Thursday, February 23, 2012

Certain European banks playing dangerous games with accounting rules

European banks are announcing new losses associated with the Greek bonds writedowns.
Bloomberg: RBS, Britain’s biggest government-owned lender, posted a wider-than-expected full-year loss after taking a sovereign-debt impairment of 1.1 billion pounds ($1.7 billion). Commerzbank, Germany’s second-biggest lender, booked a 700 million-euro ($1.1 billion) writedown on Greek debt in the fourth quarter. Credit Agricole, France’s third-largest bank, reported a quarterly loss after 220 million euros in impairments on Greek debt.
Dexia and the insurance firm Allianz also took losses. Greek bonds have been trading at some 25-30 cents on the euro for some time, so why are these banks taking losses now? It has to do with the wonderful international rules of “held to maturity” (HTM) accounting. Note that in spite of all the myths out there, this rule can be applied to bonds but not derivatives such as CDS. HTM bonds accrue interest (using what’s called Effective Interest Method) and are not marked to market. Impairment is supposed to take place when the value of the investment is deemed by the holder to be more than just temporary. That is if a bank believes it won’t be able to collect 100% of what is due to them under the contractual obligations, it should take a writedown on the bond. But some of these banks will now claim they didn't believe the impairment in Greek bonds is permanent, and that's why they didn't take the writedowns until the details of the Greek PSI have been announced.

Greek 5.2-7/34 government bond prices (Bloomberg)

Yes, this strange accounting rule gives European banks and other financial institutions a great deal of leeway. But for these banks to claim that Greek bonds were not impaired until the PSI deal was announced borders on accounting fraud. These writedows should have taken place months ago. What’s even more absurd is that Steven Hester who runs RBS (the UK “government agency”) is a former CFO of Credit Suisse First Boston (CSFB). He was in charge of, among other departments, product control and financial control, the groups responsible for portfolio valuation and accounting at CSFB. Having been a CFO through the Russian default crisis at CSFB should have made anyone an expert in bond "permanent impairment". Apparently Hester didn't learn his lessons. RBS must be as good with their accounting practices as they were with their risk management.
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