$5 Trillion Hidden Off Bank Balance Sheets

The Financial Times is reporting US banks fear being forced to take $5,000bn back on balance sheets.

Accounting changes could force US banks to take thousands of billions of dollars back on to their balance sheets in the coming months in a move that is likely to curb further their lending and could push them into new capital raisings, analysts have warned.

Analysts at Citigroup said a planned tightening of the rules regarding off-balance sheet vehicles would force banks to reconsider arrangements and could result in up to $5,000bn of assets coming back on to the books.

The off-balance sheet vehicles have been used by financial institutions to keep some assets off their balance sheets, thereby avoiding the need to hold regulatory capital against them.

Birgit Specht, head of securitisation analysis at Citigroup, said: "We think it is very likely that these vehicles will come back on balance sheet.

"This will not affect liquidity because [they] are funded, but it will affect debt-to-equity ratios [at banks] and so significantly impact banks' ability to lend."

Both international and US accounting bodies are working on rule changes; the US standard-setter, the Financial Accounting Standards Board, is to decide today. US rulemakers have come under domestic pressure from regulators and policymakers who felt the rules allowed banks to hide too much of their exposure to subprime assets.

Absurd Situation

The absurdity is not $5 trillion coming back on bank balance sheets. Rather the absurdity is with accounting rules that let banks hold this much stuff off balance sheets in the first place. It makes a mockery of stated leverage, value at risk, and capitalization ratios. Banks claim to be well capitalized but the ratio is a mere 6% and that 6% does not include the effects of hiding $5 trillion off balance sheets.

For a look at Citigroup's capital ratios and leverage (the latter is 19:1) please consider Digging Into Citigroup's Numbers.

FASB Review

The Financial Accountings Standards Board is discussing some of this today. Here is a link to (FASB Topics)

FASB Balance Sheet Bombshell

USBanker is writing FASB Lobs a Balance-Sheet Bombshell.

Losses tied to banks’ off-balance-sheet subprime-mortgage investments have reached into the hundreds of billions of dollars and caused some real soul searching among the nation’s top accounting group, The Financial Accounting Standards Board, which has moved quickly to radically alter the rules for how banks must account for so-called qualified special-purpose entities, or QSPEs.

Reform is needed and probably inevitable, but is FASB moving too fast? Some banks may sit on QSPEs, whose values are almost equal to their balance-sheet assets, analysts say. Forcing financial institutions to load up their balance sheets too soon with these still largely untradeable holdings could prolong the financial market’s misery.

Reform is needed and probably inevitable, but is FASB moving too fast? Some banks may sit on QSPEs, whose values are almost equal to their balance-sheet assets, analysts say. Forcing financial institutions to load up their balance sheets too soon with these still largely untradeable holdings could prolong the financial market’s misery.

Final FASB board deliberation is expected this month, with a public comment period starting in July, followed by a roundtable, at which critics are invited to “meet publicly with the board and debate,” Goldin notes. The changes could be finalized by late in the third quarter. The effective date: June 2009.

That timeframe is a blink of the eye. Consider Citigroup, which told shareholders in May that it would divest nearly $500 billion of legacy assets in two or three years. A sizeable chunk of that is QSPE material, according to analysts — and would not be a welcome sight on Citi’s balance sheet. Several other money-center banks could face peril as a result of the rule change.

The migration of exotics to the balance sheet may be inevitable. If so, the key is to make sure the path is constructive, and that includes a more gradual implementation of the new rules that FASB currently proposes. The world cannot afford another shock to the global financial markets

Everyone Wants Time

Minyan Peter, former treasurer at a large US Bank had these comments to offer.

First the FASB is well aware of the box it is in and it knows that adding assets back to bank balance sheets at a time of deleveraging is not constructive to the current crisis.

Second, and at the risk of alienating my CPA friends, what the FASB thinks is far less important right now than what the bank regulators think. RAP accounting, not GAAP is what the regulators focus on.

And I highly doubt that the regulators are going to create a "consolidation" crisis any time soon.

Are off-balance sheet assets significant? Absolutely, but they're also most significant for the world's largest banks.

As a result, rather than a knee jerk reaction, I expect that we will see a very measured and studied approach to this issue from the FASB, the bank regulators as well as the SEC.

Remember, everyone wants time.

Warranted or not, Bernanke will drag this out as long as possible. The zombification of banks continues.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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