Can Recent Bank Earnings Be Trusted?

To spectators, the banking industry appears to be staging a comeback rally. April earnings season was easy on the market, as many companies and banks beat expectations. However, can this round of earnings be trusted? Or are the numbers just a result of another mark to market bounce?

The Fundamental Facts

Economically, the fundamentals are grim. Thousands are losing their jobs each and every day, real estate continues to plummet, and as a whole, consumers just aren't ready to part with their money as they were just one year ago. As a result, many loans that were previously paid on time, every time, are now showing up 30 days late or not at all. Banks are losing money on these loans, but when was the last time that any bank “wrote off” any bad loans? Months ago!

Banks Aren't Forecasting Losses – They're “Revaluing” Them

Previously, banks would set aside large cash blocks in their budget to cover any loans that went sour. This strategy allowed banks to set aside as much liquidity as they needed, and subsequently, investors could obtain a glimpse of how well, or how poorly, their investments were performing. Today, banks have much more flexibility, granted from the mark to market accounting rule change that allows them to value their portfolio however they please. If you were a bank representative in this scenario, would you forecast losses, or simply “revalue” them?

The Bank’s Dangerous Valuation Power

If you have an ability to arbitrarily value any asset you own, you would wield tremendous power. Any asset in your possession without a real and liquid market could be given a “make believe” value.

For example, used refrigerators don't have very liquid markets, and subsequently, you could value yours to be worth $20,000. Even if your refrigerator isn't worth $20,000, you can state it on your balance sheet at $20,000 worth of assets, and you can account for losses against that $20,000 asset.

Under this accounting system, you'll always win, and so will the banks. The only way for banks to report any sizable losses is if their cash gets drawn down, or else they can instantly and easily “create” more wealth just by revaluing a certain asset. When it comes to banking stocks, caveat emptor.

Disclosure: Author owns calls in the XLF

Comments

[James Wilson:]

I would trust Pandit but few of the others.

Apr 29 03:11 AM

[Moon Kil Woong:]

In Asia property is expensive because banks only book losses if they sell for a loss. Thus they hold empty building and houses for eternity and book them as over valued. If they sold them they'd be bankrupt.

This is one of the reason Japan never recovers from it's collapse decades ago. The losses are still hidden in the bank and the banks act like eternal vampires leeching off interest earnings from credit worthy customers to pay for the losses and keep them hidden.

Whereas a normal economic system leads to further prosperity, one that operates like this leads to constant decay.

Apr 29 05:17 AM

[Jasper M:]

Dead on as usual, Moon. I have seen photos of dogs sleeping in the doorways of empty office building in Thailand. NOT the economic model I want to follow here, thank you.

Apr 29 06:39 AM

[jeandit75:]

NO

Apr 29 07:27 AM