Trust but Verify: Tracking data from banks takes diligence

The NY Times' Dealbook published an article by Jesse Eisinger in which he makes the point that the numbers being provided by the banks make it hard to for outsiders to understand what is actually happening at the banks.

For individual banks, the numbers change between the call reports, the annual reports and investor presentations.  Not only does this make it very hard to understand the individual bank, it also makes it very difficult to compare between banks.

His conclusion is outsiders should continue to Trust but Verify by exercising diligence in looking at the data.

Under the FDR Framework, governments are responsible for ensuring that market participants have access to all the useful, relevant information in an appropriate, timely manner.  The article highlights many of the ways data is currently disclosed that could be improved.

If you really want to give your brain a workout to stave off the ravages of mental decline, I recommend trying to read bank financial statements.... 

To be fair, banks do file mountain ranges of disclosure documents. They report to the S.E.C. (which protects investors), the Federal Deposit Insurance Corporation (which insures borrowers), the O.C.C. (which regulates banks) and the Federal Reserve (which also regulates banks with slightly different responsibilities). 

Day after day, they push out news releases that run dozens of pages. They prepare reams of special presentations for investors, the most recent of which from Wells ran 51 pages, on top of a 41-page news release. The S.E.C. filing from the quarter was 162 pages. 

The numbers and presentation differ slightly in all of them and often differ from other banks’ presentations, stirring a struggle among outsiders to compare apples and bananas. No professional admits this publicly, but many investors and analysts privately acknowledge that they can’t fully track the data gushing each quarter from the nation’s banks. 

Even if they could somehow reconcile all the numbers, analysts would still be significantly in the dark. In many instances, banks’ financial disclosures are drawn from estimates that only management teams are privy to. Even the simplest of concepts — how much capital a bank has — is a number based on countless calculations that, let’s face it, are not much better than guesswork. 

Why should analysts have to be in the dark?  If banks were required to disclose their current asset and liability-level data, analysts could know what was going on.

As Mr. Eisinger observes, bank capital is an accounting construct based on countless calculations drawn from management estimates that are not much better than guesswork.  This is not a ringing endorsement of capital ratios as being a reliable indicator of the solvency of a bank.

So it is all the more important that we trust bank management and regulators to make sure the numbers we see truly reflect their financial condition....  

A Wells Fargo representative told me that the bank’s disclosure was “best in class” and listed the enormous amount that it provides. 

The bank still falls short of other big banks in disclosure, according to investors and analysts I’ve spoken with. It doesn’t break out the reserves it has made by asset class, unlike Bank of America, making it particularly difficult to understand how much it is reserving for bad residential real estate loans. It doesn’t separate its business lines in the detail that the other banks do. 

Then there are its nonperforming loans. For its residential mortgages, it doesn’t classify them as nonaccrual until they are 120 days past due, instead of the more typical 90 days. The effect is to make the numbers look better. 

The crucial figure, over time, is the loss rate, the bank representative said. And since the Wells portfolio — not counting the bad Wachovia loans — has been performing consistently well for many years now, investors should believe that the bank is doing something right, and better than its competitors with its mortgage portfolio. 

Yet housing prices continue to fall, the economy is weaker than expected, and we are flirting with another financial crisis, as Europe gets its revenge on us for having exported our calamity to their continent in 2008. Wells isn’t likely to remain immune to that. “Trust but verify,” Ronald Reagan used to say of the Soviet Union. Not a bad idea.