Accounting for Losses at BofA and Fannie 21 comments
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By James Kwak
Via Yves Smith, John Hempton analyzes the quarterly results of Bank of America (so-so) and Fannie Mae (terrible). The underlying issue is that bank quarter-to-quarter results are largely driven by the amount of provisions they take against future loan losses. You can think of this as a very rough approximation to marking-to-market — instead of waiting for the loans to default, you estimate how many loans will default in the future (that estimate should change as the economic situation changes) and put that amount of money into reserves. Then when the defaults actually happen, you take the money out of reserves.
Hempton argues that Bank of America (BAC) and Fannie Mae (FNM) are estimating extremely different future loan losses, and those differences cannot be attributed to differences in their current performance (the rate at which loans are defaulting now). If I wanted to be provocative I would only show you this quote:
“If Bank of America were to provide at the same rate its quarterly losses would be 50-80 billion and it would be completely bereft of capital – it would be totally cactus. It would be – like Fannie Mae – a zombie government property.” [emphasis in original]
(“Totally cactus” — I like that.)
But to be fair, Hempton actually thinks that Bank of America is being only slightly optimistic and Fannie is being extremely pessimistic. Here’s his interpretation:
“[R]egulators are controlling Fannie in such a way that keeps it down. They are allowing Bank of America to act as if all is well whilst Fannie Mae appears to be a complete zombie. Which I think corresponds roughly to the new policymaker consensus that what is good for big banks is good for America.
“It is clear why BofA has chosen the 13 billion of provisions per quarter – which is that it roughly corresponds to their pre-tax pre-provision income. [Hempton is saying that if they took any more provisions they would be unprofitable.] Moreover – in my view the 13 billion per quarter is not far wrong so the decision is defensible. …
“[A]lmost however I cut it the situation is getting worse for BofA at roughly the same rate as it is for Fannie Mae.
“Except for one thing. The government wants BofA alive. Lots of people want Fannie Mae dead.”
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I'd place my bets on the company that is not overstating things, since that\s really what got us (the economy) into trouble.
loss rate is absurd...No facts to substantiate...This fans the ignorance that prevails on some blogs regarding accrual accounting
versus fair value accounting..BAC is nowhere nears like a zombie
bank.There are dozens out and they are populated in the small banks
undercapitalized,low loan loss reserves,too high chargeoff rate, and
most importantly too low preprovision earnings....
You can lambast the naysayers over inadequate proof but please also lambast the banks and all those trying to prop them up for the same thing.
Come on!
You don't really expect the masters to tell you the truth?
Why? because they don't have to.
Simple as that.
If you were the Master, you would be doing the same thing. So shut up and gamble like everyone else or I am sorry, invest like everyone else.
I'm reminded on a joke I made six months ago, "the best way to value a bank is to take a photo of the CEO, show it to your dog, if the dog wags his tail, well you have a winner".
But actually SEC is actually doing more than anyone to get some sort of coherency in reporting, seekingalpha.com/artic...
In July 2003 International Valuation Standards wrote to BIS saying valuations used to assess capital adequacy (and presumably solvency) were "fundamentally flawed and bound to be misleading".
What's sad is that IVS is a valuation standard that is approved by all valuation institutes of any consequence in the world, which if implemented would stop all this nonsense at a stroke.
But it's not used.
On Nov 06 03:07 PM Moon Kil Woong wrote:
> Sadly the SEC doesn't require banks to disclose in a way that is
> in the best interest of investors and the government has made accounting
> principals for banks so incongruent with actual fact that they might
> as not adhere to acounting at all. All in all, estimates and assumptions
> are shoddy because there is nothing to substantiate anything anymore.
> Thus the problem is systemwide and has nothing to do with capitalism
> whatsoever. The financial sector has abandoned all pretenses of accounting
> and accountability a long time ago.
>
> You can lambast the naysayers over inadequate proof but please also
> lambast the banks and all those trying to prop them up for the same
> thing.
Fannie Mae is a quasi government welfare employment organization (high pay with benefits) backed by the full faith and credit of the Treasury. TBTF. Taxpayers hold the bag of guano.
So much politics are interwoven here that it's impossible to sort out any facts when the books are maintained in a black box in a dark closet. Roubini had it correct all along. They are technically bankrupt. But you can still fool most of the people most of the time.
Even zombies can come back to life. Just look at CITI over the years. Of course CITI can (is) reverting to the mean state of zombie- ism. How many lives left?
Time for different policymakers.
Freddie in particular is printing money in a pre-provision basis and has substantial reserves. Why not let them provision as everyone elses do?
about 95 % is performing....and they are priced at today's real estate prices ( a probable low point for home prices)......this is
a very manageable number....by the way their tangible common equity and annual preprovision earnings vatly exceeds their mark to market.....
On Nov 07 01:39 PM John Q Dallas wrote:
> Freddie Mac just needs to spend $100M to pay Barney Frank's boyfriend
> to get the government to recapitalize. For Bank of America historic
> loan losses are meaningless. Look at the value of their collateral
> (or lack of) and non-performing loans to see that defaults will hit
> hard in the next six months. Shopping centers and retailers will
> drop like flies this holiday season. Why no confidence in American
> business? It is saddled with bloated government mandated expenses
> and a bald face lying ruling party administration.
The speculation in housing market was so wild that American banks were still holding on to massively more toxic assets that they could dump on public accounts. BAC has been subsidized to neutralize its losses so it is very possible that it is playing games to extract more cash the public by extracting more cash through tax cuts by claiming ownership of the same toxic assets.
These bank will never stop extracting cash from public through predatory mortgage lending business . Americans are better off cutting their losses now and remove publicly subsidized mortgage business from private banking forever because the business is funded through interest rates funded by public that are sold back to them with a hefty cost.
They won't help main street. They don't have to.
On Nov 06 02:50 PM bbro wrote:
> this is garbage...BAC has 914 billion in loans....50 to 80 billion
> quarterly
> loss rate is absurd...No facts to substantiate...This fans the ignorance
> that prevails on some blogs regarding accrual accounting
> versus fair value accounting..BAC is nowhere nears like a zombie
>
> bank.There are dozens out and they are populated in the small banks
>
> undercapitalized,low loan loss reserves,too high chargeoff rate,
> and
> most importantly too low preprovision earnings....
How about raiding the treasury of the United States, by Paulson, Geithner, the Fed and Barney Frank? That is a conspiracy.
How about not reigning in the too big to fail banks with regulation? That appears to be the newest conspiracy.
How about protecting the hedge fund crony bondholders of Larry Summers with Barney's weak bill that pays the creditors and stuffs the taxpayers? That is a conspiracy in progress.
So, please tell me what conspiracy don't you believe in here?
On Nov 06 08:24 PM 7footMoose wrote:
> Mr Hempton is a thoughtful analyst but misses the point. The historic
> loan losses experienced by the bank coupled with the historic loan
> losses experienced by the entire financial industry set the tone
> for expected loan losses. This in turn allows a bank to establish
> a loan loss reserve, which is then reviewed by management, the outside
> auditors and the federal examiners. The concurrence of these parties
> is essential to the process. Historically it has been the Feds who
> have insisted that the banks not salt away excess reserves for the
> future while understating current period taxable income. The idea
> that this is an arbitrary decision by the banks in an effort to hide
> potential losses only holds water if you are a hard core conspirascist
> convinced that all parties are complicit and involved. There are
> a lot of dumbbells out there but the conspiracy theory does not hold.
They are awash in defaults and defaults yet to happen including trillions in Option arm resets, adjustable rates, and Commercial loans. Banks like BoA and Wachovia, are hanging on by a thread, due to low interest rates!. Without, they will no doubt perish, as the artifical, short term incentives, temporarily stop the slow down the devastated real estate market, refinancing is the only game in town.
First of all, I would like to say that I have read a number of your articles and think they are excellent -- well-thought and provocative. I also like what John Hempton has to say, because he usually offers some type of quantitative support for his position.
That being said, I think his math is off in the article you are discussing.
A comparison is made between charge-offs and loan loss reserves. For Fannie, charge-offs include the difference between fair value and the purchase price (the outstanding principal balance) for impaired loans acquired from MBS trusts. There is no equivalent to this for a typical bank, so these charge-offs are excluded from Fannie's charge-offs.
To make the comparison between charge-offs and reserves valid, one would also need to impute charge-offs on properties that Fannie disposes of. Fannie has already taken a hit to fair value loans that acquires, and therefore does not need to charge-off as much (and may not need to charge-off anything) when a foreclosed property is disposed of, whereas a bank like B of A would.
In contrast to John Hempton's argument, B of A's loan loss reserves look quite a bit more adequate than Fannie's from my perspective. B of A's allowance for loan losses at 3Q09 was 117% of non-performing loans. Fannie's was 33%. Just like the charge-off comparison is not apples to apples, the ratio of reserves to non-performing assets is also not apples to apples. This is because some of Fannie's non-performing assets have already been charged-off to bring them to fair value at the time they are purchased from MBS trusts.
As far as I can tell, it is not possible to determine the current discount on loans carried at fair value from Fannie's financials, so it is not possible to make an apples to apples comparison of loan loss reserves to non-performing loans. However, the volume of loans purchased at fair value (~$20B acquired during 2009 at an average price of around 45 cents on the dollar) leads me to believe that Fannie's loan loss reserve is less than half as adequate than B of A's allowance.
perpetuating itself through elitist stupidity and arrogant self praises amidst an abundance of evidentiary failures and delusions.
Table 12 in FNM’s financials do the work of adjusting charge-offs to a basis closer to what a bank would report. Even if lost interest on nonperforming loans are added to the charge-off numbers, they are still very small when compared with the combined loss reserve (less than $5B per quarter compared with over $60B).
Current charge-offs are a poor relative measure of future loan losses, because Fannie is trying to accommodate. Fannie’s new loans and modifications are much more likely to default than B of A’s new loans, because the company is tightening lending standards.
A reasonable overall guess would be that actual losses on the existing portfolio will be about twice as high as the current provision for Fannie, and maybe two and one-half times for B of A. In other words, Fannie’s provisions are more adequate, but not by much.
This only tells part of the story. A potentially bigger issue is each company’s ability to earn its way through the losses, and B of A has a huge advantage on this front. B of A is earning healthy spread income on loans carried on its balance sheet. By comparison, Fannie earns this on only a small proportion of the portfolio. On the remainder, it earns a much thinner guaranty fee (around 30 bps fees vs. hundreds of basis points that B of A earns in spread income). In the third quarter, B of A earned $11.4B of net interest income. Fannie, earned $5.7B of net interest income plus guaranty fee income. Fannie is earning less and has a much bigger pool of nonperforming assets.