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All Gain, No Pain for Fifth Third?


FAS 160 means banks focus on short-term profit, ignore long-term consequences.

During the early 1990s, a Salomon Brothers analyst wrote a report entitled "All Gain, No Pain," which condemned the accounting of home equity loan securitizations, which enabled issuers to present value (frontload) all of the excess spread (net interest margins less projected loan losses) into current earnings.

And, as I recall, the analyst went on to describe how current period accounting, not cash flow, was driving financial-institution management behavior, and how securitization was effectively a drug, because the earnings consequences of stopping were so severe, and that banks had no choice but to do more and more and more to show growth.

I was reminded of this report while reading the press release from Fifth Third (FITB) yesterday, announcing the formation of a joint venture with buy-out firm Advent for FITB's transaction processing business. The FITB deal represents one of the first detailed public disclosures of the accounting for a joint venture under FAS 160 "Noncontrolling Interests in Consolidated Financial Statements."

FAS 160, which went into effect January 1, attempts to deal with the accounting treatment for sales when a company sells a majority controlling interest and retains a "minority interest" (typically less than 50% ownership) - as is typically the case in most joint ventures.

Now, as a non-accountant, joint venture accounting and the accounting for minority interests has always been murky to me, and in this regard I have always analogized it to accounting for "being engaged" -- as in neither "single" nor "married" -- where neither complete deconsolidation nor full consolidation make sense.

But if I struggled with joint ventures under the old rules, after reading FITB's announcement yesterday, I am not sure that I feel any better under the new rules. And here's why:

As described in the press release, subs of FITB lent a newly formed LLC $1.25 billion to which the company subsequently contributed its processing business. FITB then sold a 51% interest in the LLC to Advent for $561 million plus warrant.

But here's where it gets interesting. FITB then goes to explain:

"The transaction is expected to contribute significantly to Fifth Third's retained earnings, capital levels and capital ratios, generating an expected pre-tax book gain of an estimated $1.7 billion and increasing Fifth Third's tangible common equity and Tier 1 capital by an estimated $1.2 billion."


Sell something 51% of which is worth $561 million (plus warrants) and recognize a gain a pre-tax gain of $1.7 billion - and more importantly, particularly in this environment, increase tangible capital by $1.2 billion?

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