Lehman Brothers’ counter-intuitive plan to split itself in two, and somehow avoid the toxic effects of commercial real estate losses, seems to rely on a simple change in accounting treatment – moving from mark-to-market to hold-to-maturity.
So, while “good” Lehman will continue to live in the world of fair value accounting, “bad” Lehman (full of CMBS) is going the way of Japanese banks in the 1990s.
Indeed, Bruce Packard of Pali International pointed out in a note to clients on Thursday that Pali’s Japanese desk has been arguing for some time that with several hundred billion dollars in writedowns still to come across a broad range of assets, the only way out will be for a change in the interpretation of fair value accounting rules.
The simple aim is the break the negative feedback loop, since mark to market accounting can trigger forced sales into a falling market, creating a spiral. Hold-to-maturity conventions buy time – and have the handy side-effect of smoothing the bad newsflow, making it difficult for bears to raid the bank stocks concerned. Says Packard:
We believe LEH’s adoption of “Hold to Maturity” accounting (at least for it’s “bad bank spin off”) is extremely significant. This suggests we are entering a new era, with the authorities prepared to given some accounting latitude to banks that have survived thus far, in our view. The developments at LEH suggest the regulators would prefer to see banks limp onwards, rather than run the chance that another large bank failure and the systemic risk that might cause, we believe. In itself, accounting changes may not help the availability of credit in the real economy, but it may be positive for equity holders in banks, because changing the interpretation of the rules could prevent value destructive forced sales.
The obvious read-across for British banks is Barclays, which has resisted hefty marks against its own portfolio of CMBS on the basis that much of the debt will mature within the next couple of years.
Yet Barclays had £10bn of CMBS exposure at the end of the first half, of which half is American CMBS, and the current mark stands at an optimistic 96 cents in the dollar. That compares with 85 cents for Lehman (before the so-called Spin Co move) and 87 cents for RBS.
The subject is bound to come up on Monday, when Barclays are holding an analysts’ day. Expect this chart (or similar) to brandished by someone in the audience. The market that fair value rules suggest you should mark to remains very challenging indeed.
