Since the latter part of 2007, the financial world has been in one of the worst crises of the last half century. Just a cursory look at news headlines around the world reveals a telling and stress-inducing story:
• Bloomberg: U.S. Stock Futures Decline on Concern Banks Need More Capital
• Guatemala Times: The Great Depression Analogy
• SmartMoney: Investors Are Scared, and That’s the Good News
• Belfast Telegraph: US hit by its worst slump in 50 years
With these articles, the spotlight remains squarely on financial institutions as we are continually reminded of failing and nearly failing banks needing “bailouts”. Unfortunately, we are too often only exposed to part of the story. As we have addressed what these bailouts actually mean in previous commentary, we won’t readdress it here. What we would like to briefly examine here is the profitability of banking institutions and how different measures tell remarkably different stories.
We will begin by defining a term: GAAP (pronounced like gap)—an acronym referring to the Generally Accepted Accounting Principles of the United States. These principles are what the U.S. Securities and Exchange Commission (SEC) requires publicly-traded companies to use in preparing and reporting financial statements.
The other accounting method that every U.S. company is required to adhere to is the IRS Code. An underlying premise of GAAP is that companies should not overstate their earnings, which would mislead investors—while the underlying premise of the IRS Code is that companies should not understate their earnings, which would lead to less income tax for the government.
Today’s headline-grabbing losses stemming from issues like mark-to-market on securities, impairments of goodwill, and net additions to loan loss reserves—all appear on a bank’s financial statements because of GAAP requirements. What is also significant about these losses is that they don’t affect an institutions’ cash on hand and they are not tax deductible.
Recently, Zions Bancorporation’s CEO Harris Simmons asked a simple question, “How many of the nation’s largest banks paid taxes last year?”—realizing that Zions, having reported a loss last year in its financial statements, actually paid out over $300 million in taxes. It turns out that the two dozen largest domestically headquartered bank holding companies* had a GAAP net income loss which was nearly equal to that of their taxes paid. In fact, not one of these twenty-four organizations avoided paying millions—and in some cases billions—of dollars in taxes.
The point to remember is that these losses generally have more to do with accounting practices than the core operations of many of these bank holding companies, and the largest financial institutions in America are paying billions of dollars in taxes to Washington DC and their respective states.
The health of the banking industry can only be determined by an in-depth study of the industries’ financial statements. Which financial statements you decide to use (GAAP or the IRS Code) will lend to entirely different conclusions.
*The banks in the sample are taken from the 36 largest banks included in the Fed’s listing, excluding nine bank holding companies that are subsidiaries of foreign companies (that do not in all cases file 10-Ks from which the tax information is taken) and the three large trust and processing banks (Bank of New York/Mellon, State Street, and Northern Trust). The actual cash payments for income taxes are taken from the “Supplemental Disclosures of Cash Flow Information” that is a standard part of an audited financial statement’s “Consolidated Statements of Cash Flows” included in a bank holding company’s 10-K.
*Artwork from kevindooley under Creative Commons license at Flickr.com.
