One of the preferred ways for regulators to deal with failed or wobbly financial institutions is to get a stronger firm to take the problem off their hands.
But as Jon Birger of Fortune reports in a profile of bank analyst Meredith Whitney (hat tip doc holiday), new accounting rules may get in the way:
Another negative: two little-talked-about regulatory changes Whitney says will stymie banks’ recoveries. One is a new accounting rule known as FAS 141R. Given the depth of the crisis, Whitney expects to see bank regulators arranging shotgun marriages between well-capitalized institutions and foundering ones. Problem is, any such deals would have to happen before FAS 141R takes effect in December. The new rule, she says, “will make it almost impossible to do bank mergers.” The rule demands that an acquirer not only immediately mark to market the portfolio of the company being bought – and remember, bids for mortgage assets are now few and far between – but also mark to market its own portfolio as well. “Nobody’s going to want to do that,” Whitney says.
I’m not as certain the impact will be as pronounced as Whitney suggests. On the big end of the food chain, there are not a lot of strong players out there (but that still doesn’t mean a weak bank couldn’t be combined with a less weak one). But the FDIC will have a very strong preference for getting smaller failed banks folded into bigger ones, so this treatment does have the potential to cause trouble. That in turn might lead to a push to get deals done before the new rule takes effect.
However, the big issue is that the banking industry in the US and Europe is undercapitalized. Ironically, the Japanese are solvent and selectively doing deals (witness the Sumitomo Mitsui Group investment in Barclays, which at the moment is nicely in the money). Banks will have to rebuild their equity primarily via going outside the industry (ie, institutional and retail investors) or earning their way out if central banks can be can engineer a steep enough yield curve.
No problem! FAS 141R will be delayed as long as necessary.
Meredith Whitney is married to a professional wrestler. Look it up.
Seriously, if she looked like Jim Cramer no one would listen.
And, as in the 1980s S&L crisis, the regulators could offer acquirors regulatory capital forbearances.
Yesterday, it was my pleasure to sling mud at FASB under the beagle picture and thus, IMHO, watching the re-engineering of bank mechanics is something to watch closely.
IMHO, banks are obviously in the process of dumping toxic waste in a race to expand the other side of the Bollinger band, i.e, instead of taking on as much financial garbage as possible, we are now seeing fire sale panics to dump assets. To me, that sort of mis-managed, mis-informed lack of balance immediately makes me think of hedge funds that are designed to manipulate this volatility.
It is my opinion that these fire sale assets are being spun off for the purpose of repackaging — where behind the closed doors of entity protection, these assets will be transformed into subsidiaries or securities that will suddenly appear to have future value, versus being worthless.
Furthermore, the process of consolidating more and more banks will require the displacement of the toxic waste, which will find new homes in un-regulated banking institutions or enterprises, like holding companies, insurance companies that have different rules relating to the technical statutory loan loss reserves, QSPEs, subsidiaries and all the fun and games cooked into deregulation, shadow banking and derivative exposure, which enabled The Enron era, stock bubble and subprime crisis.
E.g: The most important U.S. legislation affecting both banks and insurers is the Gramm-Leach-Bliley Act of 1999, permitting the formation of financial holding companies,which can own all types of financial subsidiaries, including banks and insurance companies
* FAS 141R significantly changes the accounting for business combinations in a number of areas including the treatment of contingent
consideration, preacquisition contingencies, transaction costs, in-process
research and development and restructuring costs.
But wait, there is more….
I think you have the hots for Meredith Whitney.
No one pays attention to all that accounting garbage.
…Fannie Mae and Freddie Mac package the loans into securities for sale to investors in the so-called “to-be-announced” market that is the first stage in the life of a guaranteed MBS. SIFMA’s decision follows a controversial debate over whether to allow the loans in the TBA market, whose efficiency affects the cost of mortgages.
“We expect higher balance borrowers to receive both rate relief and increased liquidity as was desired in the legislation, while retaining the overall liquidity of the TBA market,” Sean Davy, a managing director at SIFMA in New York, said in a statement.
About $70 billion is invested in commodity hedge funds, more than double the amount three years ago, according to estimates by Chicago-based Cole Partners Asset Management, which invests in such funds.
Regardless of whether hedge funds and short-sellers exploited the firm’s weakness, it was Cayne and his colleagues who made the firm financially vulnerable. They sealed the firm’s fate by choosing to finance the vast majority of the firm’s daily needs – about $50 billion a day – in the overnight repurchase agreement (or “repo”) market, using some 71% of its mortgage book as the collateral. (By contrast, Goldman Sachs (GS) finances less than 10% of its mortgage book in the overnight market, according to [Goldman Sachs co-president Gary] Cohn.)
The collapse in home prices, of course, is a major threat to the stability of Fannie and Freddie. At the Fed, Mr. Greenspan warned for years that the two mortgage giants’ business model threatened the nation’s financial stability. He acknowledges that a government backstop for the shareholder-owned, government-sponsored enterprises, or GSEs, was unavoidable. Not only are they crucial to the ailing mortgage market now, but the Fed-financed takeover of investment bank Bear Stearns Cos. also made government backing of Fannie and Freddie debt “inevitable,” he said. “There’s no credible argument for bailing out Bear Stearns and not the GSEs.”
His quarrel is with the approach the Bush administration sold to Congress. “They should have wiped out the shareholders, nationalized the institutions with legislation that they are to be reconstituted — with necessary taxpayer support to make them financially viable — as five or 10 individual privately held units,” which the government would eventually auction off to private investors, he said.
Instead, Congress granted Treasury Secretary Henry Paulson temporary authority to use an unlimited amount of taxpayer money to lend to or invest in the companies. In response to the Greenspan critique, Mr. Paulson’s spokeswoman, Michele Davis, said, “This legislation accomplished two important goals — providing confidence in the immediate term as these institutions play a critical role in weathering the housing correction, and putting in place a new regulator with all the authorities necessary to address systemic risk posed by the GSEs.”
I think you have the hots for Meredith Whitney.
>>> So what?
I’m not an accountant…
but I read through the summary of FAS141(Revised) and didn’t see anything about requiring the acquirer to mark-to-market, mark-to-fair value or mark-to-anything acquirer assets owned or controlled prior to the acquisition date.
This Statement requires an acquirer to recognize the assets acquired, the liabilities
assumed, and any noncontrolling interest in the acquiree at the acquisition date,
measured at their fair values as of that date, with limited exceptions specified in the
Statement. That replaces Statement 141’s….
blah blah blah (summarized for your sanity)
…this Statement improves the
relevance, completeness, and representational faithfulness of the information provided
in financial reports about the assets acquired and the liabilities assumed in a business combination.
The new rule goes on to talk about
-Assets and liabilities arising from purchase related contingencies,
-Measuring goodwill or gains created from bargain purchases (kind of surprise these weren’t already the rules),
-Accounting/valuing goodwill and intagibles (including combination of deferred tax assets among others).
Like I said, I’m not an accountant and don’t read too many FASB rules so maybe the information Ms. Whitney is talking about is buried deeper in the document (358 pages).
If anyone can point me to anything in the actual FASB141(R) document supporting her claims I would greatly appreciate it.
FASB document: http://www.fasb.org/pdf/fas141r.pdf
Progress on Other Potential Solutions
BlackRock continues to explore alternative forms of leverage for its fixed income closed-end funds. One approach includes the development of a put feature for the ARPS, which would make them eligible for purchase by money market funds. This objective may be accomplished by adding the feature to the existing structure of the ARPS or through the issuance of a new form of preferred stock that includes a put feature. The existing ARPS issued by BlackRock closed-end funds or other issuers as currently structured are not eligible for purchase by money market funds. This potential solution is dependent on identifying third parties to provide liquidity commitments, demand for these instruments in the broader marketplace and obtaining necessary regulatory relief to make the ARPS eligible for purchase by money market funds.
“While there are still significant hurdles to cross in developing this structure, this has the potential to have broad applicability to helping to resolve the current illiquidity of outstanding ARPS,” said Anne Ackerley, Chief Operating Officer, BlackRock U.S. Retail Group. BlackRock also continues to explore the availability and cost of other forms of leverage, including various types of bank financing. Any potential solution will be subject to execution risk and dependent on both economic and market factors beyond BlackRock’s control.
Ok, Ill do it
Insurance companies have had to do this for 30 years, and it has not slowed down acquisitions much.
Re: “The new rule, she says, “will make it almost impossible to do bank mergers.” The rule demands that an acquirer not only immediately mark to market the portfolio of the company being bought – and remember, bids for mortgage assets are now few and far between – but also mark to market its own portfolio as well. “Nobody’s going to want to do that,” Whitney says.”
1. The changes include, among others, the accounting for goodwill, noncontrolling interests and acquisition and restructuring costs. The two standard-setting boards have described these standards as the first major common standard developed together. However, there remain a few differences between the U.S. GAAP and IFRS versions.
2. Summary of Statement No. 141 (revised 2007)
For example, Statement 141 required the acquirer to include the costs incurred to effect the acquisition (acquisition-related costs) in the cost of the acquisition that was allocated to the assets acquired and the liabilities assumed. This Statement requires those costs to be recognized separately from the acquisition. In addition, in accordance with Statement 141, restructuring costs that the acquirer expected but was not obligated to incur were recognized as if they were a liability assumed at the acquisition date. This Statement requires the acquirer to recognize those costs separately from the business combination. Therefore, this Statement improves the relevance, completeness, and representational faithfulness of the information provided in financial reports about the assets acquired and the liabilities assumed in a business combination.
More to follow…
Stolen from deep space:
Risk margin is portfolio rather than entity specific, reflecting pooling of liabilities..
The new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. The revision of 141 is part of the FASB’s push toward “fair value,” or mark-to market accounting.
Financial Week (December 10, 2007) reports that Dennis Beresford, a former FASB chairman now serving on a Securities and Exchange Commission advisory committee that is studying the U.S. financial reporting system says “The rules will be difficult to apply and will require companies and analysts to relearn a lot of things.” The article goes on to say that the revisions to 141 “essentially extend the fair-value requirements to new areas. That will increase the valuation work required of corporate finance departments, and in some cases jack up the volatility of reported earnings as various assets and liabilities are marked to market.”
Ok, back to The beagle witch hunt:
Re: FAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree.
That reference is from ASSURED GUARANTY LTD on 2/29/2008, and they break out the term “identifiable” as if this FASB spin has nothing to do with Level 3 unobservable assets, thus is this a matter of discretionary abuse where there is room to move some assets into the shadows, or is there really responsibility to report GAAP? I think these new rules allow repackaging of unobservable garbage, while SEC, FASB and all the puppets at SIFMA create conduits to pool together this aggregate trash into new AAA entities!
Banks: “If you let us hold your money again, we won’y lose it this time.”
Re: “engineer a steep enough yield curve”
That is what covered bonds and banking deregulation and issues like this:
Jumbo Conforming Mortgages Eligible for TBA Trades: SIFMA
Rates and liquidity
But what about everyone else? The inclusion of jumbo conforming mortgages could end up raising conforming rates for all borrowers as traders price in the new loans, although HW’s sources suggested that the 10 percent limit was likely “just the right proportion” to keep the TBA market on track.
The concern, as it was explained to us, is that prepayment behavior on jumbo conforming mortgages is likely quite different in trajectory than what’s observed in more traditional mortgages; the liquidity of the huge TBA market is predicated on the idea that the underlying loans share the same basic characteristics.
10:18, you’ve obviously never read her research. Not only has she happened to be spot on, her work impressive and detailed.
And being pretty worked for Erin Callan only for six months…
2:09 You’re right. My favorite report was when she recalled, “Then my husband went up on the top rope, screamed at the crowd and did a backflip into a reverse-elbow-bash!!!!”
That was so spot on. I mean I have to hand it to her, he is according to Wikipedia,
“A one-time WWE Champion, a one-time United States Champion, a one-time European Champion, a seventeen-time Hardcore Champion and a three-time World Tag Team Champion with Faarooq as part of the tag team Acolytes Protection Agency (APA).”
So Doc, much of this is just selecting what color bow the garbage comes wrapped in, eh? I am more pessimistic ever.