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July 16, 2009

How One Bank's Books Show It's "Well-Capitalized" Even As It's About to Go Insolvent

Interesting bit of news here.

Big Correction: This is CIT Group, not CitiGroup or CitiCorp as I erroneously wrote. I just kept reading the one for the other.

Any time this sort of thing happens, there's obviously a lie or misrepresentation at some place in the books or the accounting process. Here's where it happens in CIT Group's case:

CIT’s bosses, led by Chief Executive Officer Jeffrey Peek, had been touting the company’s well-capitalized status repeatedly ever since, in financial filings and investor presentations. In reality, whatever capital CIT possessed existed only in its executives’ heads -- literally.

The problem here is with the accounting standards as much as the government’s capital rules. Consider this disclosure from the footnotes to CIT’s latest annual report. As of Dec. 31, CIT said the fair market value of its loans was $8.3 billion less than the value it was using on its balance sheet. Loans at the time were about two-thirds of its $80.4 billion of total assets.

By comparison, New York-based CIT had $7.5 billion of so- called Tier 1 regulatory capital as of Dec. 31, and $8.1 billion of shareholder equity. Take away the inflated loan values, and CIT’s capital and equity would have been less than zero. CIT hasn’t said what its loans’ market values were as of March 31.

The craziest part is that the difference in the loan values came down to nothing more than CIT executives’ state of mind.

Had CIT classified the loans as “held for sale,” the accounting rules would have required the company to carry them on its balance sheet at their cost or market value, whichever was lower. By labeling almost all its loans as investments instead, CIT got to avoid writing them down to market values.

So, for capital purposes, the only difference between an insolvent CIT and a well-capitalized CIT was a mere utterance by management that it planned to keep holding the loans.
No wonder so many zombie banks continue to roam the country. All they have to do is wish away their ruin, and the rules let them.

There is one catch. As CIT said in its annual report, it’s allowed to classify loans as investments only if it “has the ability and intent” to hold them “for the foreseeable future or until maturity.” Otherwise, it must book the market losses.

It’s hard to see how CIT’s management could believe the company still has the ability to keep holding onto its loans now. Not with more than $3 billion of reported losses in the past eight quarters, a looming cash crunch, and its debt trading in the bond market as if the company might fail. A CIT spokesman, Curt Ritter, declined to comment.

And obviously if they're angling for bailout money they don't have the wherewithalll to do continue carrying bad loans as "investments."

Thanks to old guy.

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posted by Ace at 02:54 PM

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