Own credit own debt and write downs IFRS 7
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Mark-To-Market
Write Down Your Own Debt?
Peter C. Beller, 07.31.09, 03:20 PM EDT
In accounting, where up is down, failing companies like GM could gain when their bonds plummet.
The debate over mark-to-market accounting--whether to value assets at market prices--will take on a strange twist once banks, investors and regulators get wind of the latest proposal from the group that sets accounting standards. Under new rules being reviewed by the Financial Accounting Standards Board, companies will have to record gains or losses in the market values of assets they own and show them to shareholders on the income statement.
The move is part of the broad push by regulators to force firms to recognize gains and losses where shareholders can easily find them. What will likely surprise investors more is that the new rules also
allow corporations to mark their debts to market prices as well.
For a troubled company like General Motors ( GMGMQ - news - people ) before it filed for bankruptcy, it could have meant seeing a financial gain as the value of its bonds fell. Under current accounting rules, when a company like GM borrows $1 million it records the principal amount as a liability and the interest it must pay each year as an expense. If GM's bondholders doubt the company's ability to pay its debts, its bonds might fall to 80 cents per dollar face value. Under the proposed rule, creditors' pain would be GM's gain--the car company would recognize a $200,000 reduction in its liability, which is the same as a gain for a like amount.
That sets up the paradox of troubled companies benefiting, at least in accounting terms, from their own misfortune, says Dr. Paul Miller, accounting professor at the University of Colorado at Colorado Springs. "If a liability gets smaller, the company is better off," says Miller. "People don't like the idea--if they're in trouble, how could they possibly be showing gains?"
From an accounting standpoint, the ability to write down one's own debt makes some sense. If you believe the market accurately prices assets, then the price of a bond is the current value of all its future interest and principal payments. Theoretically, GM could go out and retire those debts at less cost because its lenders would be willing to accept the lower price. What shareholder advocates and frothing senators and congressmen could point to is that, in reality, if GM tried to buy up its own debt, the price would almost certainly rise, in the same way it would if an investor tried to buy all of GM's stock.
Still, the FASB rules will re-start the ongoing debate between corporations and regulators about how to best serve shareholders already burdened with financial statements running hundreds of pages and laden with opaque footnotes and exhibits. On the asset side, banks and other companies that hold large amounts of stocks and bonds may soon have to report the price swings of their portfolios directly on the income statement where it will impact the all-important earnings-per-share.
The accounting board will likely spend the rest of the year drawing up a formal draft and taking comments on it, before deliberating and making its final decision. All manner of public companies, as well as the major accounting firms, will likely weigh in with objections and modifications. But Professor Miller says FASB looks like it has picked up a head of steam and will push hard for mark-to-market rules. If that happens, investors might want to scoop up some shares of the nation's most troubled companies, just in case.
By Vladimir Guevarra and Mark Brown
Of DOW JONES NEWSWIRES
LONDON (Dow Jones)--U.K. banks that reported gains on their own debt when credit spreads widened during the first quarter could be forced to book reversals for the second quarter, when spreads tightened, analysts said Friday.
This means that the banks' second-quarter earnings could show huge declines based on the value of their own debt.
But analysts quickly pointed out that any impact on net-profit figures should be discounted because these reversals are only due to accounting procedures and have nothing to do with a bank's day-to-day operations.
The issue of reversing gains on own debt emerged after Swiss bank UBS AG (UBS) late Thursday highlighted it as one reason behind its forecast net loss in the second quarter. UBS said internal restructuring charges will also contribute to its loss.
Exane BNP Paribas analyst Ian Gordon said that UBS' warning "could have a read-across on HSBC and most other banks which mark the value of their debts to market."
"For HSBC and others, like Barclays, we may see reversals in the second quarter offsetting the widening in the first quarter. It could lead to a decrease in profits," Gordon said.
RBC Capital Markets said UBS' warning indicates that "the long period of uninterrupted gains that banks enjoyed as their credit deteriorated may be coming to an end."
In the first quarter, HSBC Holdings PLC (HBC), for example, booked a $6.6 billion gain on its own debt as credit spreads widened. This was up from a gain of $2.5 billion in the first quarter of last year.
Another analyst said that there is a chance that not all recent gains by banks will be wiped out. "The spreads have expanded massively in the past couple of years. The tightening started only recently, so that will wipe out only a part of the previous gains," he said.
The spread to the risk-free borrowing rate on bonds issued by many banks has tightened significantly since peaking in mid-March.
According to the widely watched iBoxx indexes of financial companies' debt, senior bond spreads peaked at around 3.2% but have recovered to just above 2%.
Spreads on more junior lower Tier 2 debt have tightened from around 9% to around 5.4%.
Credit spreads widen when markets are stressed and investors worry about higher default risk, driving the price of existing bonds, as a percentage of their face value, down.
When investors are more confident that they will get their money back, spreads tighten and bond prices rise.
Some banks have argued that they could buy their bonds back in the secondary market at a cheaper price than they had originally sold them for, making gains in the process. Some of these gains may be reversed as spreads tighten and prices recover.
Barclays PLC (BCS) said May 7 that it had a gain of GBP279 million on the revaluation of its own credit for the first quarter.
Royal Bank of Scotland PLC (RBS) similarly recorded a gain on the value of its own credit in the first quarter, which it said amounted to GBP1.28 billion.
A spokesman for HSBC said Friday that "the positive or negative impact in a particular reporting period will be determined by the movements in credit spreads." He pointed to the bank's statement May 11, which already noted that credit spreads have narrowed in April, reversing a "significant proportion" of its recent gains.
Spokesmen for both Barclays and RBS declined to comment on whether there was likely to be any reversal in gains. Most U.K. banks report first-half earnings in early August.
Exane BNP Paribas' Gordon said any reversal shouldn't have much of an effect on particular banks in the immediate future. "We know that these gains could reverse over time. Whether it happens now or at a later date, it doesn't really matter."
Gordon said the reversals could hurt stated profits.
"But will it have any impact on regulatory capital? No," he said. "It provides a negative shock to the headline number but not to the underlying number. We only care about the underlying number, stripping out one-offs like own debt."
"Fair valuing of own debt doesn't create or destroy capital. It's just an accounting procedure you have to do once in a while," he said.
Gordon cited HSBC's presentations on the matter, saying that "HSBC has been very open and honest about this."
The other analyst said that "good analysts will know that you need to strip out the gains or losses on own debt. I wouldn't have taken them into account as profits last year, so I wouldn't take them into account as losses this year."
HSBC shares closed up 0.9%, RBS was up 3.7% and Barclays ended down 0.6%.
-By Vladimir Guevarra, Dow Jones Newswires. Tel. +44 (0) 2078429486, vladimir.guevarra@dowjones.com
(Marietta Cauchi contributed to this article.)
Mark-To-Market
Write Down Your Own Debt?
Peter C. Beller, 07.31.09, 03:20 PM EDT
In accounting, where up is down, failing companies like GM could gain when their bonds plummet.
The debate over mark-to-market accounting--whether to value assets at market prices--will take on a strange twist once banks, investors and regulators get wind of the latest proposal from the group that sets accounting standards. Under new rules being reviewed by the Financial Accounting Standards Board, companies will have to record gains or losses in the market values of assets they own and show them to shareholders on the income statement.
The move is part of the broad push by regulators to force firms to recognize gains and losses where shareholders can easily find them. What will likely surprise investors more is that the new rules also
allow corporations to mark their debts to market prices as well.
For a troubled company like General Motors ( GMGMQ - news - people ) before it filed for bankruptcy, it could have meant seeing a financial gain as the value of its bonds fell. Under current accounting rules, when a company like GM borrows $1 million it records the principal amount as a liability and the interest it must pay each year as an expense. If GM's bondholders doubt the company's ability to pay its debts, its bonds might fall to 80 cents per dollar face value. Under the proposed rule, creditors' pain would be GM's gain--the car company would recognize a $200,000 reduction in its liability, which is the same as a gain for a like amount.
That sets up the paradox of troubled companies benefiting, at least in accounting terms, from their own misfortune, says Dr. Paul Miller, accounting professor at the University of Colorado at Colorado Springs. "If a liability gets smaller, the company is better off," says Miller. "People don't like the idea--if they're in trouble, how could they possibly be showing gains?"
From an accounting standpoint, the ability to write down one's own debt makes some sense. If you believe the market accurately prices assets, then the price of a bond is the current value of all its future interest and principal payments. Theoretically, GM could go out and retire those debts at less cost because its lenders would be willing to accept the lower price. What shareholder advocates and frothing senators and congressmen could point to is that, in reality, if GM tried to buy up its own debt, the price would almost certainly rise, in the same way it would if an investor tried to buy all of GM's stock.
Still, the FASB rules will re-start the ongoing debate between corporations and regulators about how to best serve shareholders already burdened with financial statements running hundreds of pages and laden with opaque footnotes and exhibits. On the asset side, banks and other companies that hold large amounts of stocks and bonds may soon have to report the price swings of their portfolios directly on the income statement where it will impact the all-important earnings-per-share.
The accounting board will likely spend the rest of the year drawing up a formal draft and taking comments on it, before deliberating and making its final decision. All manner of public companies, as well as the major accounting firms, will likely weigh in with objections and modifications. But Professor Miller says FASB looks like it has picked up a head of steam and will push hard for mark-to-market rules. If that happens, investors might want to scoop up some shares of the nation's most troubled companies, just in case.
By Vladimir Guevarra and Mark Brown
Of DOW JONES NEWSWIRES
LONDON (Dow Jones)--U.K. banks that reported gains on their own debt when credit spreads widened during the first quarter could be forced to book reversals for the second quarter, when spreads tightened, analysts said Friday.
This means that the banks' second-quarter earnings could show huge declines based on the value of their own debt.
But analysts quickly pointed out that any impact on net-profit figures should be discounted because these reversals are only due to accounting procedures and have nothing to do with a bank's day-to-day operations.
The issue of reversing gains on own debt emerged after Swiss bank UBS AG (UBS) late Thursday highlighted it as one reason behind its forecast net loss in the second quarter. UBS said internal restructuring charges will also contribute to its loss.
Exane BNP Paribas analyst Ian Gordon said that UBS' warning "could have a read-across on HSBC and most other banks which mark the value of their debts to market."
"For HSBC and others, like Barclays, we may see reversals in the second quarter offsetting the widening in the first quarter. It could lead to a decrease in profits," Gordon said.
RBC Capital Markets said UBS' warning indicates that "the long period of uninterrupted gains that banks enjoyed as their credit deteriorated may be coming to an end."
In the first quarter, HSBC Holdings PLC (HBC), for example, booked a $6.6 billion gain on its own debt as credit spreads widened. This was up from a gain of $2.5 billion in the first quarter of last year.
Another analyst said that there is a chance that not all recent gains by banks will be wiped out. "The spreads have expanded massively in the past couple of years. The tightening started only recently, so that will wipe out only a part of the previous gains," he said.
The spread to the risk-free borrowing rate on bonds issued by many banks has tightened significantly since peaking in mid-March.
According to the widely watched iBoxx indexes of financial companies' debt, senior bond spreads peaked at around 3.2% but have recovered to just above 2%.
Spreads on more junior lower Tier 2 debt have tightened from around 9% to around 5.4%.
Credit spreads widen when markets are stressed and investors worry about higher default risk, driving the price of existing bonds, as a percentage of their face value, down.
When investors are more confident that they will get their money back, spreads tighten and bond prices rise.
Some banks have argued that they could buy their bonds back in the secondary market at a cheaper price than they had originally sold them for, making gains in the process. Some of these gains may be reversed as spreads tighten and prices recover.
Barclays PLC (BCS) said May 7 that it had a gain of GBP279 million on the revaluation of its own credit for the first quarter.
Royal Bank of Scotland PLC (RBS) similarly recorded a gain on the value of its own credit in the first quarter, which it said amounted to GBP1.28 billion.
A spokesman for HSBC said Friday that "the positive or negative impact in a particular reporting period will be determined by the movements in credit spreads." He pointed to the bank's statement May 11, which already noted that credit spreads have narrowed in April, reversing a "significant proportion" of its recent gains.
Spokesmen for both Barclays and RBS declined to comment on whether there was likely to be any reversal in gains. Most U.K. banks report first-half earnings in early August.
Exane BNP Paribas' Gordon said any reversal shouldn't have much of an effect on particular banks in the immediate future. "We know that these gains could reverse over time. Whether it happens now or at a later date, it doesn't really matter."
Gordon said the reversals could hurt stated profits.
"But will it have any impact on regulatory capital? No," he said. "It provides a negative shock to the headline number but not to the underlying number. We only care about the underlying number, stripping out one-offs like own debt."
"Fair valuing of own debt doesn't create or destroy capital. It's just an accounting procedure you have to do once in a while," he said.
Gordon cited HSBC's presentations on the matter, saying that "HSBC has been very open and honest about this."
The other analyst said that "good analysts will know that you need to strip out the gains or losses on own debt. I wouldn't have taken them into account as profits last year, so I wouldn't take them into account as losses this year."
HSBC shares closed up 0.9%, RBS was up 3.7% and Barclays ended down 0.6%.
-By Vladimir Guevarra, Dow Jones Newswires. Tel. +44 (0) 2078429486, vladimir.guevarra@dowjones.com
(Marietta Cauchi contributed to this article.)