Monday, December 22, 2008

Reclassifying from Available-For-Sale to Hold-To-Maturity

Back in September Asset-Backed Alert put out an article describing how various banks (Zions Bancorp, National Penn and others) have rearranged their CDO holdings, reclassifying certain CDOs, previously held as available-for-sale (AFS), into hold-to-maturity (HTM) accounts.

Some background musings relating to yesterday's Financial Times article about IASB, and possibly FASB's adoption of dual AFS and HTM measurements:

This reclassification allows banks to avoid FASB 157-esqe "fair value" accounting, and employ an "amortized cost" (think, "intrinsic") analysis rather than marking to (a rather volatile) market.

The International Accounting Standards Board (IASB) and FASB have been in heavy communication about fair value accounting for a while now, with the hope of maintaining cross-Atlantic consistency. Thus far, FASB has been the stronger proponent of fair value measurement, with IASB allowing for greater leniency and maneuverability.

Some more recent examples:
- Citigroup plans to reclassify approximately $80bn of assets (likely to dampen the effect of further writedowns at year-end)
- IAS 39 reclassifications: see Deutsche Bank's and Unicredit's Q3 2008 earnings conference calls of Oct. 30 and Nov. 11, respectively

These principles present various challenges, including the ability to recognize and appreciate the likelihood of an asset's impairment, and whether it's other-than-temporarily-impaired (OTTI) as a result of market conditions.

But let's consider the crucial item here: irrespective of whether they're impaired assets, why not take the writedown today, even if its not a fundamental, permanent writedown? The sooner the banking system licks its wounds and returns to profitability, the better, and from a macro-perspective the sooner we can shrug the burden of losses the sooner we can return to a functioning, profitable financial market.

TARP has provided the banks with the liquidity to stomach the loss now, but it looks like CEOs (and perhaps FASB and IASB) are allowing the short-sightedness to continue and, with it, prolonging the pain.

1 comment:

Anonymous said...

In answer to the question as why not take the hits today and return to profitability - This idea is conditioned on several concepts:

1. When the company writes down the asset, it impairs that company's capital. The company is now further restricted in the amount of business it can do, thereby reducing profit potential.

2. Financial institutions that take their hit will not be able to write as much business, i.e. loans and insurance policies - thereby impacting the other businesses that rely on these products to do business - further impacting profits.

3. As the business that would have gotten loans/insurance are forced to downsize their operations due to lack of working capital or insurance to take on new projects, the businesses will be forced to reduce their workforces. This impacts the economy in general with lower stock market and real estate prices resulting in still further hits in step 1.