Smoking and Mirroring

When it comes to describing how many Wall Street firms operate, some expressions seem perfect.

Like "smoke and mirrors."

According to The Phrase Finder, it's use as a label for trickery or deception can be traced back to journalist and author Jimmy Breslin, who once described political power as an illusion conjured up through "mirrors and blue smoke."

Nowadays, however, the expression seems best suited to describing the dubious lengths that struggling financial institutions are going to in order to "prove" that they are healthy and that all is well.

In "Banks Find New Ways to Ease Pain of Bad Loans," the Wall Street Journal's David Enrich details a few examples of this farcical charade.

In January, Astoria Financial Corp. told investors that its pile of nonperforming loans had grown to about $106 million as of the end of last year. Three months later, the thrift holding company said the number was just $68 million.

How did Astoria do it? By changing its internal policy on when mortgages are classified on its books as troubled. The Lake Success, N.Y., company now counts home loans as nonperforming when the borrower misses at least three payments, instead of two.

Astoria says the change was made partly to make its disclosures on shaky mortgages more consistent with those of other lenders. An Astoria spokesman didn't respond to requests for comment. But the shift shows one of the ways lenders increasingly are trying to make their real-estate misery look not quite so bad.

From lengthening the time it takes to write off troubled mortgages, to parking lousy loans in subsidiaries that don't count toward regulatory capital levels, the creative maneuvers are perfectly legal.

Yet they could deepen suspicion about financial stocks, already suffering from dismal investor sentiment as loan delinquencies balloon and capital levels shrivel with no end in sight.

"Spending all the time gaming the system rather than addressing the problems doesn't reflect well on the institutions," said David Fanger, chief credit officer in the financial-institutions group at Moody's Investors Service, a unit of Moody's Corp. "What this really is about is buying yourself time. ... At the end of the day, the losses are likely to not be that different."

Still, as long as the environment continues to worsen for big and small U.S. banks, more of them are likely to explore such now-you-see-it, now-you-don't strategies to prop up profits and keep antsy regulators off their backs, bankers and lawyers say.

At Wells Fargo & Co., the fourth-largest U.S. bank by stock-market value, investors and analysts are jittery about its $83.6 billion portfolio of home-equity loans, which is showing signs of stress as real-estate values tumble throughout much of the country.

Until recently, the San Francisco bank had written off home-equity loans -- essentially taking a charge to earnings in anticipation of borrowers' defaulting -- once borrowers fell 120 days behind on payments. But on April 1, the bank started waiting for up to 180 days.

'Out of Character'

Some analysts note that the shift will postpone a potentially bruising wave of losses, thereby boosting Wells Fargo's second-quarter results when they are reported next month. "It is kind of out of character for Wells," says Joe Morford, a banking analyst at RBC Capital Markets. "They tend to use more conservative standards."

Wells Fargo spokeswoman Julia Tunis says the change was meant to help borrowers. "The extra time helps avoid having loans charged off when better solutions might be available for our customers," she says. In a securities filing, Wells Fargo said that the 180-day charge-off standard is "consistent with" federal regulatory guidelines.

BankAtlantic Bancorp Inc., which is based in Fort Lauderdale, Fla., earlier this year transferred about $100 million of troubled commercial-real-estate loans into a new subsidiary.

That essentially erased the loans from BankAtlantic's retail-banking unit. Since that unit is federally regulated, BankAtlantic eventually might have faced regulatory action if it didn't substantially beef up the unit's capital and reserve levels to cover the bad loans.

Because the BankAtlantic subsidiary that holds the bad loans isn't regulated, it doesn't face the same capital requirements. But the new structure won't insulate the parent company's profits -- or shareholders -- from losses if borrowers default on the loans, analysts said.

Alan Levan, BankAtlantic's chief executive, declined to comment on how much the loan transfer bolstered the regulated unit's capital levels. "The reason for doing it is to separate some of these problem loans out of the bank so that they can get special focus in an isolated subsidiary," he said.

Other lenders have been considering the use of similar "bad-bank" structures as a way to cleanse their balance sheets of shaky loans. In April, Peter Raskind, chairman and CEO of National City Corp., said the Cleveland bank "could imagine...several different variations of good-bank/bad-bank kinds of structures" to help shed problem assets.

Two banks that investors love to hate, Wachovia Corp. and Washington Mutual Inc., troubled some analysts by using data from the Office of Federal Housing Enterprise Oversight when they announced first-quarter results. Other lenders rely on a data source that is more pessimistic about the housing market.

Charter Switch

Another eyebrow raiser: switching bank charters so that a lender is scrutinized by a different regulator.

Last week, Colonial BancGroup Inc., Montgomery, Ala., announced that it changed its Colonial Bank unit from a nationally chartered bank to a state-chartered bank, effective immediately.

That means the regional bank no longer will be regulated by the Office of the Comptroller of the Currency, which has become increasingly critical of banks such as Colonial with heavy concentrations of loans to finance real-estate construction projects.

Instead, Colonial's primary regulators now are the Alabama Banking Department, also based in Montgomery, and the Federal Deposit Insurance Corp. The change probably "is meant to distance [Colonial] from what is perceived as the more aggressive and onerous of the bank regulators," said Kevin Fitzsimmons, a bank analyst at Sandler O'Neill & Partners.

Colonial spokeswoman Merrie Tolbert denies that. Being a state-chartered bank "gives us more flexibility" and will save the company more than $1 million a year in regulatory fees, she said.

Trabo Reed, Alabama's deputy superintendent of banking, said his examiners won't give Colonial a free pass. "There's not going to be a significant amount of difference" between the OCC and state regulators, he says.

Comments

[Independent Accountant]

I can't hate Wachovia. Those idiots bought Golden West from the Sandlers. I would no more buy something from the Sandlers than Sam "gravedancer" Zell.

[Rocky]

Some of the biggest losers in the past year of the lousy risk management practices of banks, brokerage firms and insurance companies have been the employees of these very companies. James Cayne of Bear Stearns lost close to $900 million in stock value when that company collapsed. Even a mid-level 45 year old employee with 20 years seniority at one of these companies has suffered significant losses. The company I used to work for made its 401K plan matching contributions in company stock (a common practice among employers), which could not be moved to another fund until the employee reached age 50. Prior to the change in Federal law after the Enron fiasco, there was no Federal requirement to allow such an investment change at all and my employer did not permit it. Unfortunately, many employees did not learn from Enron and probably had some of their own 401K plan contributions invested in company stock as well. Countless billions of dollars in financial service companiers' employee wealth have been wiped out in the past year. How would you like to worked for one of the following companies in the past year: BS, PMI, ABK, MBI, WM etc? Not only did your 401K plan get hammered, you may have lost your job as well. In the 2+ years, since I gained control over my own 401K money (after retiring) and rolled it into an IRA, my returns have been positive but nowhere near the "8%" often assumed for pension plans. I doubt that I am even keeping up with my personal inflation rate. I certainly don't have all the answers. No wonder so many Americans are so grumpy!

[roger]

Rocky Corporate power is in the saddle & the corporate structure is ruthless in its effort to downsize it is constantly trying to eliminate pensions /health benefits it will even go after the crumbs of the very poor grumpiness will not cut it,a good education in political science might help of course that means less TV for the masses

[ab]

Uh, magicians have been doing tricks with smoke and mirrors LONG before jimmy Breslin.

[Rocky]

Roger, A good education in basic finance would help even more. But millions of Americans would rather leave their financial fate in the hands of the Almighty, giving them more TV watching time.