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What They’re Really Saying Is: Banks Lie
October 7, 2009 by Neil · 3 Comments
Banks that made commercial real estate loans have toxic loans on their books that they are unwilling to purge. If commercial real estate values have dropped 30-40% over the last several years, and banks lent at 75-80% LTV, then their borrowers have negative equity across the board. If these loans were marked to market, perhaps few banks would even remain standing. As a result, many banks are quietly doing the “extend and pretend” exercise. They are extending the loans on favorable terms to clients with whom they have relationships. Larger banks, however, typically securitized the loans a thousand different ways, and sold off pieces to any number of elusive parties.
While everyone agrees that banks are in a far more precarious position now than they were in, say, 2001, the banks’ accounting practices suggests otherwise.
A recent in-depth analysis by economists Harry Huizinga and Luc Laeven revealed that while only 8% of banks at the end of 2001 had a market-to-book value of assets ratio of less than one, by the end of 2008, more than 60% of US bank holding companies made that claim.
Over the same period, the average ratio of Tier 1 capital to bank assets stayed constant at about 11%. The market value of bank equity thus dropped precipitously against a backdrop of virtually constant book capital. In other words, if the bank has the same amount of assets to protect itself from a default, and the assets have clearly dropped in value, then their cushion is woefully insufficient.
1. Banks’ balance sheets overvalue real-estate-related assets compared to the market value of these assets.
2. Banks with large exposure to MBS (mortgage backed securities) experience large excess returns when fair-value accounting rules are relaxed. On April 9, 2009, The Financial Accounting Standards Board (FASB) granted banks wide latitude in determining the value of their assets. With this great power, came great irresponsibility.
3. Banks use accounting discretion regarding loan losses and the classification of assets to preserve book capital. Banks have considerable discretion in the timing of their loan loss provisioning for bad loans and in the realisation of loan losses in the form of charge-offs. This gives otherwise zombie banks (dead by any clinical definition) a new lease on life.
Until Uncle Sam forces the banks to come clean, commercial real estate prices, including the multifamily asset class, will continue to stall.
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Check out what others are saying about this post...[...] As this site has repeatedly emphasized, banks have hoarded their TARP money to shore up their books, instead of loaning out the funds. They keep the bad loans on their books with values that have no bearing on reality. Were they to engage in genuine mark to market accounting practices, which Uncle Sam undid this year, many of them would explode. April 9, 2009 is a date which will live in banking infamy: On that day, the Financial Accounting Standards Board (FASB) granted banks wide latitude in determining the value… [...]
[...] make it easier for banks to appear solvent, the FASB, a seemingly independent agency gutted mark to market accounting rules for banks in June, 2009. Critics said that the FASB succumbed to pressure from lobbyists and politicians. If many [...]
[...] Banks with large exposure to MBS (mortgage backed securities) experience large excess returns when fair-value accounting rules are relaxed. On April 9, 2009, The Financial Accounting Standards Board (FASB) granted banks wide latitude in det… [...]