Category: accounting

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UK Banking System is One Big Impaired Asset

An interesting passage from the IFRS accounting standards

The core principle in IAS 36 is that an asset must not be carried in the financial statements at more than the highest amount to be recovered through its use or sale. If the carrying amount exceeds the recoverable amount, the asset is described as impaired. The entity must reduce the carrying amount of the asset to its recoverable amount, and recognise an impairment loss. IAS 36 also applies to groups of assets that do not generate cash flows individually (known as cash-generating units). [My emphasis]

IAS 36 applies to all assets except those for which other standards address impairment. The exceptions include inventories, deferred tax assets, assets arising from employee benefits, financial assets within the scope of IFRS 9, investment property measured at fair value, biological assets within the scope of IAS 41, some assets arising from insurance contracts, and non-current assets held for sale.

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To Be or Not to Be, L&G’s £10 Billion Question

L&G have been much in the news recently, so too has our own Dean Buckner, with star appearances in the Financial Times, the Times and the Daily Mail (see also here) and all in two days.

The fur continues to fly over L&G’s planned June 4th dividend, but the attention is shifting subtly from the dividend itself to the underlying valuation methodology and the central issue is (one again) the Matching Adjustment.

There is also the issue of the firm’s ‘virus spread’ losses or, more precisely, Dean’s estimate that these could be up to £10.3 billion. Dean has stirred up a right hornets’ nest this time.

Here is my take.

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Just 2019 Solvency and Financial Condition Report

The Just Group SFCR is out today.  One thing leapt out.  Table S.22.01.22 on page 110 which quantifies the effect of transitionals and matching adjustment, shows a large increase in the effect of TMTP from £1.7bn in 2018 to £2.8 bn in 2019, that more than a £1bn increase. The figure is broadly consistent with the figure for JRL on p.120 and for Partnership Life on p.129 (although, unlike last year, they don’t add up precisely).

If correct, the coverage ratio would have fallen to 82%.

Yet the figure is not consistent with the figures on p.80, which show the effect of transitionals at only £1bn, leaving the capital coverage ratio broadly unchanged at 141%. I have no way of explaining this.

Note also the weird lack of sensitivity to a 100bp changes in credit spreads, given on p.10 as 1% of coverage ratio. The puzzle is resolved on p.62 where it states “Credit Spread Risk: “The 100bps increase in credit spread for corporate bonds (excludes gilts, EIBs, any other government/supranational) assumes that the Fundamental Spread and volatility adjustment remain unchanged”.

More bizarre insurance accounting, in other words. The fundamental spread represents the supposed default risk for the firm, which if unchanged would not impact p/l. The widening of the spread, for example in a crisis period like now, would therefore be attributable to a change in Matching Adjustment, and the fall in asset value be matched by a corresponding fall in obligations.

This is not false accounting at all!

 

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Coronavirus exposes illusion of UK bank capital strength

A great piece here by Jonathan Ford of the FT. For those on the wrong side of the paywall, his case is as follows.

The Bank intervened last week to stop banks paying out dividends, the official reason being the coronavirus panic. But why didn’t the Bank prevent capital distributions earlier, given the much-heralded capital rebuilding exercise? Ford argues that the official measure of capital strength, CET1, may be illusory, given that it is based on ‘risk weighted assets’, a subjective and hence gameable measure of asset value.

A less gameable measure involves comparing equity not with a RWAs, but simply the total unadjusted asset number. Moreover, because accounting measures of book equity are backward-looking and may conceal losses, it makes sense to use the bank’s market capitalisation in their stead — especially when events are moving fast.

He quotes our own Professor Dowd saying that Barclays’ leverage ratio (equity divided by unadjusted asset value) is now just 1.2 per cent.

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More sirens

This  (the Siren Call of illiquidity) refers. “Illiquidity is not costless”. But now see this teaser from Moody’s analytics.

“Constructing discount curves for IFRS 17 presents insurers with a number of challenges,” said Christophe Burckbuchler, Managing Director at Moody’s Analytics. “These include the selection of an appropriate methodology that provides stable and robust valuations of liabilities, and production of curves and necessary documentation to meet reporting timelines. Our new service addresses these challenges and enables insurers to accelerate their IFRS 17 project and production timelines.”

It’s difficult to comment without sight of the product, but it looks like a way of using the IFRS 17 provision for a matching adjustment-like illiquidity discount. Moody’s is well-placed to offer such a service with their copious data on default rates. With a suitably chosen historical period, the realised default rate will be lower, perhaps much lower, than the spread-implied default rate. So the difference between the two rates ‘must’ correspond to an illiquidity premium!

It will either end well, or it will not.

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Considering every angle

I just spotted a comment from ‘JKingdom3’ on our letter to the FT last month (Capital created by matching adjustment is entirely artificial, see Eumaeus “Our Reply to Rothesay“, 5 November 2019).

Kingdom wonders whether we have considered every angle, arguing that “In a world where firms seek to maximise their profit subject to the constraints they face, the “correct” assets required to meet this will be the assets corresponding to the least cost to the shareholder”. He contrasts investing

1. … $74.41 in the risk-free asset, hold no capital over ten years, and pay the policyholder $100 in ten years’ time with certainty; and

2. … $67.56 in the risky asset, and hold the minimum capital needed to meet the 99.5% requirement each year over the ten years.

He suggests that option 2 is a good deal for policyholders, and a better deal for investors. Correct or not?

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Unbalanced sheets

The Independent Expert report on the Prudential-Rothesay transfer has a curious statement in footnote 17.

The figure of c.£11.3 billion differs from the figure of c.£12.9 billion in paragraph 5.17 because £11.3 billion is the gross BEL held by Rothesay in relation to the reinsured business, whereas £12.9 billion is PAC’s gross BEL in relation to the reinsured business. The difference between these figures principally arises because the Transferring Business is not part of PAC’s Matching Adjustment portfolio (and therefore its BEL is not calculated using the Matching Adjustment), whereas the inwardly reinsured business in Rothesay under the Laker Reinsurance Agreement is part of Rothesay’s Matching Adjustment portfolio, which means that Rothesay’s BEL is calculated using a discount curve that includes a Matching Adjustment, resulting in a higher discount rate and a lower BEL.

My emphasis.

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