The Securities and Exchange Commission (SEC) is scrutinizing an unknown number of regional and community banks, in an attempt to detect if these have resorted to off beam accounting practices in their troubled commercial real estate loan modifications, the Wall Street Journal reported on Thursday.
The banking industry has already been hit hard by a significant amount of troubled loans offered during the credit explosion. A significant amount of these loans are still alive and, must under any circumstance, be absorbed by banks. Quite obviously, the banking system could now be vulnerable to some severe problems. However, banks are acting smart by modifying those loans in a way that makes them look better than they actually are.
Practices Under Scrutiny
Among others, SEC is examining a practice known as “extend and pretend” or “amend and pretend,” under which borrowers will be allowed more time to repay a loan.
There is another common practice under SEC’s investigation called “troubled debt restructurings.” Under this, banks can buy some time to modify loans; change their terms or split big loans into small amounts.
Though banks are allowed to modify loans through both these practices, the process of accounting is a major concern for SEC. There could be accounting manipulations hidden beneath these loan modifications. In order to reduce the reserves required for problem loans, at times,banks separate a portion of problem loans and give it a “performing” status.
Also, under these practices, many banks have evaded the write-downs to keep their balance sheets clean. SEC is trying to ensure that these accounting steps are properly reported to investors and regulators.
The primary intension of SEC is to stop manipulations (if any) by unearthing such malpractices and rooting out troubled loans offered during the recession.
Target Banks
Though we got no wind about the number of banks approached by SEC, several financial institutions including Fifth Third Bancorp (FITB) have disclosed that they are under the SEC scannerrelated to commercial loans.
In its annual report filed on February 28,Fifth Third Bancorpsaid that the SEC had requested it for several information pertaining to accounting and reporting matters of certain commercial loans. The company further said that such investigation may result in an enforcement proceeding by the SEC that might have adverse effects on its profitability.
Regulators are now actively supervising companies in an effort to stop any fraudulent activity, mis-statement of results or any wrong doing associated with investors or financial markets. For example, ex-director at Goldman Sachs Group Inc. (GS), Rajat Gupta, was charged by the SEC on March 1 for insider trading. Mr. Gupta had allegedly passed inside information to Raj Rajaratnam, a hedge-fund manager.
Better Late Than Never
We are not sure why SEC took its own sweet time to start investigation related to loan modification practices. However, though late, this would save us from yet another financial crisis by reducing problem loans in a proper way.
The Financial Accounting Standards Board is mulling over the final set rules for banks to deal with problem loans. Though restrictions by regulators will result in fewer loan modifications and, consequently, decelerate the pace of economic recovery, many concealed clutters that triggered the last recession will be well avoided.
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