Are Banks now in Write-Up Territory?
As many debt securities jumped in values, are banks that experienced write downs before all in for a write up? A close examination reveals that the answer is neither obvious nor universal.
With banks already shrinking their portfolios of distressed assets, write ups will not be huge. For banks that have been hedging against potential write downs, if any hedging positions have yet to be cleared, with markets now rising in value, there would be losses from the wrong way hedge, reducing gains from marking up the underlying securities.
Under the proposed change to mark-to-market accounting rule, a write-down or write-up is now carried out based more on a company’s own judgment and less on market transactions. As such, a write up is not required in the current market run up. A bank may choose not to write up anything, if it doesn’t need any unrealized gains to boost its earnings because that will set too high a bar for future earnings comparisons.
To be clear, commercial banks carry more loans on their books than invested securities. Banks don’t mark loans to market; they write them off when deemed as non-performing. Securities backed by those loans may have been traded up, but if a borrower stops making payments on a loan, the bank writes it off as a loss.
Understand that when a bank packs its loans to sell as securities to investors, these loan-backed securities are shown as the bank’s own debt on the balance sheet. Accounting rules require all banks mark their own debt to market. With debt securities now rising in value, banks that issued them “owe more” now than before, effecting a write down on its earnings.
Recent rally has helped stabilizing the capital market business for many banks, but expecting too much of a write up is only a speculation.
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