Bloomberg’s Weil: Banks Accounting is Troubling

In an commentary piece on called Next Bubble to Burst Is Banks’ Big Loan Values, Johnathan Weil exposes some distressing nuggets of information that are buried in the footnotes of banks’ quarterly reports. We encourage every investor to read the entire commentary, but a key portion is reprinted below.

“It’s amazing what a little sunshine can accomplish.

Check out the footnotes to Regions Financial Corp.’s latest quarterly report, and you’ll see a remarkable disclosure. There, in an easy-to-read chart, the company divulged that the loans on its books as of June 30 were worth $22.8 billion less than what its balance sheet said. The Birmingham, Alabama-based bank’s shareholder equity, by comparison, was just $18.7 billion.

So, if it weren’t for the inflated loan values, Regions’ equity would be less than zero. Meanwhile, the government continues to classify Regions as “well capitalized.”

While disclosures of this sort aren’t new, their frequency is. This summer’s round of interim financial reports marked the first time U.S. companies had to publish the fair market values of all their financial instruments on a quarterly basis. Before, such disclosures had been required only annually under the Financial Accounting Standards Board’s rules.” — Johnathan Weil,

Because of a recent change to Financial Accounting Standard’s Board rules, banks are now required to report on the fair-value accounting (also known as mark to market accounting) for the loans on their balance sheet each quarter. Since, the FASB relaxed mark to market accounting rules, banks do not have to write-down loans that have lost value, unless they plan on selling them or they are nearing to maturity. Mark to market accounting rules get a lot of blame for adversely impacting bank’s balance sheets as the market spiraled downward. Interestingly, the market’s spring lows correspond almost perfectly with congressional hearings on MTM accounting. The “relaxed” standards mean that although banks do have to specify the “fair-value” of their loans, they do not effect net income if the bank’s management intends to hold the loan to maturity.

Weil did the leg work and looked through a bunch of banks’ quarterly reports and found that a great number of them are in more trouble than it first appears. Regions Financial (NYSE:RF) is the most extreme case, but Bank of America (NYSE:BAC) and Wells Fargo (NYSE:WFC) as well as regional banks SunTrust (NYSE:STI) and Keycorp (NYSE:KEY) appear much less capitalized when looking at the value of their loans. So, much of the recent rally has been built upon the foundation of a stronger financial sector. Sure, banks are reporting profits again, but there are also a lot of nasty loans on the balance sheets of major banks.

Clearly, the relaxation of mark to market has served the purpose of giving banks a breather from book value destroying write-downs. However, as Weil exposed, book value is really simply accounting fiction. We are hopeful that in the balance of time a lot of these loans recover a substantial amount of value, but we do not want to invest based on hope. Many of the credit issues that caused this mess are still yet to be worked out, and at Ockham we remain very wary of bank stocks.

Bloomberg’s Weil: Banks Accounting is Troubling

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

Ockham Research provides its research in a variety of forms and products including our company specific reports, portfolio analytics tools, newsletters, and blog posts. We also offer a white labeling research solution that can give any financial services firm their own research presence without the time and cost associated with building such a robust coverage universe of their own.

1 Comment on Bloomberg’s Weil: Banks Accounting is Troubling

  1. What is also troubling is that book value SHOULD mean next to nothing when markets are in panic sell mode, as should “tangible equity” and “capital ratio”.
    Instead, the banks should be valued on the basis of their cashflow, earnings power and short term ability to meet obligations.
    Wells Fargo, for example, had a much poorer “tangible equity ratio” than JPM or BAC, but their balance sheet was superior (lower default rates, higher down payments, better collateral), as is being manifested by their superior earning power, and which will be continually demonstrated over the next decade.
    10 years from now, we’ll look back at when they *only* had 2.86% tangible book value and ask ourselves “so what?”

Leave a Reply

Your email address will not be published.