Events Current #3: Valuing Home Loans
Read the article below and answer the questions that follow.
June 19, 2008
Banks Find New Ways
To Ease Pain of Bad Loans
By DAVID ENRICH
June 19, 2008; Page C1
In January, Astoria Financial Corp. told investors that its pile of nonperforming loans had grown to about
$106 million as of the end of last year. Three months later, the thrift holding company said the number
was just $68 million.
How did Astoria do it? By changing its internal policy on when mortgages are classified on its books as
troubled. The Lake Success, N.Y., company now counts home loans as nonperforming when the
borrower misses at least three payments, instead of two.
Astoria says the change was made partly to make its disclosures on shaky
mortgages more consistent with those of other lenders. An Astoria
spokesman didn't respond to requests for comment. But the shift shows
one of the ways lenders increasingly are trying to make their realestate misery look not quite so bad.
From lengthening the time it takes to write off troubled mortgages, to
parking lousy loans in subsidiaries that don't count toward regulatory
capital levels, the creative maneuvers are perfectly legal.
Yet they could deepen suspicion about financial stocks, already suffering
from dismal investor sentiment as loan delinquencies balloon and capital
levels shrivel with no end in sight.
"Spending all the time gaming the system rather than addressing the
problems doesn't reflect well on the institutions," said David Fanger,
chief credit officer in the financial-institutions group at Moody's Investors
Service, a unit of Moody's Corp. "What this really is about is buying
yourself time. ... At the end of the day, the losses are likely to not be that different."
Still, as long as the environment continues to worsen for big and small U.S. banks, more of them are
likely to explore such now-you-see-it, now-you-don't strategies to prop up profits and keep
antsy regulators off their backs, bankers and lawyers say.
At W ells Fargo & Co., the fourth-largest U.S. bank by stock-market value, investors and analysts are
jittery about its $83.6 billion portfolio of home-equity loans, which is showing signs of stress as real-estate
values tumble throughout much of the country.
Until recently, the San Francisco bank had written off home-equity loans -- essentially taking a charge to
earnings in anticipation of borrowers' defaulting -- once borrowers fell 120 days behind on payments. But
on April 1, the bank started waiting for up to 180 days.
'Out of Character'
Some analysts note that the shift will postpone a potentially bruising wave of losses, thereby boosting
W ells Fargo's second-quarter results when they are reported next month. "It is kind of out of character for
W ells," says Joe Morford, a banking analyst at RBC Capital Markets. "They tend to use more
conservative standards."
W ells Fargo spokeswoman Julia Tunis says the change was meant to help borrowers. "The extra time
helps avoid having loans charged off when better solutions might be available for our customers," she
says. In a securities filing, Wells Fargo said that the 180-day charge-off standard is "consistent with"
f ederal regulatory guidelines.
BankAtlantic Bancorp Inc., which is based in Fort Lauderdale, Fla., earlier this year transferred about
$100 million of troubled commercial-real-estate loans into a new subsidiary.
That essentially erased the loans from BankAtlantic's retail-banking unit. Since that unit is federally
regulated, BankAtlantic eventually might have faced regulatory action if it didn't substantially beef up the
unit's capital and reserve levels to cover the bad loans.
Because BankAtlantic the subsidiary that holds the bad loans isn't regulated, it doesn't face the same
capital requirements. But the new structure won't insulate the parent company's profits -- or shareholders
-- from losses if borrowers default on the loans, analysts said.
Alan Levan, BankAtlantic's chief executive, declined to comment on how much the loan transfer bolstered
the regulated unit's capital levels. "The reason for doing it is to separate some of these problem loans out
of the bank so that they can get special focus in an isolated subsidiary," he said.
Other lenders have been considering the use of similar "bad-bank" structures as a way to cleanse their
balance sheets of shaky loans. In April, Peter Raskind, chairman and CEO of National City Corp., said
the Cleveland bank "could imagine...several different variations of good-bank/bad-bank kinds of
structures" to help shed problem assets.
Two banks that investors love to hate, W achovia Corp. and W ashington Mutual Inc., troubled some
analysts by using data from the Office of Federal Housing Enterprise Oversight when they announced
first-quarter results. Other lenders rely on a data source that is more pessimistic about the housing
market.
Charter Switch
Another eyebrow raiser: switching bank charters so that a lender is scrutinized by a different regulator.
Last week, Colonial BancGroup Inc., Montgomery, Ala., announced that it changed its Colonial Bank unit
from a nationally chartered bank to a state-chartered bank, effective immediately.
That means the regional bank no longer will be regulated by the Office of the Comptroller of the Currency,
which has become increasingly critical of banks such as Colonial with heavy concentrations of loans to
finance real-estate construction projects.
Instead, Colonial's primary regulators now are the Alabama Banking Department, also based in
Montgomery, and the Federal Deposit Insurance Corp. The change probably "is meant to distance
[Colonial] from what is perceived as the more aggressive and onerous of the bank regulators," said Kevin
Fitzsimmons, a bank analyst at Sandler O'Neill & Partners.
Colonial spokeswoman Merrie Tolbert denies that. Being a state-chartered bank "gives us more flexibility"
and will save the company more than $1 million a year in regulatory fees, she said.
Trabo Reed, Alabama's deputy superintendent of banking, said his examiners won't give Colonial a free
pass. "There's not going to be a significant amount of difference" between the OCC and state regulators,
he says.
Write to David Enrich at [e-mail]
Questions
1.) As it relates to this article, what changes to the financial statements did Astoria Financial
Corporation, Wells Fargo, BankAtlantic, and Colonia BancGroup make? What are the
reasons why the companies made these changes? Are these changes permissible under
GAAP?
2.) Wells Fargo and Astoria extended the number of days customers were behind on
payments before consider these to be troubled mortgages. What effect does this have
on the financial statements (both the balance sheet and the income statement)? How does
this relate to our Chapter 8 discussion on valuation of receivables?
3.) What is the role of transparency as it relates to the financial statements? Do you think
Astoria and Wells Fargo were promoting transparency by changing their internal policy
on when mortgages are classified on the books as troubled?
4.) When a company establishes a reserve on its financial statements against these loans,
do consumers still have a legal obligation to pay the loan off?
5.) What is the role of regulators in this situation? In your opinion, what should be the role of
regulators?