Mark-to-Market Accounting: OneWest and WaMu; Commentary by Brian Wesbury and Robert Stein: Bernanke Finally Fingers Mark-To-Market March 8, 2010
Mark-to-Market Accounting: OneWest and WaMu; Commentary by Brian Wesbury and Robert Stein
Some folks trust to reason Others trust to might I don't
trust to nothing But I know it come out right
Say it once again now Oh I hope you understand When it's
done and over Lord, a man is just a man
The Grateful Dead - "Playin' in the Band" Lyrics by Robert
Hunter. Music by Bob Weir
First a couple of updates. On Sunday The New York
Times published a map prepared by graphics editor Hannah Fairfield using
the data from the division of insurance and research at the FDIC and analytics
from The IRA Bank Monitor showing the distribution of banks large and small
across the US. The map illustrates the fact that most of the communities in the
US are served by smaller regional and community banks, which hold more than half
of total deposits. While large banks account for half of total assets in the
banking system, their liabilities tend to be only about half deposits, thus the
apparent disparity. To view the map, click the link below:
http://www.nytimes.com/interactive/2010/03/07/business/07metricsg.html?ref=business
Second, last week the Los Angeles City Council voted 12-0 to
pass Councilman Richard Alarcon's motion to require banks doing business with
the City, or seeking to do business with the City, to report on the details of
their local reinvestment in the community. To read the blog post by IRA CEO
Dennis Santiago, who attended the City Council meeting, click the link below:
http://www.huffingtonpost.com/dennis-santiago/los-angeles-pushes-for-re_b_488126.html
In this issue of The Institutional Risk Analyst, we
feature a guest comment regarding mark-to-market accounting by Brian Wesbury
Brian S. Wesbury, Chief Economist, and Robert Stein, Senior Economist, of First Trust Advisors LP in Chicago. But before we go to
our feature, we thought we'd take a look at the Q4 2009 results for OneWest
Bank, FSB, from The IRA Bank Monitor.
Bank Profile: OneWest Bank, FSB
OneWest has been the center of a storm of controversy in the
conspiracy theorist community, much of it erroneous, because of the fact that
the acquirer is sponsored by some of the biggest names on Wall Street and in Silicon Valley. OneWest
Bank Group LLC (OWBG), which wholly owns OneWest Bank, FSB, is a privately-held
thrift holding company whose investors include Steven Mnuchin, entities advised
by J.C. Flowers & Co. LLC, Paulson & Co., MSD Capital, L.P (Michael Dell), Stone Point
Capital LLC, SSP Offshore LLC (Soros Strategic Partners) and SILAR MCF-I LLC.
A year ago, OWBG purchased the banking operations of IndyMac
Federal Bank, which was being operated in conservatorship by the FDIC. When the
Office of Thrift Supervision closed the $32 billion asset IndyMac FSB in July
2008, there were no buyers for the bank, period. The FDIC selected
conservatorship instead of an immediate liquidation in an effort to safeguard
the deposits and maximize the recovery to the Deposit Insurance Fund (DIF).
Even when OWBG acquired IndyMac in March 2009 from the
receivership created by the FDIC prior to the sale, there were only two bid
groups: the winning group led by former Goldman Sachs investment banker Steve
Mnuchin and a group led by Goldman Sachs (GS). But the real significance of the
sale of IndyMac was that it began to thaw the market for dead banks. Today there
is a large crowd of funds gathering in the hope of buying a dead bank, but most
of the opportunities to buy failed depositories will go to other banks. See our
post on ZeroHedge last week (The Newest Scam from Wall Street: Investing in Private Equity
Funds that Acquire Failed Banks) in this regard.
IRA Bank Stress Index Rating - OneWest Bank FSB Q4
2009
IRA Letter
Grade A+ This institution exhibits significantly lower stress than the
industry average. |
Stress Score
|
Overall
0.3
|
ROE
0.2
|
Loan
Defaults
0.0
|
Capital
0.6
|
Lending
Capacity
0.5
|
Efficiency
0.2
|
Industry Benchmark
|
21.5
|
100.0
|
4.4
|
0.9
|
1.0
|
1.2 | | Source: FDIC/The IRA Bank Monitor The IRA Bank Stress Index is a
quarterly survey of all FDIC insured depositories. The benchmark year of 1995=1.
The current average stress level for the US banking industry of 21.5 as of Q4
2009 was more than a full order of magnitude above the benchmark
year.
As part of the sale, the FDIC cut a deal whereby if OneWest
Bank adhered to the loan modification program designed by the FDIC, any loans
that subsequently went into default above a certain threshold would be covered
by a loss sharing agreement. For all of you out there who mistakenly think that
the FDIC cut OWBG a special deal, this is the same loss sharing agreement
that applies to all acquisitions of failed banks from the FDIC. So far, the
FDIC has not paid out dollar one on the loss sharing agreement with OneWest
Bank, either on IndyMac or on any of the two other failed banks subsequently
acquired by OWBG. These include FirstFederal Bank of California and La Jolla
Bank FSB. No surprise then that when you look at the profile for OneWest Bank in
the professional version of The IRA Bank Monitor (which reflects only the
IndyMac transaction, BTW) you will notice that the bank is reporting no loan
defaults, zero, nechevo, bupkes, nada.
While FDIC may eventually need to make payouts under the loss
share agreement with OneWest and other acquirers of dead banks, most of the loss
on IndyMac has already been realized. Indeed, we begin to suspect that many of
these loss sharing agreements will not be significant compared to the cost of
resolution of the failed bank. Based on preliminary analysis performed by the
FDIC at the time of closure, the estimated cost of the IndyMac resolution to the
Deposit Insurance Fund was between $4 and $8 billion. At the time of the sale to
OWBG, the estimate loss to the DIF was over $10 billion or one third of the
assets of IndyMac. Losses to the DIF in this cycle are averaging over 30% of the
assets of failed banks vs. 11% in the S&L crisis of the 1980s.
Now a lot of observers have argued that the FDIC cut OWBG a
sweetheart deal. Compared to merely buying a troubled bank this side of a
resolution, buying IndyMac was sweet, but not because the FDIC has given special
treatment to OneWest Bank. No, the vigorish in buying dead banks comes from the
wonders of purchase accounting via the Financial Accounting Standards Board.
Next time you banksters walk past the FASB HQ in Norwalk, CT, step inside for a
moment and put a few dollars in the collection box underneath the statue of St.
Robert of the Revised Basis.
As with the purchase of Washington Mutual by JPMorgan Chase
(JPM), the subsidy in these deals comes from the write-down of the assets of the
failed bank. JPM, don't forget, paid just cents on the dollar for the assets of
WaMu that it acquired from the FDIC and the same holds true of the acquisition
of IndyMac by OWBG. That means that if a loan defaults and the recovery is above
the new cost basis for the loan, JPM or OneWest does not lose money. They
make money.
Indeed, a foreclosure on a home secured by a mortgage loan that
has been written down can actually generate an accounting gain for the
bank. On a short sale, for example, even if the proceeds don't cover the old
loan balance, JPM, OneWest and all of the other acquirers of failed banks take
an accounting gain vs the new cost basis for the loan. But again, this was not
the doing of the FDIC or the result of loss sharing, but rather stems from the
purchase accounting rules put in place years ago by the FASB.
Even with the extreme mark down of the WaMu transaction,
because well less than half of WaMu's liabilities were comprised of insured
deposits, the FDIC did not take a loss on that transaction. The assets of WaMu
were cleansed of legacy liabilities, including unliquidated liabilities like
loan rescission claims from securitizations. In fact, all of the potential
claims against the parent companies of WaMu and IndyMac for rescission of
securitized loans are sitting in bankruptcy court, where they will likely remain
and effectively die.
The same cannot be said about Bear, Stearns & Co., however,
a fact that is going to be causing JPM considerable heartburn in future
quarters. The JPM bankers thought they were ever so clever stuffing the Federal
Reserve Bank of New York with the nasty bits and pieces that were inside the
Bear mortgage conduit. But they apparently overlooked the unliquidated claims
against Bear's securitizations, which now have an average loss rate in the
mid-20% range. We hear in the litigation channel that some Bear securitization
deals have loss rates several time that average loss rate. Suffice to say that
the mortgage underwriting standards at Bear seemingly left a little to be
desired and now claims from that rancid corpus of mortgage securitizations are
JPM's problem. We'll be discussing this in detail in a future comment in The IRA
Advisory Service.
Prior to the sale to OWBG, the assets of IndyMac were written
down to just about zero in the receivership, which is our guess as to why
OneWest Bank is still reporting zero defaults. As in the case of Wells Fargo
(WFC) and Wachovia Bank, the write down of assets to "fair value" effectively
hides future losses. The FDIC and the creditors of the estate of IndyMac Bank
FSB bear the real cost of the transaction so far, at least unless and until FDIC
is required to participate in loss sharing. You can see the balance sheet of the
estate of IndyMac Bank in liquidation here:
http://www.fdic.gov/bank/individual/failed/indymacbalsheet.html
All of the public information about the IndyMac transaction is
available here:
http://www.fdic.gov/bank/individual/failed/IndyMac.html
Notice that there were $8.7 billion in unpaid deposit claims
and $5 billion in assets in liquidation as of the end of Q3 2009. So far,
uninsured deposits have received 50% of their claims. The FDIC has determined
that insufficient assets exist in the receivership of IndyMac Bank to make any
distribution to general unsecured claims, and therefore such claims will recover
nothing. Uninsured depositors are first in line in terms of the priority for
recoveries from the receivership.
|
Guest Commentary
Now to our feature. We've known Brian Wesbury since he worked on
Capitol Hill. His comments on the statement by Fed Chairman Ben Bernanke
regarding mark-to-market are right on target, but you will notice
that they conflict with current practice as described above in the examples of
JPM and OneWest. Once a bank fails and the loans are in receivership, the only
thing that matters is the cash bid for the assets -- at least under current GAAP
accounting rules. The debate over mark-to-market accounting illustrates the fact
that accounting is not science but art; merely one perspective on reality that
is always flawed.
As we read the comment by First Trust, it occurred to
us that the Fed's quantitative easing during 2009 was not simply about propping
up prices for Treasuries, MBS and anything else on bank balance sheets. It was
also a work-around for mark-to-market accounting. While regulators gave banks a
pass on mark-to-market accounting for regulatory capital purposes, they could
not block the impact of mark-to-market on GAAP disclosure with the SEC. As we've
noted in our research notes on specific banks, there were no significant
securities marks in Q4 2009 or Q3 for that matter. In our view, QE was a way for
the Fed to help banks avoid mark-to-market marks on their securities books. But
as our friend Greg Smith at asset workout specialists Aram Global noted last
week, the economics of the ABS asset classes that comprised the lion's share of
Fed's purchases under QE are continuing to deteriorate. Chairman Bernanke, investors in CRE loans and the trial lawyers will eventually figure this out.
Bernanke Finally Fingers Mark-To-Market
"…commercial real estate loans should not be marked down because
the collateral value has declined. It depends on the income from the property,
not the collateral value."
Ben S. Bernanke Chairman, Board of Governors of the Federal
Reserve System February 24, 2010
It would have been much better for the economy if Chairman
Bernanke had been this clear about mark-to-market accounting back in 2008. If he
had been, the US might have avoided the Panic of 2008. But it's never too late,
and now that mark-to-market ideology is affecting the ability of the Federal
Reserve to exit its quantitative easing, he's finally onboard.
In November 2007, FASB reinstated mark-to-market accounting for
the first time since 1938. This rule uses bids (exit prices) to value assets. So
far, so good. However, in 2008, the market for asset-backed securities dried up.
The prices of bonds that were still paying in full fell by 60% or 70%, and those
losses were often driven through the income statement. This wiped out regulatory
capital, caused bankruptcies and created a vicious downward spiral in the
economy. In retrospect, it is clear that this accounting rule was a potent
pro-cyclical force behind the Panic of 2008.
Finally, on April 2, 2009, FASB allowed banks to use "cash
flow" to value bonds when the market was illiquid - exactly like Bernanke said
last week. This fixed the immediate problems in the system, and the economy and
financial markets have been on the mend ever since. In fact, the stock market
bottomed on March 9, 2009 - the very day markets found out that Representatives
Barney Frank and Paul Kanjorski would hold a hearing to force FASB to change the
misguided accounting policy.
However, over-zealous bank regulators are now enforcing their
own version of mark-to-market accounting by using the appraisal process.
Regulators are forcing banks to write down loan values and increase loan-loss
reserves by using appraiser-driven valuations. Yes, that's right; these are the
same appraisers who over-valued properties five years ago. Now, because they
often use foreclosures and distressed sales as comparable recent transactions,
they undervalue properties.
To the regulators, it does not matter if the loan is still
being paid on time. And it does not matter if the lower valuation of the
collateral will force an already stressed borrower to come up with more cash.
Regulators have decided that they want banks better capitalized and the way they
can do that is to reduce the value of a bank's assets and then force these banks
to raise money from shareholders.
This, in turn, is undermining bank lending, hurting small
business and making it more difficult to reduce unemployment. The worst part is
that it is not necessary. Banks are better capitalized today than they were in
the early 1980s when banking losses were significantly worse. Back then, we did
not have mark-to-market rules forcing banks out of business; instead we allowed
the actual performance of loans to determine the viability of these
institutions.
Banks could not "make-up" loan values in the 1980s and 1990s.
In fact, more than 2,700 banks and S&L's eventually failed even though we
did not have mark-to-market accounting. Mark-to-market accounting does not solve
problems, it creates them by acting as a pro-cyclical force. Milton Friedman
understood this and wrote about the devastating link between mark-to-market
accounting and Great Depression bank failures. Franklin Delano Roosevelt finally
figured this out in 1938 and suspended the rule. The Depression ended soon
after. Coincidence: We think not.
Similarly, in 2009 with mark-to-market rules in place, two
stimulus bills totaling over $1 trillion, a $700 billion TARP, zero percent
interest rates, and trillions in other Fed and Treasury actions did not turn the
market around. Private money did not flow into the banking system until FASB
finally allowed cash flows to be used to value assets (when markets were
illiquid).
Once the rule was changed, banks were able to raise $100
billion in private capital. And since then, TARP has been repaid by institutions
that were forced to take it, while PPIP never got off the ground. It was
mark-to-market accounting that created the Panic of 2008, not a failure of the
capitalist system.
But these overly strict accounting rules still have many
adherents, bank regulators among them. And as long as it remains a threat to the
system, the system will not fully heal. For example, a viable market for the
securitization of asset-backed loans is highly unlikely to reappear until
mark-to-market accounting is dead and buried. Why would anyone buy asset-backed
securities when there is the potential (readily witnessed over the past few
years) for market-driven declines in value to undermine the ability of the
financial system to hold them even if cash flows are not impeded?
If you don't believe this, read the following exchange from
last week (February 24th) between Fed Chairman Ben Bernanke and Congressman
Kanjorski (D-PA).
Rep. Kanjorski: I'm particularly interested in…the commercial
real estate problem. Could you give us your assessment of…that…problem…and if
there's any action we in the Congress should take….
Chairman Bernanke: Congressman, it remains probably the
biggest credit issue that we still have. Yesterday, Chairman Baird talked
about the increase in the number of problem banks. A great number of those
banks are in trouble because of their commercial real estate positions…. The
Fed has done a couple of things here. We have issued…guidance on commercial
real estate, which gives a number of ways of helping, for example instructing
banks to try to restructure troubled commercial real estate loans, and
making the point that commercial real estate loans should not be marked
down because the collateral value has declined. It depends on the income from
the property, not the collateral value. We've also, as you know, had
this TALF program which has been trying to restart the CMBS - commercial
mortgage-backed securities - market with limited success in quantities. But we
have brought down the spreads and the financing situation is a bit better. So
we are seeing a few rays of light in this area, but it does remain a
very difficult category of credit, particularly for the small and
medium sized banks in our country. [Our emphasis added.]
While Mr. Bernanke did not directly link accounting rules with
his attempt to "restart" the CMBS market, it is clear that if mark-to-market
accounting remains alive, this market will not be resurrected easily. No matter
how much money the Federal Reserve throws at the market for securitized assets,
the private sector will remain skittish if there is the potential for an
accounting rule to wreck the market again.
This is very important for the Fed's exit strategy and for the
growth of the loan market in the years ahead. Without securitization, bank
lending will continue to drag and the Fed will be worried about its withdrawal
of support for the system. The US needs a viable securitization marketplace and
mark-to-market accounting remains a stumbling block.
Mark-to-market accounting needs to die. It should be stabbed in
the heart with a cedar stake, shot through the temple with a silver bullet and
then buried under six feet of garlic powder. Like the evil killer in a horror
flick, we need to make sure it never gets up off the floor ever again. While we
do not agree with everything Ben Bernanke is doing these days, his comments,
which finger the impact of accounting rules and conventions on the economy, are
right on the money. Hopefully, the SEC, Treasury, the FDIC, Congress, and FASB
were listening.
|
Questions? Comments? info@institutionalriskanalytics.com
About IRA Products and Services
IRA offers advanced analytics for risk surveillance and investment research via subscription products such as the IRA Bank Monitor for Professionals covering the US banking industry and the IRA Corporate Monitor covering public companies. For a trial subscription or an on-line demonstration, please register here. IRA Advisory Services including our channel research and diligence support services are available to qualified clients. For more information, please contact our offices. IRA for Consumers
IRA provides consumers easy to buy online reports to independently check on their banks via our How's My Bank? system. IRA on Web 2.0
For updates during the week please follow IRA www.twitter.com/IRABankMonitor.
The Institutional Risk Analyst is published by Lord, Whalen LLC (LW) and may not be reproduced, disseminated, or distributed, in part or in whole, by any means, outside of the recipient's organization without express written authorization from LW. It is a violation of federal copyright law to reproduce all or part of this publication or its contents by any means. This material does not constitute a solicitation for the purchase or sale of any securities or investments. The opinions expressed herein are based on publicly available information and are considered reliable. However, LW makes NO WARRANTIES OR REPRESENTATIONS OF ANY SORT with respect to this report. Any person using this material does so solely at their own risk and LW and/or its employees shall be under no liability whatsoever in any respect thereof.
|
|
|