From Tuesday’s FT — some letter-writing:
Some European financial institutions should have taken bigger losses on their Greek government bond holdings in recent results announcements, according to the body that sets their accounting rules. In a letter sent to the European Securities and Markets Authority, the European Union’s market regulator, the International Accounting Standards Board criticised the inconsistent way in which banks and insurers have been writing down the value of their Greek sovereign debt.
The IASB doesn’t name names in its letter, but there are two that spring to mind — BNP Paribas and CNP Assurances. The two firms managed to sidestep larger write downs in H1, when they reclassified their Greek government debt as ‘Level 3′ assets, effectively marking the bonds to model.
Were they big outliers? Twenty financial institutions reported impairments in the first half of the year, according to JPMorgan’s Peter Elwin — a man who’s been on top of Greek debt accounting developments for some time now. He’s even knocked up this handy chart of recent accounting treatments:
On the whole, write downs of bonds totalled about 21 per cent for held-to-maturity (HTM) loans, while bonds classified as available-for-sale (AFS) were roughly in line with (massive) market moves.
But BNP Paribas and CNP?
Well, here’s Elwin’s opinion:
Both BNP and CNP justify using Level 3 valuation techniques based on the argument that GGBs are no longer traded in an ‘active market’. BNP’s 2Q11 results statement sets out their arguments in detail and we reproduce extracts in the Appendix, but their arguments, in our view, can be summarised as ‘we don’t believe GGB market prices are correct so we’re going to use our own valuation model instead’.
We are not convinced by the arguments in favour of marking-to-model, and we do not believe the use of this approach is warranted. In our view the market for GGBs remains active enough to ensure that the prices quoted should continue to be used for IFRS valuation purposes (at least to the extent of supporting a Level 2 approach).
The fact that BNP and CNP stand alone in our sample universe in terms of adopting a mark-to-model approach suggests that the other companies in our sample share our scepticism regarding these arguments (and that their auditors feel likewise).
In fact, according to Elwin, the two companies’ write downs would have been as high as 50 per cent had they not used Level 3 (both of them held their Greek debt as AFS). Intriguingly, BNP Paribas has also reclassified its Greek debt from fair value AFS to Loans & Receivables, held at amortised cost.
Why would it do that?, you ask. Here’s Elwin:
The AFS loss reserve must be amortised back through the P&L over the bond’s remaining life and so is offset against the interest income on the bond. In effect, reclassifying the bond to amortised cost avoids future P&L volatility, but in exchange for lower income. We estimated BNP’s exposure to Greece as equivalent to 8% of its Core Tier 1 Equity and this may partly explain its enthusiasm for the accounting techniques discussed above and in the preceding section
Yes, ’cause a 30 per cent loss on assets equivalent to 8 per cent of Core Tier 1 would have reduced capital by, oh, 2.4 per cent. (BNP posted a Core Tier 1 common equity ratio of 9.6 per cent).
No wonder the IASB is perturbed.
Related link:
Greece as a test for auditors – FT Alphaville