Banks Back in the Black?

Recent news stories may make it seem that the banking industry is rebounding from the crisis that brought it to its knees. But is this a true recovery? An article in today's Wall Street Journal says changes to fair value may be distorting reality.

The Financial Accounting Standards Board (FASB) relaxed mark-to-market accounting rules in April, giving banks new flexibility regarding impairment charges. The changes to fair value help banks avoid reductions to earnings when taking other-than-temporary impairment (OTTI) charges, which can now be moved into "other comprehensive income" on a bank's balance sheet if the bank intends to keep the troubled securities.

The WSJ article -- written by Michael Rapoport, who was recently honored by the NYSSCPA for  his financial journalism -- notes that Wells Fargo and State Street were two whose second-quarter earnings benefited from their use of the new fair value accounting.

From the article:

"The effect doesn't appear as pronounced in the second quarter -- but some banks are still realizing sizable benefits. Wells Fargo had $664 million in second-quarter pretax impairment charges added to other comprehensive income but not assessed against earnings, on top of $334 million in the first quarter. Had this been charged to earnings, pretax second-quarter income would have been 14.1% lower.

State Street, which adopted the FASB changes for the first time this quarter, said $103 million of its impairment charges were "not related to credit," so they were kept out of earnings. Without this, its pretax earnings would have been 13.8% lower. State Street said the move reflects the bank's position that the assets involved would mature at full par value."

The fair value rollback may have been a product of the crisis, but the consensus -- from CPAs to bankers to Nobel-prize-winning economist Paul Krugman -- is that it didn't cause it.