Mark to Market – Are You Kidding?

A recent article titled ‘Number of the Week: Banks Should Hold More Capital‘ – reading time 2 minutes – reports on a study that suggests Banks optimally should have a Capital:Assets ratio of 52% in circumstances where, based on rules apparently drawn up in Basil last year, big global banks must meet a 7% Capital:Assets ratio by 2019.

Assuming the ‘capital‘ this article is speaking of is based on bank financial statements prepared in accordance with Generally Accepted Accounting Principles, I hark back to the comments I made two years ago with respect to the Mark-to-Market rule changes that I then made.  For example, see

• Mark-to-Market (March 11),
• More on Mark-to-Market (March 12),
• Mark-to-Market Update March 17, 2009, and
• Mark-To-Market Rule Change Raises Its Ugly Head Once Again! (April 21, 2009).

If you read only one of these, read the first one dated March 11, 2009, as it explains what ‘mark-to-market‘ is, and why in my view the rules that then existed ought not to have been tampered with.

If the assumption I have made in the previous paragraph is a correct one, I say ‘hold on to your hat‘ in the possible hurricane of bank financial problems that we may face going forward.  This is because I think some or all of those banks may have overstated assets on their books as a result of the 2009 changes in the mark-to-market rules.  Those rule changes gave bank management much more subjective latitude when stating the book value of their carried assets than they previously had.

If this is a subject that interests you, I suggest a second recent article titled ‘As Bankers Kill Off Mark-To-Market For Good, Former FDIC Chairman Gloats‘ – reading time 4 minutes – is a must read.  Apparently about two weeks ago U.S. ‘accounting rule makers’ reversed a ‘controversial proposal’  that would have required banks to use market prices when valuing their balance sheet loans’.  The article reproduces what I think is a ‘quite extraordinary’ letter from a former Chairman of the U.S. Federal Insurance Deposit Corporation which letter states “The MTM (mark-to-market) policy senselessly destroyed some $500 billion capital in our financial system when the markets collapsed in 2008.  This destroyed some $4 trillion of bank lending capacity and was a major contributor to the financial panic and ensuing economic collapse”.  I am not often at a ‘loss for words’.  This time I am.  Please read the article and send me comments if you either agree or disagree with my views on mark-to-market accounting for financial institutions.  You can find me at info@stockresearchportal.com.

Roubini on 2011

Economic Collapse Scenarios?

Another short mid-January article I think worth reading is titled ‘12 Economic Collapse Scenarios That We Could Potentially See In 2011‘ – reading time 2 minutes.  The author of this article is much less bullish than Roubini, citing among other things (1) U.S. debt levels, (2) outstanding world credit, (3) a potentially high oil price, (4) food inflation leading to food riots – interesting prediction in light of the subsequent Tunisia/Egyptian riots, (5) U. Housing issues, and (6) very high U.S. State and Municipal debt levels.

Unless you are fed up reading negative economic data, I suggest you read this short article.

Additions to Stock Research Portal’s Company Universe

Today we added the following Companies to our Company Universe:

Alexander Nubia International Inc. (TSXV:AAN).  We currently categorize Alexander Nubia International Inc. as a gold explorer (copper, lead, silver, zinc) operating principally in Africa (Egypt). Alexander Nubia International Inc.’s current market capitalization is approximately Cdn $25 million.  Review research data on Alexander Nubia International Inc.

American Manganese Inc. (TSXV:AMY).  We currently categorize American Manganese Inc. as a manganese explorer operating principally in the United States (Arizona). American Manganese Inc.’s current market capitalization is approximately Cdn $38 million.  Review research data on American Manganese Inc.

Chieftain Metals Inc. (TSX:CFB).  We currently categorize Chieftain Metals Inc. as a base metals explorer (copper, gold, lead, silver, zinc) operating principally in the Canada (British Columbia). Chieftain Metals Inc.’s current market capitalization is approximately Cdn $66 million.  Review research data on Chieftain Metals Inc.

Press Release Highlights

The following table summarizes the companies in Stock Research Portal’s Company Universe who yesterday issued Press Releases and whose shares increased in price from the previous day’s close by more than Cdn$0.05, more than 10%, and whose share volumes yesterday exceeded their trailing 3 month average trading volume.  You can research each of these companies by clicking on the company name in the table.

* Yesterday’s data, or latest trading day’s data, as applicable

Insider Trading Highlights

The following table summarizes the companies in Stock Research Portal’s Company Universe for who our system yesterday reported insiders who filed reports indicating they had acquired shares through ‘purchase’ transactions.  You can research each of these companies by clicking on the company name in the table.

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An article titled ‘Credit markets regain record pace’ says that “Taking advantage of open markets, companies rich and poor are selling debt – whether they need to or not”, reporting that “Bankers and investors are expecting a flood of such fundraising transactions after both bond and credit markets have soared in the past month, driving down the cost of raising capital”.  Finance 101 would say there is a prospective danger in companies borrowing more than they need, or borrowing because they can’t (or don’t want to for shareholder dilution reasons) raise equity.  Depending on fact specific circumstances, such borrowing may increase the risk profile of a company’s outstanding equity shares.  This in turn ultimately may lead to even more shareholder dilution than might be experienced today if and when equity capital must be raised to repay that debt, or in an ultimate bad result, ‘business failure’.  In my view it is one thing to be conservative and add equity financing when it is available to strength a company’s balance sheet, or to create a ‘rainy day fund’ for a company ‘because equity financing is available’ on favourable terms.  It is quite another to raise unneeded cash through debt because ‘one can’.  The latter could prove to be a dangerous game for the companies that do it if we don’t experience near-term economic recovery, and a particularly dangerous game if the world economy worsens from here.

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An article yesterday titled ‘Banks applaud planned mark-to-market rules’ says Canada’s Accounting Standards Board unveiled proposed changes Thursday to relax mark-to-market rules that apply to some troubled holdings that have been affected by the market turmoil, making it easier for banks and other companies to avoid writedowns. Why wouldn’t banks applaud this? It will enable them to report better earnings and balance sheets than they otherwise would have to do. That said, a modification to the previously approved U.S. model is that the proposed rule change is only available for debt instruments that companies intend to hold to maturity. Canada will still require securities being held for sale to be recorded at fair market value. The proposed change is a compromise that moves Canada largely in line with recent mark-to-market accounting rules while not fully copying the new U.S. model – but in my view is nonetheless wrong-headed. Essentially what this does is to some degree create ‘lipstick on a pig’ balance sheets, and defers the problem of loss recognition where losses on debt instruments expected to be held in the long term ultimately are realized. It also may, depending on how it is drafted, give Bank managements the subjective ability to place debt instruments in the ‘hold to maturity category’ when otherwise they might not have done this.

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An article yesterday titled ‘Toxic debt writedowns may reach US$4.1-trillion’ reports the International Monetary Fund now thinks Global writedowns of toxic debt among banks and other financial institutions in the United States, Europe and Japan could reach US$4.1-trillion of which the deterioration in U.S. originated assets may account for as much as U.S.$2.7-trillion – up by $500 billion from the IMF’s January forecast, and that globally banks will face the bulk of the writedowns. The article reports that “Since the start of the crisis (presumably dated to about September 2008), market capitalization of global banks has more than halved to US$1.6-trillion from US$3.6-trillion. The IMF apparently thinks Financial Institutions are likely to face losses for a period that would be broadly consistent with the time it took banks to recover during the Great Depression and in Sweden in the early 1990s, but that current writedowns are likely to be more severe than during those crises.

The question I continue to have with respect to these IMF quantifications of forecasted ‘toxic asset’ losses is what accounting standard is assumed when they are generated. If conventional mark-to-market rules are being applied to generate these forecasts it seems to me that is one thing. However, if the new and more subjective mark-to-market rules are being use to generate them the picture may turn out to be far worse than any current forecast implies.

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