatements! And still some investors are naively placated by recent earnings reports and guidance as if they can be trusted. In this sense, upbeat stories on how banks have beat recent estimates by a penny mask the larger reality that most of these earnings are likely to be massively restated later on.
“Noncurrent loan growth remains high. The annualized net charge-off rate in the first quarter rose to 0.99 percent, more than double the 0.45 percent rate of a year earlier and the highest quarterly net charge-off rate since the fourth quarter of 2001. Even with the heightened level of charge-offs, the amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) rose by $26.0 billion (23.6 percent) in the first quarter, following a $27.0-billion increase in the fourth quarter of 2007. Loans secured by real estate accounted for close to 90 percent of the total increase, but almost all major loan categories registered higher noncurrent levels.”
“Insured institutions continued to build their loan-loss reserves in the first quarter. The industry's ratio of loss reserves to total loans and leases increased from 1.30 percent to 1.52 percent, the highest level since the first quarter of 2004. However, the growth in loss reserves was outstripped by the rise in noncurrent loans, and the industry's “coverage ratio” fell for the eighth consecutive quarter, to 89 cents in reserves for every $1.00 of noncurrent loans from 93 cents at the end of 2007. This is the lowest level for the coverage ratio since the first quarter of 1993.”
So while there are more loss reserves per dollar of total loans, the reserves have not kept up with the escalating ratio of loans that are going bad.
And lest one think the “evil US banks” are alone in this mess, we find that similar issues are now coming to the fore in most countries around the world,
European banks are lagging behind their U.S. counterparts in disclosing risk information recommended by the Financial Stability Forum. Also see Nordic banks warn of credit crisis ahead.
The Forum, a group of regulators, central bankers and finance ministers assembled by the Group of Seven leading industrial nations, had urged banks to come clean on losses from the credit crisis by mid-2008. So far European banks have said that they need more time to assess and make the proper disclosures.
“Bank write-downs have already amounted to more for European institutions than for U.S. banks, $168 billion compared with about $130 billion, said Imene Rahmouni-Rousseau, head of financial stability and markets at the Banque de France, citing Bloomberg data of two weeks ago.
Analysts have said that the FSF's recommendations are voluntary and lack the teeth to force banks to change.
“Now 10 months after the crisis broke … and some of the major banks have yet to make adequate disclosures in areas that the market and counterparties consider critical,” Andresen said. “This is highly detrimental to confidence.”
As banks scramble to sort through the tangled web they made and now are caught in, the Financial Accounting Standards Board (FASB) is working to declare some substantive changes to accounting requirements for off-balance-sheet debt held in so-called qualified special-purpose entities, or QSPEs. See FASB lobs a Balance-Sheet Bombshell.
FASB has decided to “eliminate the concept of the QSPE” in the revised financial-accounting standard, FAS 140, and also will “remove the related scope exemption from FIN 46R,” says FASB director of technical activities Russ Goldin. FASB is sill studying actual implementation and disclosure issues, but it seems pretty clear those unpriceable, lamentable assets are headed for the balance sheets. With a public comment period starting in July, followed by a roundtable, at which critics are invited to “meet publicly with the board and debate,” the changes could be finalized by late in the third quarter. The effective date: June 2009.
Some banks may sit on QSPEs, whose values are almost equal to their balance-sheet assets. Bringing all QSPEs onto the balance sheet could create a capitalization problem for some and will most certainly limit the ability of many to lend.
Remember: “admission of a problem is the first step to recovery.” The best time for tighter regulation on banks and off-balance sheet accounting would have been in 2001 and coming out of the ENRON fiasco. But that did not happen. So now we have to make the necessary changes in a reactive way to clean up the mess. Unfortunately it will be now hitting the books when the economy and credit markets can least afford it.
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