Marking The Whole Loan (Accrual) Books
A: When CSLA analyst Mike Mayo warned about the whole loan (accrual or 'hold') books on the banks balance sheets back in early April, he got the idea right but not the timing. Putting yourself back into time & place, the call had merit but when looking back today in hindsight many may say Mayo didn't know what the heck he was talking about. Afterall, if he was right then how the heck could the market and the bank stocks see the whopping rallies they have seen over the past 4 months. Now here is the deal - banks actually have wound down and marked down tons of mortgage backed securities that were supposed to be marked to market. When the FASB tweaked the accounting rules for assets marked-to-market, something the banks lobbied heavily for, I'm sure the behavior stopped or slowed big time. But nevertheless, most of the marks for these securities have been drastically lowered. What has NOT been significantly lowered, in terms of book valuations, were the whole loan books that are accounted for as 'accrual' or 'hold to maturity' books and do not require a daily mark to market adjustment. Rather these books are marked down as the whole book starts to nonperform and loan losses are provisioned on a quarterly basis. Is this where the meat of the concern should be?
First a quick explanation on "Mark-To-Market" vs "Accrual Book" accounting tactics from a quant trader over at GetOnTheDesk.com:
"...a mark-to-market book will always be changing value. Usually trading books and hedge funds are marked-to-market. All liquid products and futures are marked-to-market. It usually means you have to fund the positions via some funding rate because you're probably not just putting cash up directly. You may have margin calls on the marked positions. For exchange traded securities the exchange closes are used as daily marks. For illiquid assets (i.e. those illiquid sub-prime mortgage securities that everyone's whining about), you often mark to market as well (by getting dealer prices on a daily basis, for example). A mark-to-market book must be sensitive to the daily changes in risk and PnL.The billion dollar question then becomes: WHERE ARE THE MARKS FOR THESE WHOLE LOAN BOOKS THAT ARE 'ACCRUAL OR HOLD-TO-MATURITY' BOOKS THAT DO NOT HAVE TO BE MARKED TO MARKET!An accrual book does not need to worry about a lot of the above. The assumption is that the assets being held are not held for risky reasons, they are being held for accounting reasons. Thus it is less likely the assets will need to be quickly liquidated. These accounts tend to hold stuff longer, make bigger moves and not be as concerned about the daily PnL of the book. On an accrual book, the long term view is the most important. Traders and portfolio managers will make sure their macro view is correct and their liabilities are hedged for the long term."
This was the basis for Mayo's argument in April as he stated:
"New government actions might not help as much as expected, especially given that loans have been marked down to only 98 cents on the dollar, on average."That '$0.98 on the dollar' remark was in regards to the whole loans held on accrual books of the banks balance sheets - NOT the pools of loans that were securitized and held as mortgage backed securities and marked down big time. The damage that we saw in 2008, with all those write-downs, was mainly from marks being adjusted to these securities (not the whole loans) as they were adjusted to the market price that happened to be severely pressured. The damage was done and the marks were reset until the FASB put a stop to the madness with the suspension of M2M accounting requirements. But the whole loan books didn't have to be adjusted. I refer to the NY Times, "Are Bailouts Part of the Problem?":
"Thus far in the crisis, banks have mainly written down the value of securitized products that were backed by pools of loans including mortgages. Accounting rules generally forced financial institutions to take multbillion-dollar hits to their balance sheet by marking down the value of those securitized products to market prices. But banks aren’t required to write down the trillions of dollars in whole loans on their books, because they are classified as being “held to maturity.” As such, they can keep the full value of the loan on their books until the loan term ends — or the borrower defaults."That is how I described it to you back in April after seeing Mayo's comment about loans only being marked to 98 cents on the dollar - "but from what I am hearing many of these loans are marked down more and sitting on 'accrual (hold) books', which are marked on the spot based on loan defaults and overall book performance. Loan loss provisions are done on a quarterly basis, not as assets stop performing. If the total loans in the book deteriorated 5%, well then the entire book is remarked down 5% from the previous mark or par. It's backward looking".
So, how much is out there in the whole loan book world? Trillions! Where are those books valued? How unrealistic are the valuations? When you hear talk about a 'lost decade' or 'zombie banks', it is stuff like this that makes the problem never seem to go away. Could the whole loan books be the source of this prolonged problem? Quite possibly.
Today we see 3 headlines ushering in concern over the banking sector after a fierce 5-month rally:
a) Bob Prechter Calls For a 2nd Larger Wave Down Ahead
b) Dick Bove Says Bank Earnings Wont Improve in 2nd Half
c) Congressional Oversight Panel Warns of Continued Risk of Troubled Assets
The Congressional Oversight Panel uses this phrase on the future risks:
"The nation‟s banks continue to hold on their books billions of dollars in assets about whose proper valuation there is a dispute and that are very difficult to sell without banks experiencing substantial write-downs that can trigger a return to financial instability. Whatever values are assigned to these troubled assets for accounting purposes, their actual value and their potential impact on the solvency of the banks that hold them are uncertain and will likely remain so for some time; the degree of uncertainty is difficult for anyone to estimate confidently."What are your thoughts? Have the bank stocks moved too far too fast in reaction to the fed engineered recapitalization environment? Or, are the Whole Loan Books a whole lotta nothing to worry about?
Comments (10)
FAS 166/167 comes due Q1 2010. They published it on their web site so anyone can read the actual document.
Fitch and other credit rating agencies CLAIM that it will have no effect. But, considering their track record in the past. . . .
I have not heard anything substantive on the legal front - if anything, any mention of it has been marginalized or brushed aside.
That is not a particularly healthy attitude considering the ABX and CMBX indices could quickly telegraph a move down again - but not to the same levels as last fall when TED >4.0.
Posted by In Debt We Trust | August 11, 2009 4:34 PM
IDWT - I thought it was the FASB 115-2 accounting change that allowed banks to move toxic assets into avail-for-sale & held-to-maturity classifications so that they didnt have to mark them to market.
Plus they didnt have an effect on earnings or regulatory capital requirements?
So confusing with all these FASB changes to allow banks to try to heal themselves and ignore the real damage from coming all at once
Posted by Noah | August 11, 2009 4:40 PM
Norwalk, CT, June 12, 2009—The FASB today published Financial Accounting Statements No. 166, Accounting for Transfers of Financial Assets, and No. 167, Amendments to FASB Interpretation No. 46(R), which change the way entities account for securitizations and special-purpose entities. The new standards will impact financial institution balance sheets beginning in 2010. The impact of both new standards has been taken into account by regulators in the recent “stress tests.”
These projects were initiated at the request of investors, the SEC, and The President’s Working Group on Financial Markets (the infamous "PPT").
Statement 166 is a revision to Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures.
Statement 167 is a revision to FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, and changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance.
http://www.fasb.org/
Posted by In Debt We Trust | August 11, 2009 4:53 PM
check this out too
http://www.stinson.com/files/FASBRelaxes.pdf
Two Significant Changes: FSP FAS 115-2 and FAS 124-2 imposes two significant changes on accounting for asset impairments with respect to debt securities.
• First, the new guidance changes when an impairment may be classified as temporary. Previously, in order to classify an impairment as temporary, an entity's management had to assert that it had both the intent and the ability to hold the asset until recovery. Under this new guidance, the entity's management must only assert that:
♦ it does not have the intent to sell the asset; and
♦ it is more likely than not that the entity will not have to sell the asset before recovery of its cost basis.
This change is significant because an entity must only meet a "more likely than not" standard in order to avoid writing an asset down as being impaired. Prior to making this assertion, an entity must consider all available information relevant to the collectibility of the security.
• Second, FSP FAS 115-2 now requires entities to divide "other-than-temporary impairment losses of debt securities" for which the entity asserts "it is not more likely than" to be required to sell the debt security before recovery of its amortized cost basis into two components:
♦ credit losses and
♦ other losses.
Under the final guidance, credit losses are recognized in earnings and are based on the entity's estimate of decreased cash flows or other credit related deterioration. Entities recognize other losses, non-credit losses, in other comprehensive income. Even though the impairment is accounted for separately, when presenting an other-than-temporary impairment, entities will present the total other-than-temporary impairment in the statement of earnings with an offset for the amount recognized in other comprehensive income.
Similarly, the new guidance requires entities present separately in other comprehensive income amounts realized relating to impairments on held-to-maturity debt securities as well as amounts realized relating to impairments on available-for-sale debt securities
Posted by Noah | August 11, 2009 5:07 PM
The real question is will we finally see bank bondholders take a haircut? The too big to fail mentality, the problem loans, the fact that there really isn't anything with a decent ROI to put money and even with ~0% borrowing rates we're going to see a long, drawn out japanese economy. They just have that much going against them.
Posted by MeekSheep | August 11, 2009 7:44 PM
You catch this, off topic but not off website focus:
http://www.crainsnewyork.com/article/20090809/SMALLBIZ/308099970#
Posted by MeekSheep | August 11, 2009 9:26 PM
Meek - yep, thought it was old news. Most new devs release batches of units, not all inventory, until those sell and then release a new batch. So youll see 5 studios, 5 1BRs, 5 2-BRS, etc. released at once., This is to avoid flooding the market with 170 units at a time and distorting inventory trends and total supply.
I would think most of the conversion and development boom is behind us, but YES, there are many unsold units and shadow inventory. Hard to get a grasp on it though
Posted by Noah | August 12, 2009 6:34 AM
I hope you don't mind but I re-posted your question on another board.
Inthevastmiddle has a nice and simple response:
http://www.stockstop.org/viewtopic.php?f=2&t=1961
For accrual or hold-to-maturity loan books, the bank makes quarterly loan loss reserves. This is generally measured against net charge offs to see if the losses were adequately reserved. A very simple way to look at it is as an accounts receivable book. You expect to collect 100% of x% and some discounted % of y%. You can be pretty accurate at doing this with a few years of history. However, for one to sell their entire accounts receivable book they would not get near the result of just collecting on it. That is oversimplified since A/R is short term assets while the others are long term assets, but wouldn't it be silly to be asking CSCO to mark their A/R to market?
Now for loans that are repackaged endlessly into CDS derivatives, there is plenty wrong with stating that you intend to hold to maturity. But even loans bought by a bank must now be marked to market when placed on the books. (The law might be changing on that though, since that might have been only a temporary rule to encourage banks to buy stressed loan portfolios from failing banks and using the losses against earnings.)
Posted by In Debt We Trust | August 12, 2009 2:18 PM
Thank you! That looks like a great resource
Posted by website design New York City | December 19, 2009 7:34 AM
Thanks for posting this very informative article. I have learned a lot. Cheers to a wonderful 2010!
Posted by website design New York City | January 23, 2010 7:20 AM