Extend and Pretend - US Regional Bank Day of Reckoning

The Wall Street Journal published an article on December 8th entitled "What Zions Consider a Loss". the article was placed on the back page of the "Money & Investing" section. The point of the article by Peter Eavis is that Zions capital structure and therefore its Tier 1 capital adequacy ratio is benefiting from a lax accounting and regulatory environment. Management, likely to be the CFO and bank's Treasurer, have marked difficult to price, impaired securities at prices management considers fair. This procedure has been called "marked to model". Among the trading community we have christened it "mark to myth". What is important to shareholders and to the "brokered money community" (large deposits of money placed at the bank through brokers)is that Zions and other banks like it do not have a sudden earnings hiccup. Under present accounting regulations, Zions management is able to delay any immediate recognition of losses. Thus there is no impact on the earnings statement for the moment. Management is able to claim that any dramatic drop in market prices is overdone. Asset price recovery will occur at some future date. There is an imposed time limit of several quarters before biting the bullet.

On January 1st 2010, the new FASB regulations #166 and 167 will hopefully address the “mark to myth” presently used. Under the #166 and #167 banks will have to mark their impaired securities to “fair value”.

I am skeptical. One has only to go to the FDIC website and look up the Uniform Bank Performance Report (http://www.ffiec.gov/UBPR.htm) to ascertain the wave of potential pain that resides in our banking system. I would specifically draw attention to the Peer Group Data Reports. “Off Balance Sheet Items and Derivatives Analysis” are listed for each bank as are “Non accrual and Restructured Loans”. Many of the “Off Balance Sheet Items” are the CDOs, CLOs and other Asset Backed Securities referred to in the article.

There is a tremendous amount of restructuring work to be done. The potential for another financial credit bust has not dissipated.