Banks love to pretend that the loans on their books are worth more than the market says they are. They’ve made this argument vociferously since the beginning of the financial crisis, and they’re still making it today. They’ve made it loudly enough that they’ve sold Hank Paulson and Tim Geithner on it, among others.
But don’t be fooled!
Thanks to an accounting requirement that investors somehow managed to get past the bank lobby, banks are forced to tell the truth about their loans once a year. And that’s producing some interesting admissions.
For example, those by Regions Financial and Huntington, both of which would be insolvent if not for the fake loan values they put on their balance sheets.
Consider yesterday’s disclosures by Regions Financial Corp. in the annual report it filed with securities regulators. For purposes of its balance sheet, Regions said it finished last year with $94.9 billion of loans that it was holding as investments. In a footnote, however, it said the “fair value” of those same loans was $79.9 billion, or $15 billion less.
It’s a similar story at Huntington Bancshares Inc. The balance-sheet value for its loan portfolio was $40.2 billion as of Dec. 31. Yet Huntington said the fair value of those loans was $33.9 billion. The bank’s annual report said the lower figure “reflected discounts that Huntington believed are consistent with transactions occurring in the market place.”
And what would happen if the banks told the truth?
Regions’ stock-market value is now $2.6 billion, or 19 per cent of the bank’s $13.5 billion of common shareholder equity. Take away the $15 billion of excess value on its loan portfolio, and the company’s common equity would be less than zero…
Huntington’s market capitalisation is $608 million, a smidgeon of its $5.3 billion book value. The Columbus, Ohio- based bank also would have negative common equity were it not for the rules that say it doesn’t have to mark all loans at fair value.
Having made his point, Weil lets fly:
The infuriating part about these disclosures is that the banks knew all last year that the market values of their loan portfolios were plunging. And yet they weren’t required to disclose the numbers so investors could see for themselves…
The purpose of a balance sheet is to provide a snapshot of a company’s financial position at a given moment in time. And the whole point of having a capital cushion is to help a financial institution absorb losses. If a bank’s assets in real life aren’t worth what the balance sheet says, its capital is illusory, no matter what crazy maths the government uses to prettify banks’ official capital measures.
Think about it: If you were applying for a loan today, which figure do you think the lender would use to appraise your collateral? The price it would fetch now in an orderly sale? Or the value that you hope to realise someday when market prices supposedly get better? This is a no-brainer.
Yes, it is.