By DAVID MOON, Moon Capital
December 16, 2007
A popular topic of
conversation these days is the turmoil in the banking and financial-services
stocks. A lot of people around here know that First Horizon (parent company of
First Tennessee Bank and some other
financial-services companies) has declined 53 percent in the last ten months.
That may be a little more extreme than some of its
regional banking brethren, but First Horizon is hardly alone. SunTrust is down
25 percent. Regions and BB&T are off 39% and 18%,
It's not just regional banks. Zurich-based brokerage
giant UBS has been under financial pressure as a result of a combined $14.4
billion in write-downs in the third and fourth quarters. To shore up its
finances, it received $11.5 billion in new investment capital last week, $1.8
billion from an unnamed Middle East investor and the other $9.7 billion from the
investment arm of the government of Singapore.
How could things get this bad this
How did a ship the size of the Titanic sink so quickly?
It didn't. It took on water for hours while Leonardo DiCaprio and that other guy
chased Kate Winslet around the vessel.
I'm not suggesting any of the aforementioned financial
firms are experiencing Titanic-esque difficulties. But like water pouring into
the hull of a mighty ship, when bad loans and bad borrowers collide, the
consequences are predictable, even if not immediate.
One of the many problems, however, is that generally
accepted accounting principles often fail to accurately describe an economic
In the last 12 months, First Horizon's reported earnings
have declined 69 percent.
That's true in accounting sense, but not in economic
Each time a bank makes a loan it sets aside a reserve for
an amount it expects not to collect on the loan. Borrowers are seldom thoughtful
enough to inform you on the front end if they plan to default on their loans.
The lender has to guess...er...estimate.
For years First Horizon guessed
In 2005, First Horizon increased its loans by more than
$4 billion and its allowance for loan losses by $32 million. But it actually
wrote off $37 million in bad loans. In 2006, it wrote off $55
Had the company been reserving an amount that would have
adequately covered its eventual loan losses, it would have reported lower
earnings in those years.
They didn't break any laws; it was all in complete
accordance with the accounting rules.
loaning more money to people whose financial statements suggest they can't pay
it back - even if real estate agents say otherwise - believe the financial
There is a bright side. If companies were overstating
their real earnings before the mortgage market decline, then their earnings
really haven't declined as much as it first appears; that's because they weren't
as high as they originally appeared several years ago.
Confused? I'm afraid that might not be a complete
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).