All's Fair In Love and Value: Part 2

Thursday, October 15, 2009 , , , , , 0 Comments

Hey look! Bloomberg does fair value. Spot on, Jonathan Weil, well done.


Here’s the best tip I ever got on how to read a company’s financial statements: Read the footnotes first, because that’s usually where the bodies are buried.

The main caveat is that the notes might not tell the whole truth either. That’s especially the case with banks.

A big improvement to the accounting rules this year is that lenders now must disclose their loans’ fair-market values every quarter, rather than just once a year. When a bank says its loans are worth much less than their balance-sheet amount, that means a large portion of its capital cushion may be illusory.

Such gaps arise because loans don’t have to be carried on the balance sheet at fair value, giving lenders lots of wiggle room to play with.

One irksome problem: Sometimes the numbers in the fair- value footnotes look more like mark-to-make-believe than mark- to-market, particularly when weak banks say their loan values are rock-hard.

I’ll get to some of the big-name banks such as Citigroup Inc. shortly. First, consider an Illinois lender with $3.6 billion of assets on its books called Midwest Banc Holdings Inc.

Midwest said its loans had a fair value of $2.53 billion as of June 30, which was about $35 million more than their carrying amount on the bank’s balance sheet. There are reasons to be skeptical, though.

Fair value is supposed to represent the price at which an asset would change hands in an orderly, arm’s-length transaction. Judging by Midwest’s stock price, it’s hard to believe those loans are worth quite so much.

Midwest’s shares trade for 62 cents, giving the company a $17 million stock-market value. That’s less than 20 percent of its reported book value, or common shareholder equity, which tells you the market doesn’t trust the bank’s asset values. The stock hasn’t traded for more than a buck since June 22.

Meanwhile, Midwest missed its last two scheduled dividend payments under the Treasury Department’s Troubled Asset Relief Program. In August, it said it had not made a required $5 million principal payment to one of its lenders. If its assets are so valuable, management should buy the company for themselves.

Midwest is one of 33 banks that skipped paying TARP dividends to the U.S. bailout program in August, according to SNL Financial, a bank-research firm. It’s not the only one of them with funny-looking fair-value numbers.

While Weil is right to call the footnotes the "graveyard" of financial bodies, auditors should be trained to sniff them out like bloodhounds looking for missing 3 year olds.

Regions [Financial - (RF)], an audit client of Ernst & Young LLP, estimated the loans on its books as of June 30 were worth 25 percent less than their $90.9 billion carrying value. That was no surprise, though. Its shares trade for less than half the company’s book value. BB&T and Commerce, for instance, trade for more than book.

“We and our accountants interpreted that in the strictest manner,” Ritter said at a Sept. 15 investor conference, referring to the FASB fair-value rules. “I don’t think we’ll hear anything probably from the SEC. But I’d be surprised if some other banks don’t, or else we and our accountants missed something.”

Memo to Securities and Exchange Commission Chairman Mary Schapiro: Did you catch that?

Oh snap. You know, I don't really have anything to add to this because, well, I'm sort of sick of the entire thing and would rather take a nap. Same old same old with the beancounters, I guess.

Jr Deputy Accountant

Some say he’s half man half fish, others say he’s more of a seventy/thirty split. Either way he’s a fishy bastard.