Rumors On Mark-To-Market Accounting And Loan Loss Provisions: What's The Real Story?

Energy-Related Losses Mount

Bank loan loss impairments related to the energy sector are set to rise rapidly.

Banks have made drilling loans to companies that are only profitable at oil prices above $50. And the price of oil just closed under $30 for the first time in about 12 years.

Diving Into Rumors

Zero Hedge has an interesting post on Saturday entitled Dallas Fed Quietly Suspends Energy Mark-To-Market On Default Contagion Fears.

In his post, ZeroHedge claims “The Dallas Fed met with the banks a week ago and effectively suspended mark-to-market on energy debts and as a result no impairments are being written down. Furthermore, as we reported earlier this week, the Fed indicated ‘under the table’ that banks were to work with the energy companies on delivering without a markdown on worry that a backstop, or bail-in, was needed after reviewing loan losses which would exceed the current tier 1 capital tranches.”

Mark-to-Market Accounting History

You cannot suspend what has already been suspended.

On April 3, 2009, the Wall Street Journal reported FASB Eases Mark-to-Market Rules.

Suspension of mark-to-market account was one of the factors that ignited the stock market in Spring of 2009.

Wikipedia has these notes on Mark-to-Market Accounting.

On September 30, 2008, the SEC and the FASB issued a joint clarification regarding the implementation of fair value accounting in cases where a market is disorderly or inactive. Section 132 of the Emergency Economic Stabilization Act of 2008, which passed on October 3, 2008, restated the SEC’s authority to suspend the application of FAS 157.

On October 10, 2008, the FASB issued further guidance to provide an example of how to estimate fair value in cases where the market for that asset is not active at a reporting date.

On December 30, 2008, the SEC issued its report under Sec. 133 and decided not to suspend mark-to-market accounting. [Mish Comment: Markets that rallied into the end of the year, collapsed again in January and February]

On March 16, 2009, FASB proposed allowing companies to use more leeway in valuing their assets under “mark-to-market” accounting. On April 2, 2009, after a 15-day public comment period and a contentious testimony before the U.S. House Financial Services subcommittee, FASB eased the mark-to-market rules through the release of three FASB Staff Positions (FSPs). Financial institutions are still required by the rules to mark transactions to market prices but more so in a steady market and less so when the market is inactive. To proponents of the rules, this eliminates the unnecessary “positive feedback loop” that can result in a weakened economy. [Mish Comment: Markets took off just ahead of the change and never looked back]

On April 9, 2009, FASB issued an official update to FAS 157 that eases the mark-to-market rules when the market is unsteady or inactive. Early adopters were allowed to apply the ruling as of March 15, 2009, and the rest as of June 15, 2009. It was anticipated that these changes could significantly increase banks’ statements of earnings and allow them to defer reporting losses.

No Subsequent Mark-to-Market Changes

There have been no subsequent changes. And here we are, back in bubble land, with hidden losses mounting again.

By, how much? Who the hell knows because mark-to-market accounting has already been effectively suspended.

We do have some facts, however.

More Banks Take Energy Hits

The Wall Street Journal reports More Banks Take Hits on Energy Loans.

Months of low oil prices are starting to take a toll on banks. Large U.S. banks reporting earnings Friday said they saw more energy loans go bad in the fourth quarter. Many lenders also added millions of dollars to reserves in anticipation that more oil-and-gas loans will sour.

“It’s starting to spread,” said William Demchak, chief executive of PNC Financial Services Group Inc. on a conference call after the bank’s earnings were announced. Credit issues from low energy prices are affecting “anybody who was in the game as the oil boom started,” he said.

Citigroup Inc. added to its rainy-day reserves for soured loans for the first time since 2009, adding $250 million specifically for energy and $494 million overall. “Obviously there is some pressure in the energy-related markets at this point in time,” John Gerspach, Citigroup’s chief financial officer, said on a conference call Friday.

As many as one-third of American oil-and-gas producers could tip toward bankruptcy and restructuring by mid-2017, according to Wolfe Research. Survival, for some, would be possible if oil rebounded to at least $50 a barrel, many analysts say.

Concerns about oil and gas exposure have battered the stocks of banks with big energy portfolios. Zions Bancorp shares are down 18% since the beginning of the year, while BOK’s are down 20% and Cullen/Frost Bankers Inc. shares are down 22% during that period. The KBW Nasdaq Bank Index is down 13% amid a broad market decline.

Still, banks continue to maintain that any energy losses remain manageable.

Wells Fargo & Co. had $90 million in higher losses in its oil-and-gas portfolio during the fourth quarter, and the bank said it boosted its commercial-loan reserves as a result. Wells Fargo played down the potential impact of the energy problems, noting that oil and gas loans remained around only 2% of its total loans, and that more than 90% of the problem oil-and-gas loans in its portfolio were current on their interest payments as of the end of 2015.