Banks and securities firms, reeling from record losses resulting from the collapse of the mortgage securities market, are failing to acknowledge in their income statements at least US$35 billion in additional writedowns included in their balance sheets, regulatory filings show.
Citigroup Inc subtracted US$2 billion from equity for the declining value of home-loan bonds in its quarterly report to the Securities and Exchange Commission on May 2 without mentioning the deduction in the earnings statement or conference call with investors that followed.
ING Groep NV placed 3.6 billion euros (US$5.6 billion) in negative valuations in its capital account, while disclosing only an 80 million euro depletion to income.
The balance-sheet adjustments are in addition to US$344 billion in writedowns and credit losses already reported on the income statements of more than 100 banks. These companies have raised US$263 billion from sovereign wealth funds, their own governments and public investors to shore up capital.
The balance-sheet writedowns also reduce equity, which needs to be replenished. Adding the US$35 billion leaves the banks with a US$116 billion mountain of losses to climb.
“The smart people are the ones who’ve identified the problems, put them out there in full transparency, and addressed them by raising more capital,” said Michael Holland, who oversees more than US$4 billion as chairman of Holland & Co in New York. “There is still billions of dollars of crap out there that hasn’t worked itself through the system. Banks need more capital to work that all out.”
Taking losses on a balance sheet instead of an income statement is acceptable under accounting rules, which make a distinction between so-called trading books and long-term investments. Changes in value on the trading side go straight to revenue. Changes in the value of bonds held for the long haul can be marked down on the equity line of a balance sheet, as long as the declines aren’t considered permanent.
Banks that are more willing to acknowledge their balance-sheet writedowns, such as ING, say the valuations of assets will be reversed when markets recover.
ING, the biggest Dutch financial-services company, said in its first-quarter earnings report last week that the drop in the value of bonds tied to home loans that are held to maturity is irrelevant as long as the underlying mortgages don’t default.
With that logic, most of the writedowns on the income statements could be reversed if asset prices recover. While some declines in valuations may reverse, most of the losses are permanent impairments caused by surging defaults on US mortgages, said Janet Tavakoli, author of Collateralized Debt Obligations & Structured Finance.
“Of course we can’t tell how much of a bank’s portfolio may actually be good stuff that will pay back at maturity,” she said. “But there’s tremendous value loss that’s fundamental, not just due to credit market gyrations.”
Keeping those markdowns off income statements just delays the realization of the losses, said Brad Hintz, a New York-based analyst at Sanford C. Bernstein & Co.
“The banks that have taken advantage of this accounting approach are going to have a price to pay later,” said Hintz, the third-highest ranked securities analyst in an Institutional Investor magazine survey. “You don’t avoid the price. Those that have taken it all in their income statements will come out with clean balance sheets and move on.”