Thursday, September 1, 2011

Officials Warn Lenders On Greek-Debt Values



The Wall Street Journal
By MICHAEL RAPOPORT And DAVID ENRICH
In an unusual move, international accounting rule makers said some European banks haven't taken big-enough write-downs on the value of the distressed Greek government debt they hold.
Some banks are using their own models to value their Greek bonds and other distressed sovereign debt when accounting rules dictate that they should be using market prices to determine the securities' fair value, the International Accounting Standards Board said in a letter this month to the European Union's chief securities regulator.
In some cases, using the "mark to model" approach, as opposed to "mark to market," may have helped some banks to dodge potentially painful losses in recent midyear financial reports.
Banks are applying the rules on write-downs inconsistently, and that is "a matter of great concern to us," IASB Chairman Hans Hoogervorst wrote in the letter to the European Securities and Markets Authority. The IASB, which sets the accounting rules used in Europe and much of the rest of the world, doesn't usually comment on how its rules are applied, but the inconsistency prompted it to do so in this case, Mr. Hoogervorst said.
In response to the letter, the ESMA is reviewing whether there are differences in how companies treat their sovereign debt and whether such differences are acceptable under accounting rules, the regulator said in a statement. The general findings will be shared with the IASB, the ESMA said.
The letter was dated Aug. 4. The IASB didn't release it publicly until Tuesday, after the Financial Times reported on the IASB's concerns.
The episode could add to questions about the strength of European banks at a time when many big lenders have been under pressure in the market. Shares of France's Société Générale SA fell as much as 22% in a day this month amid doubts about big banks' capital and access to dollar funding.
International Monetary Fund chief Christine Lagarde called on Saturday for European countries to urgently recapitalize their banks. Others, however, have pointed to last month's "stress tests" as evidence that the Continent's banks aren't facing a widespread capital shortfall.
"The only banks that need to be recapitalized are those that didn't pass the European stress tests," Bank of France Governor Christian Noyer said in a television interview Tuesday. "There are a few banks that need to be recapitalized rapidly."
The issue of banks' inconsistent accounting drew attention when the banks announced second-quarter earnings. Banks generally were transparent about the size of the discounts they used and how they came up with those numbers, and they were explicit about the fact that there was a split in the industry, with banks using different accounting methods and arriving at varying loss estimates on similar bonds.
Mr. Hoogervorst didn't single out any specific banks for criticism. But BNP Paribas SA is one bank that used an internal model to try to estimate the Greek bonds' value, arguing that they were so thinly traded that it was impossible to derive an accurate estimate of their value based on observable trades. Mr. Hoogervorstsaid that just because trading activity in a market has declined, that doesn't mean banks are free to ignore market prices when valuing a security. Even when using their own models, they are supposed to consider market prices as a factor.
"Market prices not representative of fair value," France's BNP Paribas executives said in an Aug. 2 investor slide presentation, citing "the illiquidity of the bonds." BNP arrived at a 21% discount to the bonds' book value, prompting the bank to set aside more than €500 million, or roughly $725 million, to cover the increased likelihood of losses.
A BNP spokesman wasn't available to comment.
By contrast, many other banks did attempt to value the Greek bonds at the prices that they were changing hands in the market—a method that pointed to the bonds being worth at most half of their face value. Royal Bank of Scotland Group PLC, for example, calculated a 50% loss rate on its £1.45 billion ($2.38 billion) of Greek government bonds, and set aside £733 million to cover potential losses. The bank said it could recoup some of those losses later this year, depending on the final outcome of the Greek debt restructuring.
"Although the level of trading activity in Greek government bonds has decreased, transactions are still taking place," Mr. Hoogervorst said. The rules are "clear that unless there is evidence that the prices in those transactions do not represent fair value...the observed transactions prices should be used to measure fair value."
It is "hard to imagine" that there are buyers willing to buy the bonds at the prices suggested by the valuation methods some banks are using, he said.
—William Launder, William Horobin and Noemie Bisserbe contributed to this article.
Write to Michael Rapoport at Michael.Rapoport@dowjones.com and David Enrich atdavid.enrich@wsj.com

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