Tuesday, April 14, 2009

Riddle me this...


Spend some time last week ruminating with one of this blog's faithful readers about the stock market soaring on word that the US Bank 'Wells Fargo' had projected a surprising $3 Billion first quarter profit.

Howard Atkins, chief financial officer for Wells Fargo, said in the release, "Business momentum in the quarter reflected strength in our traditional banking businesses, strong capital markets activities, and exceptionally strong mortgage banking results — $100 billion in mortgage originations, with a 41 percent increase in the unclosed application pipeline to $100 billion at quarter end, an indication of strong second quarter mortgage originations.”


Market investors seized on the news. And since so many pundits have identified the stabalizing of US Banks as a key condition of restoring prosperity to the North American economy; the news was significant.

But you can colour me a skeptic.

Aforementioned faithful reader had a chuckle over my pensive reaction. But it seems my doubt may not have been completely misplaced.

I came across a report today on Housing Wire that suggests that as much as nearly one-third of the bank’s first quarter earnings may be nothing more than an accounting maneuver.

Apparently the jump in earnings pertains to FAS 160, an accounting rule first announced in 2007 that became effective on January 1, 2009. The rule addresses accounting for minority interests, and mandates that the ownership interests in subsidiaries held by parties other than the parent corporation be clearly identified and presented as equity for the purpose of consolidated reports.

The effect of the new accounting rule allows certain liabilities to ‘jump over’ to the asset book as non-cash transactions via paid-in capital, thereby rolling directly into earnings and boosting reported equity.

In the case of Wells Fargo, the bank found itself with up to $824m it could use this quarter as an accounting gain to earnings.

Now... even if HousingWire’s Teri Buhl is correct... that still leaves more than $2 billion in profit. But even that remaining profit margin may not survive scrutiny.

Further investigation has lead critics to query the status of a large number of bad loans at Wachovia, the diversified, wholly owned financial services subsidiary that Wells Fargo recently acquired. What happened to them?

In it's announced earnings, Wells Fargo gave no details on delinquency trends or Wachovia’s credit losses.

Now there is rampant speculation that the timing of the merger has obscured these losses through purchase accounting adjustments.

So while this anomaly is being investigated investors are being cautioned to remember that what Wells Fargo has released is merely a quarterly statement. Quarterly statements are not audited (only annual reports undergo a full audit).

And what is the significance of all of this?

Well... under normal circumstances such accounting games within corporate PR announcements raise nary an eyebrow with the general public.

But in these tenuous times, the stock market received a huge boost on the Wells Fargo first quarter profit announcement. And the announcement has played a crucial part in bolstering the confidence of the public in the governments efforts to resusictate the economy.

These are times of strained public confidence and trust in both Wall Street and the Banking Community. I suspect that if this so called 'profit' turns out to be an accounting slight-of-hand, there may be a severe public counter-reaction.

And that counter-reaction could trigger another round of significant losses on Wall Street.

We will watch with great interest as this unfolds.


Email: village_whisperer@live.ca

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