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Bank Earnings: The Hole Truth, Part 2


The only way to fix the banking system is to acknowledge the ways it's broken.

As an appendix to Bank Earnings: The Hole Truth (in which I discussed Wells Fargo (WFC), Goldman Sachs (GS) and Citigroup (C)), I would offer the following quote from Bank of America's (BAC) results on Monday:

"Noninterest income included $2.2 billion in gains related to mark-to-market adjustments on certain Merrill Lynch structured notes as a result of credit spreads widening."

For non-accountants, the translation of this statement would be as follows: "Because the market is now more doubtful of our ability to meet our obligations on these structured notes than they were at the end of December, we can recognize a $2.2 billion gain this quarter."

And to those wondering, B of A was hardly alone in reporting sizable gains due to spread widening.

I realize that these are very difficult times for financial-services companies, but I learned a long time ago that the only route to progress is dealing with reality.

With that as background, I would offer to any number of regional banks who reported earnings recently that the correct disclosure when writing off goodwill is not "This is a non-cash charge, which should be ignored, because it does not effect cash or regulatory capital." Instead, the disclosure should be, "In hindsight we overpaid for an acquisition and based on lower forecast earnings from this business in the future, we need to write down most of the purchase price."

Similarly, all statements which include the use of "pre" or "excluding" bad things must immediately cease. As the following statement from Huntington (HBAN) yesterday morning on "Pre-tax, Pre-provision Income Trends" reveals, these statements border on delusion:

"One performance metric that Management believes is useful in analyzing performance in times of economic stress is the level of earnings adjusted to exclude provision expense and other volatile items not considered to represent core, noncredit related banking activities.

"Provision expense is excluded because its absolute level is elevated and volatile in times of economic stress. We also exclude securities gains or losses since in times of economic stress investment securities market valuations also may become particularly volatile. This has been the case over the last several quarters. Lastly, we exclude amortization of intangibles expense because the size of this quarter's goodwill impairment is unusually magnified in times of severe stock valuation pressure and is not indicative of future performance trends."

Maybe management should just have said "Taking out all the bad things that happened, we had a great quarter!"

You can't make this stuff up.
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