Thursday, January 12, 2012

Financial frankness for banks

Jonathan Weil wrote an interesting column for Bloomberg titled Financial Frankness is a Bad Dream for Banks.

As regular readers know, ultra transparency is the ultimate in financial frankness.  Ultra transparency requires banks to disclose on an on-going basis their current asset, liabilities and off-balance sheet exposure details.

With this data, market participants can assess and price the true risk of the bank much more accurately than they can with current disclosure requirements that leave the banks resembling 'black boxes'.

So why is financial frankness a bad dream for banks?

It is a bad dream because there is no logical stopping point in disclosure between the current 'black box' and ultra transparency.  Restoring and preserving the market's trust requires ultra transparency.

The market does not reward banks for recognizing some losses while other losses remain hidden on the bank balance sheets.  This is not surprising because anything less than ultra transparency leaves the bank resembling a 'black box' and prevents the market from assessing and pricing the true risk of the bank.

There’s a simple explanation for why the world’s zombie banks remain so reluctant to write off worthless assets and tap the equity markets for fresh capital. They don’t want to end up like UniCredit SpA. (UCG) 
This month has been a nightmare for the Italian bank’s shareholders. Since embarking last week on a 7.5 billion euro ($9.7 billion) stock sale at a steep discount to its Jan. 3 closing price, UniCredit shares have fallen 39 percent to 2.56 euros. 
It seems no good deed goes unpunished when it comes to lenders besieged by Europe’s debt crisis. A little bit of candor about the true state of a company’s finances can hurt a lot. 
That undoubtedly is the message some other lenders facing large capital shortfalls will take from UniCredit’s troubles. The incentive now, just as most banks are undergoing their year- end audits, will be to stick with the pretense that all is well and there’s no need to raise additional capital. 
Not that a lot of them have better options. There’s only so much private-sector capital available to go around.... 
This month’s offering was spurred in part by UniCredit’s decision in November to take large writedowns for the third quarter, resulting in a 10.6 billion euro loss, mostly for intangible assets such as goodwill leftover from ill-fated acquisitions. The loss was the largest disclosed for the period by a euro-area bank. 
The European Banking Authority also weighed in last month after its latest stress tests, saying UniCredit had almost an 8 billion euro capital shortfall.

The markets sense, with good reason, that the latest cash infusion won’t be enough....  
Investors still see a huge hole in the company’s books that UniCredit executives have yet to admit. Had UniCredit taken swift action sooner to mop up and replenish its balance sheet, it might not be in the precarious position it is today. 
This is one of the lessons everyone should have learned from the collapses of Lehman Brothers Holdings Inc., Fannie Mae and Freddie Mac in 2008: Come clean about your losses to preserve the markets’ trust, and raise more capital than you think you will ever need to get through a crisis while you can, because you might not get another chance. 
UniCredit seems to be coming a tiny bit clean, and raising a smidgeon of the money it needs. At least it’s doing something, though. 
Elsewhere in Europe this generally isn’t the case. On average the 31 companies in the Euro Stoxx Banks Index (SX7E) trade for 39 percent of common equity, or book value, according to data compiled by Bloomberg. France’s Credit Agricole SA (ACA) trades for 23 percent of book. Yet somehow the European Banking Authority last month concluded it had no capital shortfall. 
The situation in the U.S. is better, but not good. Bank of America Corp. (BAC), for example, trades for 33 percent of book and insists it doesn’t need to sell new common shares, in spite of the markets’ contrary verdict. If Europe’s banks get shut out of the equity markets, leading the worst-off to seek government rescues, any window that remains open for U.S. financial institutions could close quickly, if it hasn’t already.

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