Banks Stand to Reap Billions From Purchased Bad Loans

Wednesday, 27 May 2009 08:40 AM

By Julie Crawshaw

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An accounting rule that governs how banks book acquired loans is making it possible for banks that purchased bad loans to reap billions.

Applying this regulation — known as the purchase accounting rule — to mortgages and commercial loans that lost value during the credit crisis gives acquiring banks an incentive to mark down loans they acquire as aggressively as possible, says RBC Capital Markets analyst Gerard Cassidy.

"One of the beauties of purchase accounting is after you mark down your assets, you accrete them back in," Cassidy told Bloomberg. "Those transactions should be favorable over the long run."

Here’s how it works: When JPMorgan bought WaMu out of receivership last September, it used the purchase accounting rule to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent.

Now, JPMorgan says that first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.

So JPMorgan, Wells Fargo, Bank of America, and PNC Financial Services all stand to make big bucks on bad loans they bought from Washington Mutual, Wachovia, Countrywide and National City.

Their combined deals provide a $56 billion in accretable yields, which is the difference between the value of the loans on the banks’ balance sheets and the cash flow they’re expected to produce.

However, it’s tough to tell how much the yield will increase the acquiring banks’ total revenues because banks don’t disclose all their expenses and book the additional revenues over the lives of the loans.

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