Citi’s Basel-dodging, capital-avoiding, accounting switch | FT Alphaville

Citi’s Basel-dodging, capital-avoiding, accounting switch

Citi doing weird accounting manoeuvres? Perish the thought!

From the bank’s first-quarter results press release:

In the first quarter 2011, Citigroup transferred $12.7 billion of assets in the Special Asset Pool in Citi Holdings from HTM to trading. This transfer permits the sale of those assets, which have disproportionately higher risk-weightings under Basel III. The transfer resulted in a net $709 million pre-tax charge to revenues, from the recognition of $1.7 billion in pre-tax losses ($1.0 after-tax) which were previously reflected in accumulated other comprehensive income (AOCI), partially offset by $946 million of mark-to-market and realized gains on those assets.

That’s $12.7bn of assets that were held-to-maturity (HTM) now becoming available-for-sale (AFS).

Why would Citi do such a thing given that it resulted in that $709m charge in the first quarter? Because doing so now “enables it to take advantage of a recovery in the market for distressed assets and boost capital buffers as Basel III rules are phased in between 2013 and 2019,” according to the FT. Which is actually a nice way of saying the bank will be able to avoid higher capital charges on the assets.

Remember, Citi originally designated the assets as HTM back in 2008, in an effort to avoid having to mark them to market during the depths of the financial crisis. Under then-accounting rules, HTM assets were accounted for at amortised cost, while assets held for sale were accounted for at fair value.

That discretion — the ability to switch between HTM and AFS — incidentally, is one of the reasons that it’s difficult to criticise mark-to-market accounting for worsening the crisis. The International Accounting Standards Board (IASB) made it easier for companies to do this in 2008, following pressure from European banks and some politicians. European financials had complained, in particular, that US accounting rules gave their American rivals more flexibility than they had on this point.

The European and US flexibility does come with a caveat though. If it’s easier for banks to reclassify from AFS to HTM, they shouldn’t be able to switch back whenever it suits them. There have to be criteria.

So back to Citi. As the FT reports:

However, accounting rules require financial groups seeking to move assets back to their “trading” book to show that the facts around their initial decision had significantly changed. John Gerspach, Citi’s chief financial officer, said the company argued that Basel’s higher risk weightings constituted such a change. Citi’s argument was accepted by the US Securities and Exchange Commission, potentially paving the way for other banks to follow suit.

Avoiding higher capital — now an SEC-sanctioned reason for accounting reclassification.

(H/T The FT’s Jennifer Hughes)

Related links:
Citi puts $12.7bn portfolio up for sale – FT
From Level I to Level III, the myth of fair value – FT Alphaville