Issue of the week

What’s hiding in banks’ portfolios?

It all comes down to values, said Grace Wong in CNNmoney.com. When the big commercial and investment banks report their third-quarter financial results over the next two weeks, investors and analysts won’t just be focusing on revenues and profits, for a change. Instead, they’ll also be looking at how the banks actually value their portfolios, especially those comprising subprime mortgages. It’s a crucial issue—not just for the banks but for the broader economy as well. “Investor confidence in the way banks value what they own” has been flagging since the summer, when two multibillion-dollar funds run by Wall Street giant Bear Stearns suddenly collapsed because their supposedly safe mortgage securities were essentially worthless. “A lot of people,” said Mike Thompson of earnings tracker Thomas Financial, “are trying to understand the total magnitude of their exposure.”

It didn’t used to be this complicated, said Joe Bel Bruno in the Associated Press. When the markets are functioning smoothly, it’s easy to put a value on a bond or a share of stock. Just take the last price at which the security traded, and that’s what it’s worth. But ever since the credit markets froze up last summer, trades of subprime mortgage securities have been few and far between, so the last trade is no guide to value. In such murky circumstances, accounting rules “let firms place a value on assets based solely on their best guess of their worth.”

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That’s why investors need to pay close attention to the way the banks spin their results, said Herb Greenberg in The Wall Street Journal. “When the news isn’t good, the message is orchestrated with great care and precision.” Take Citigroup’s preview last week of its third-quarter results. The bank disclosed that it would likely earn 47 cents a share, less than half of the $1.11 a share it had forecast earlier. “The company blamed it largely on $5.9 billion in unexpected losses and charges.” Roughly half of those losses were from subprime mortgage bonds and similar toxic debt, the rest from higher losses on consumer debt. But there was an odd omission in Citi’s announcement. “There was no mention of 2008.” In other words, the bank refused to predict whether its bad-debt problems would continue in future quarters. For investors, Citi’s reticence sends one clear message: “Don’t just be on the lookout for what they say but also for what they don’t.”

The banks would love you to believe that the darkest days of the credit crunch are behind them, said Jim Jubak in MSN’s Moneycentral.com. Don’t. “There’s not a chance the worst is over, and Wall Street knows it.” Considering the amount of “damaged goods” in the banks’ portfolios, the write-offs they’re taking are “relatively tiny.” Clearly, they’re taking advantage of the latitude afforded them by accounting rules, marking time until the market bounces back from “the panic prices of the past two months.” They’re not lying, exactly, but what they say shouldn’t be confused with the whole truth, either. “Am I being too cynical? Surely, Wall Street executives wouldn’t say one thing while they believe another, would they?”