Above is the KBW bank index (extrapolated back to 1990 via another bank index). When I was working for a bank in the 1990, I remember we always had lots of unrecognized gains in our book of assets acquired from the S&L crisis. It seemed like a bottomless cookie jar that bailed us out whenever we needed it. As there were lots of banks, and bank assets, sold well below their value, it seeded the best decade of bank stock returns ever. But after the latest crisis, bank stocks have stagnated well below their prior peaks.
I think this time, we have a reverse cookie jar. Banks had a lot of mortgage assets, and not only have those prices fallen, but the rules have changed, so that the time to foreclosure has more than doubled. Thus, banks still have lots of unrecognized losses, and like Japan in the 1990s, hope to slowly write them off. I'm guessing. One thing I learned about banking is that unless you have some first hand knowledge that CFOs have, you don't really know.
7 comments:
your point is well-taken, but doesn't this imply a lot of nasty accounting, somehow coordinated across the whole industry? banks are required to write down their foreclosure-pipeline loans to estimated fair value (e.g. JPM talks about writing stuff down by expected severity when 150 days past due, even though it may take another 150+ days to actually get the property), and while they could certainly wind up being wrong/very wrong, it's not as if they're carrying these things at par...Sure, severities can and probably will increase (though we're not yet seeing that in data out of the securitized market), but I think that a lot of the embedded loss in this area is already recognized. The inflow of new problem mortgages has been decreasing pretty steadily.
Nobody talks about Level 3 assets anymore, but the banks are still stuffed. Goldman has 7% Level 3 and the others do too.
FASB allowed mark to model on Level 3 assets that were to be held to maturity. The intent I think was to give the banks room to breath until the market (asset market, not equities) recovered and the assets could be sold.
What I wonder about is a second leg down in housing as the Prime (2006-2007) mortgages implode, and whether this will prompt renewed interest in bank assets.
Nobody will predict bankruptcy, not with the Fed standing by, but at the very least they will mark down earnings forecasts as the banks game of 1) mark to model 2) asset markup in value 3) loan loss reserve reduction 4) earnings bump up, goes into reverse.
"but doesn't this imply a lot of nasty accounting, somehow coordinated across the whole industry?"
Funny you should ask:
http://www.fasb.org/sbd040209.shtml
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=agfrKseJ94jc
If a bank has faced a few years of losses, they might be able to recognize a loss carry forward asset (negative tax liability) if they can show they will be profitable for the year in which the asset will be recognized.
Hopefully, the public accounting firm auditing the bank will be wary about allowing the bank to recognize the asset.
But, the prospect for banks varies. Citi is worrisome. Their gains have come from "Oh, we only had $2 billion in losses when we had forecasted $9 billion", and their strategy of getting their stock above where institutional investors can take positions seems to have faltered. Nevertheless, their international business is doing fairly well.
Hey Eric, you don't have a public email so I thought that I would reference you this paper here. It is very relevant to what you blog about.
http://dx.doi.org/10.1016/j.jfineco.2010.11.003
there is also this one...
http://dx.doi.org/10.1016/j.jfineco.2011.01.003
Citi took massive writedowns where they could hide a cookie jar. I'm assuming JPM set up a cookie jar with Wamu and Wells Fargo did the same with Wachovia. So there is plenty of room to massage earnings, at least at some banks.
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