Bank reporting cocktail leaves investors groggy

Mon Dec 17, 2012 1:50am EST

* Inconsistency makes investors wary of bank stocks

* Big differences in treatment of mortgage arrears, "doubtful" loans

* Bank of England wants UK banks to justify their approaches

* Standardisation will put some banks in a bad light

By Laura Noonan

LONDON, Dec 17 (Reuters) - European banks are under pressure to standardise how they measure their riskiness as investors grow increasingly wary of the kaleidoscope of methods used.

The variety of approaches covering critical matters such as when a loan becomes impaired and defining what is suspect directly affects how much capital banks must hold and the sort of returns investors can expect.

Efforts to harmonise reporting standards have been going on for nearly a decade, but the financial crisis has brought the issue to a head as investors, burned by tumbling share prices and emergency cash calls, are steering clear of those lenders whose risk models they don't trust.

"This lack of comparability does in our view weigh on the investibility of some banks," said Jon Peace, a London-based banking analyst with Nomura.

"Where transparency is too low to form a clear view on the accuracy of the calculations, investors will be inclined to discount the shares for the uncertainty, whether or not it is warranted."

Other analysts, who will only speak anonymously because of the sensitivity of the topic, are more blunt, with one describing financial statements as "pointless", given the lack of consistency across banks and the discretion they have on key metrics.

COMPARING APPLES WITH APPLES

The treatment of mortgage arrears is particularly diverse.

As a general rule, home loans are defined as being in arrears if the repayments are more than 90 days overdue, but it varies widely across Europe.

In Portugal, a home loan is overdue when just one month's payment is missed. In Italy, it is one or two months.

At the other end of the spectrum, Denmark's arrears clock only starts ticking three and a half months after the last payment was made.

In Italy, IntesaSanpaolo was so concerned that comparisons with non-Italian banks would lead to "flawed conclusions" that it incorporated an international comparison into its last results presentation.

Under the method selected for that presentation, Spanish banks' bad loans would triple to a quarter of total loans. The comparable figure for Italian banks was 9.9 percent.

"We see that in an apple-for-apple comparison, the Spanish figures would triple and would be 2.5 times higher than the Italian ratio," Chief Executive Enrico Cucchiani said.

"Italian asset quality is significantly underappreciated, and we also see that there is a clear need for greater harmonisation and transparency."

'Doubtful' loans are another minefield. Some countries use payment history as the sole determinant, while others use more subjective clauses; in Spain and Portugal, for example, a loan can be classed as doubtful if repayment is considered "uncertain".

One analyst said the quality of banks' disclosure was "just as problematic" as the different definitions they use; some banks tell you lots, and some banks tell you very little.

Alain Laurin, a senior vice president at credit rating agency Moody's, said the agency got good co-operation when it asked for more information.

Four analysts, who did not work for ratings agencies, reported a different experience. "Of course we can ask," said one. "It doesn't mean we get it."

WHO IS RIGHT?

Then there's the issue of capital.

Risk-weighted assets (RWAs), which are a key determinant of the amount of capital a bank needs to hold, are treated differently even by banks in the same country, even though all banks must have their RWA models approved by local regulators.

RWAs are a bank's assets, usually loans, adjusted for the likelihood of non-payment.

A recent study by the Bank of England recently showed how some banks can put a low 'weighting' adjustment on a certain type of loan, meaning there is a strong chance it will be repaid, while others might assign a far higher weight to the same portfolio.

"Banks in Sweden report RWAs of 5 percent for mortgages, and banks in Slovakia (apply) RWAs of 50 percent, which is a bit surprising at first sight," said Moody's Laurin.

"You have to take a view on whether these differences in RWA are justified or not justified."

A recent IMF study noted that since the financial crisis broke, some investors have started to interpret high-risk weightings as a sign banks were being more cautious with their assessments.

In a report this month into the "Investibility of UK Banks", the Association of British Insurers, which represents some of Britain's biggest investors, cited a lack of confidence in comparing asset risk as one of the reasons pension funds and insurers were steering clear of UK bank stocks.

"It's difficult to know who is right, but the fact that there is a difference means that somebody, almost by definition, is wrong," said Mike Trippett, a consultant with the ABI.

UK banks may soon see more consistency in their RWA treatments, however, as the Bank of England and the Financial Services Authority recently asked them to justify their approach or change it.

The wider European banking community will also see changes over the coming years as policymakers, learning from the mistakes of the financial crisis, move to standardise bank reporting.

The European Banking Federation, which represents banking lobby groups in 31 countries, said it was in favour of the changes.

But Laurin at Moody's warned that for some banks the process could be distinctly uncomfortable.

"Being transparent is always good for the good banks and bad for the bad," said Laurin. "Some banks don't want to put certain information into the public domain because the consequences can be material."

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