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Throughout my tenure of writing for Seeking Alpha, I have consistently come across talk of banks not valuing their assets correctly. The general view is that the government caved in to banker (bankster) pressure to suspend mark to market accounting. To be honest, this is not the case. Instead, banks are allowed to "fairly value" assets using three separate categories, depending on the asset in question.

The truth is, that the vast majority of "fair value" assets (securities carried on balance sheet at cost are called held-to-maturity securities, see Fair Value Accounting Is Alive And Well) on bank balance sheets are valued using current market data or similar criterion (Level I and Level II assets.) The general point of contention with bank accounting is the use of the Level III category, in which assets are valued using complex estimates that can be incredibly arbitrary. However, these estimates are not as nefarious as some would think. The method most used to value Level III assets is discounting of cash flows received from the asset. This is a perfectly legitimate and ordinary process used in the world of business. Many investors, myself included, are still wary of these risky assets, and it is always a good idea to learn the specifics of a potential investment's riskiest assets instead of ignore them. With JPMorgan's (NYSE:JPM) recent mark to market losses on its synthetic credit derivatives portfolio, these types of assets should be evaluated and monitored even more closely.

I will use the most recent 10-Q filings of Bank of America (NYSE:BAC), JPMorgan Chase, Citigroup (NYSE:C), and Wells Fargo (NYSE:WFC) to analyze the amount of Level III assets on each balance sheet. I will also demonstrate, for each bank, the significant changes in Level III assets from last quarter, and then compare the ratio of Level III assets to total assets of each bank against their peer banks.

Bank of America

First, let's take a look at Bank of America's 10-Q page 192 where Level III assets are shown in detail.

Make Up And Dollar Amount of Level 3 Assets: Q1 2012

Security Dollar Valuation (millions) % of Total Assets
Corporate Securities $6,001 .2751%
Equity Securities $525 .0241%
Non-U.S. Sovereign Debt $546 .025%
Mortgage Trading Loans and ABS $4,012 .1839%
Derivative Assets $11,315 .5187%
MBS Agency $33 .0015%
MBS Agency - CMO $0 0
MBS Non-Agency Residential $29 .0013%
MBS Non-Agency Commercial $38 .0017%
Corporate/Agency Bonds $131 .0060%
Other Taxable Securities $4175 .1914%
Tax-Exempt Securities $1,895 .0869%
Loans and Leases $2,782 .1275%
Mortgage Servicing Rights $7,589 .3479%
Loans Held For Sale $2,862 .1312%
Other Assets $3,487 .1598%
Total $45,420 2.08%

Observations:

  • Total Level III assets decreased by $6.1 billion, or 12%, sequentially. This was due to increased liquidity in several markets, and various sales and settlements of contracts and securities.
  • Derivative assets make up the bulk of Level III assets, but have decreased by about $2 billion since last quarter.
  • BAC also booked a $1.4 billion loss associated with various derivatives contracts this quarter.
  • Loans carried on the balance sheet at cost (since they are HTM securities: See Fair Value Accounting Is Alive And Well for explanation), are overvalued by $11.5 billion.

JPMorgan Chase

Now lets take a look at J.P. Morgan's most recent 10-Q, page 95.

Make Up And Dollar Amount of Level 3 Assets: Q1 2012

Security Dollar Valuation (millions) % of Total Assets
Corporate Securities $5,463 .2354%
Equity Securities $1,248 .0538%
Non-U.S. Sovereign Debt $81 .0035%
Mortgage Trading Loans and ABS $32,882 1.4171%
Derivative Assets $29,530 .1533%
MBS Agency $79 .0034%
MBS Agency - CMO $0 0
MBS Non-Agency Residential $699 .0301%
MBS Non-Agency Commercial $1,451 .0625%
Corporate/Agency Bonds $131 .0056%
Other Taxable Securities $4175 .1799%
Tax-Exempt Securities $1,747 .0753%
Loans and Leases $11,144 .4803%
Mortgage Servicing Rights $8,039 .3465%
Loans Held For Sale $1,766 .0761%
Other Assets $12,598 .5429%
Total $106,727

4.60%

Observations:

  • JPMorgan's ratio of Level III (risky) assets to total assets is 230% higher than Bank of America's ratio.
  • Level III assets have decreased by about $9.2 billion Q/Q, driven by sales and settlements of assets, a $5.5 billion decrease in derivatives due to "tightening credit spreads," and a $1.6 billion net loss (this is due to the $2.3 billion dollar loss attributed to the synthetic credit portfolio).
  • There is a negligible difference between the carrying value of HTM securities, and their estimated fair values.

Below is a list of Wells Fargo's Level III assets for the first quarter in 2012.

Make Up And Dollar Amount of Level 3 Assets: Q1 2012

Security Dollar Valuation (millions) % of Total Assets
Corporate Securities $440 .03%
Equity Securities $1,179 .09%
Non-U.S. Sovereign Debt $0 0%
Mortgage Trading Loans and ABS $13,533 1.01%
Derivative Assets $2,796 .21%
MBS Agency $53 .004%
MBS Agency - CMO $0 0
MBS Non-Agency Residential $58 .004%
MBS Non-Agency Commercial $232 .02%
Collateralized Debt Obligations $10,702 .80%
Tax-Exempt Securities $12,617 .95%
Loans and Leases $25 .002
Mortgage Servicing Rights $13,578 1.02%
Loans Held For Sale $0 0%
Other Assets $336 .03%
Total $55,550

4.16%

Observations:

  • Level III assets have increased by $2.3 billion from last quarter. This was fueled by purchasing of more corporate debt securities and non-marketable equity securities.
  • The difference between the carrying value of HTM securities and their estimated fair values is positive by about $2.5 billion (the fair value exceeds carrying value).

Citigroup

Now let's take a look at Citigroup's most recent 10-Q (p.161), and see how they match up to Wells Fargo, Bank of America, and JPMorgan.

Make Up And Dollar Amount of Level 3 Assets: Q1 2012

Security Dollar Valuation (millions) % of Total Assets
Federal Funds $4,497 .231%
Corporate Securities $4,825 .248%
Equity Securities $1,517 .078%
Non-U.S. Sovereign Debt $1,208 .062%
Mortgage Trading Loans and ABS $11,738 .60%
Derivative Assets $11,787 .606%
MBS Agency $934 .048%
MBS Agency - CMO $0 0%
MBS Non-Agency Residential $0 0%
MBS Non-Agency Commercial $6 0%
Tax-Exempt Securities $682 .035%
Loans and Leases $4,278 .22%
Mortgage Servicing Rights $2,691 .138%
Non-Marketable Equity $8,287 .426%
Other Assets $4,964 .255%
Total $57,637

2.96%

Observations

  • Level III assets have decreased by $3.1 billion since last quarter. This was due to losses recorded on credit derivatives of $1.2 billion, and a settlement of $2.2 billion in credit derivatives.
  • Difference between HTM securities and estimated fair value is $13.3 billion (fair value is less than carrying value).

Overall Observations:

(click to enlarge)

  • The bar graph shows that solely looking at the "risky assets"/ Total Assets Wells Fargo and JPMorgan are riskier investments than Citigroup and Bank of America.
  • Obviously an investment decision should not be based on this observation alone, but it is definitely worth taking into consideration.
  • It is ironic that Bank of America and Citigroup, both of which are considered the most unsafe banks, have lower riskier assets (as a percentage of total assets) than JPMorgan and Wells Fargo.

Conclusion

There is more to making an investment decision than looking at the amount of Level III assets on a particular balance sheet, but it is always a good idea to know this information. The cons of the relatively higher number of riskier assets owned by JPMorgan and Wells Fargo are offset by the appropriately valued HTM securities carried on their balance sheets, and the benefits of the relatively lower number of riskier assets owned by Bank of America and Citigroup are offset by the overvalued HTM securities on their balance sheets. The primary purpose of this article is to give investors information that will help them make an informed decision. I hope this helps and good luck out there.

Source: A Comparison Of Big Bank Level III Assets

Additional disclosure: Currently watching all banks listed in article. I believe that they will be much cheaper in the coming months.