Thursday, October 30, 2008

Maybank and the Mark-to-market Rule

The Star Online report on the travails of Maybank's corporate indigestion over its acquisition of PT Bank Internasional Indonesia (BII) first announced in March and, a 20% stake in MCB Bank of Pakistan announced in May leads in to the topic of my interest today.

It is about the mark-to-market accounting rule contained in what is known globally as International Accounting Standard (IAS) 39 or, in Malaysia as Financial Reporting Standard (FRS) 139. What is that, you ask?

FRS 139 is an accounting standard that requires companies or banks to adopt fair value accounting in valuing financial instruments in their books. I stand to be corrected, but, as I understand it, FRS 139 requires company auditors to use the prevailing market price of equities and instruments owned by companies or banks as the true and fair value of those assets.

At the moment, the controversial mark to market ruling in relation to accounting principles is confined to the financial sector.

But come Jan 1, 2010, the ruling will apply to all industries across the Malaysian economy, from finance and plantations to construction.

On that day, all listed companies in Malaysia will have to comply with the FRS 139. The Malaysian Accounting Board of Standards (MASB) is reported on October 13, to have finally given an ultimatum on the date of its implementation after deferring it to enable companies to get ready for the much-talked-about standard.

Maybank's risk of impairment losses
The Star Online's report goes on to say, In a sense, the acquisitions have become casualties of circumstances as global asset prices plummeted further in the last couple of months.

Maybank’s investments in the two countries are sizeable. It has spent RM5.5bil for a 71.86% stake in BII and a mandatory general offer for the rest of the shares would probably draw all minority shareholders to accept. Maybank’s offer, which closes on Nov 19, is 510 rupiah a share compared with BII’s price of 455 rupiah yesterday, which would probably have been much lower if not for the offer.

Full acceptance to the offer would cost Maybank an additional RM2.4bil for the balance of 28.14% of BII. Its cost would then be about RM7.9bil for the whole of BII.

Maybank’s purchase of a 20% stake in MCB Bank for a total of RM2.87bil was completed in August. Its cost was about 470 rupees a share compared with MCB’s price of 235.75 rupees yesterday. In total, Maybank would have spent about RM10.8bil cash for its investments in the two banks.

The FRS 139 mark-to-market rule will require Maybank to state the investment value based on the current market values and prices as at the date when it closes its accounts in each quarter. This is where the impaired value of the BII and MCB Bank investments will send Maybank's board of directors running for cover and, when shareholders, analysts and the general Malaysian public go super-ballistic.

A perspective: Defer the mark-to-market rule
Let's leave the Maybank investment saga for the other hyenas to devour. I'm more interested in looking at the bigger picture about FRS 139.

MASB's members are quoted as saying that the need to establish the IFRS framework is imperative to ensure Malaysia is not left out of the globalisation wave, especially since more than 100 countries are converging or have converged with it.

Let's pause here for a bit. Let's wear our Malaysian hat instead of the globalisation hat. Let's be a bit nationalistic and look at what's best for Malaysia now.

If you've read the various posts in this blog and many in the blog list, it is quite evident that Malaysia is not immune to the economic turmoil that is now threatening to spill over from the Malaysian capital market into the real economy.

In this context, would it not be a wiser strategy for MOF1 or MOF2 to pick up the telephone to call MASB's chairman Datuk Zainal Abidin Putih and MASB to defer the application of FRS 139.

The forex market is behaving irrationally. The capital market is behaving irrationally. In the US, Europe and Australia, the financial markets are behaving irrationally.

So, what would the mark to market rule be marking the values at? Obviously depressed prices. Is that a true and fair valuation? I don't think so.

Do you think I'm being absurdly out-of-the-box again?

A further perspective: US defers the mark-to-market rule
In the wake of the Wall Street financial and market turmoil, it has been alleged that the mark-to-market rule played (and, is playing) a significant role in the crisis.

Whether this is true or not is difficult to conclusively prove. Certainly the proximity of the mark-to-market rule (called FAS 157 in the US) going into effect and the credit crisis made the US regulators suspicious. And logically it appears that the mark-to-market rule could have a deleterious effect on Wall Street's sentiments.

To be more specific, Section 132 of the US Emergency Economic Stabilization Act of 2008, titled Authority to Suspend Mark-to-Market Accounting restates the Securities and Exchange Commission (SEC)’s authority to suspend the application of the mark-to-market rule if the SEC determines that it is in the public interest and protects investors.

Furthermore, Section 133 of the Act, titled Study on Mark-to-Market Accounting, requires the SEC, in consultation with the Federal Reserve Board and the Department of the Treasury, to conduct a study on mark-to-market accounting standards as provided in FAS 157, including its effects on balance sheets, impact on the quality of financial information, and other matters, and to report to Congress within 90 days on its findings.

The US Emergency Economic Stabilization Act of 2008 was passed, and signed into law on October 3, 2008.

On September 30, 2008, the SEC and the FASB issued a joint clarification regarding the implementation of fair value accounting in cases where a market is disorderly or inactive.

This guidance clarified that forced liquidations are not indicative of fair value, as this is not an orderly transaction.

Further, it clarified that estimates of fair value can be made using the expected cash flows from such instruments owned by the financial institutions, provided that the estimates reflect adjustments that a willing buyer would make, such as adjustments for default and liquidity risks.

My message is:
Put Malaysia first, globalisation second.

7 comments:

Anonymous said...

I don't think your suggestion is absurd. After all FRS139 deferment and the other suggestion on market suspension are logical reactions to irrational market behavior. It stands to reason that if the US could quickly institute stopper valves on mark-to-market, then there should be no reason for anyone to expect a small market like ours not to signify our wisdom as well. After all, the basis for the rule is a free market reflecting fair value, not a free-dive market reflecting fire-sale value disconnected from all fundamentals. We have seen the latter situation before during the height of the Asian crisis, even for bluechips like Maybank. If we don't defer, our counters will be easy targets for those who have made their pile from the last batch of oil futures, possibly the only ones left on this planet with hidden funds. One can then ask, how is globalization served if it just amounts to exposing oneself to be acquired without a fair exchange?

Having said (all) that (;P), i would like to ask a question and i suspect your respective answers may reinforce the above argument which is just a puny subset of the blogger's extensive thesis. The qustion is this: do you think bluechip counters like Maybank, IOI, Genting and Petronas are considered barometer benchmarks of the local bourse by serious tranche investors?

If your answer is yes, then we must thank our blogger here for the tying together the heads-up on Maybank and the potential impact of mark-to-rule on all our sectors, not just financial...

..because, it seems, Maybank has just crossed a bridge too far:

http://ifile.it/9pnxd5i

Did they factor into the acquisition the fact that not just the target bank but the entire country in which it belongs is about to keel over? So what sort of returns do they envisage, say, by 2010?

de minimis said...

hi walla

I suspect you know what the answer is. The stocks you mentioned are KLCI-linked. They are some of the heavy-weight blue chips that Bursa has seen fit to contribute to the indicia of the KLCI. So, yes. If Maybank's share prices are irrationally valued then KLCI would present a negative barometric reading.

But, just for fun, let's take our little hypothetical Eurocopter (pardon the pun) to an even higher altitude and ask this question: Should the KLCI be regarded as a barometer of economic confidence. "Market confidence" is fine. But "economic confidence"?

This is why I am happy in being a small fry keeping "virtual company" with intellectual giants like Nouriel Roubini who has called for a "standstill" of sorts for the financial markets.

The barometer has broken down and needs serious fixing. It's just the opinion of a madman, anyway.

myop101 said...

Well, I have to disagree with you on this one.

Understandably, we call the current drastic fall in share market as irrational. But just about a year ago, when the share prices went up quite drastically, was it rational? Has fundamentals of those companies improve so much that it warrants such high prices?

I am quite sure many claimed credits, whether it is properly due or not, on that "achievement" and in fact, many would have recorded improvements in their balance sheet thanks to the higher share prices then.

but right now, because the market tanked and the share prices are down, we began to question if the market traded shares are correctly priced since the inherent value has not changed.

yet if we believe in this argument, can anyone of us here convince the other person to buy those same shares based a year ago pricing? If not, how can it be fair value? It is not the seller's position that we should take into account in an arm's length transaction. It is also a buyer's position.

Otherwise, if the seller do not intend to sell but wants to reflect the proper value, it must have a proper and consistent mechanism widely accepted and acknowledged to value the company differently from a pricing indicator easily available by using the Star online to find.

the whole point of valuing based on mark-to-market is to reflect the fair value of the investment at that particular point in time. If the company year end is 31 December 2008, the market traded shares should reflect the fair value as at 31 December 2008.

volatility is the inherent nature in market traded instruments. and the decisions of investors who acquire these companies, whether as part of business synergy and expansion or merely investment in nature has to therefore reflect it in the books.

if Maybank (for instance) are adamant that BII is there for the long haul and they don't see the market properly reflecting the value of BII, then the question is, Maybank must justify why they continually keep the listing status of BII and allowing it to bring the same volatility into its balance sheet.

which is why, any smart and rational investor would actually read the annual report and financial statements to note what they are buying into.

so is it fair to blame the accounting standards and mask what we observe today from being reported in the books?

in this regard, my opinion is this has little to do with globalisation but more to do with reflecting the fair picture of what these companies have in their books at that reporting date.

walla said...

tabik spring, myop101

(that also torpedoes my hk model but 139 intervention ;P)

de minimis said...

myop101

FRS139 is an important rule. And I fully agree with your analysis which supports the intent of the rule.

But, my point is that we cannot be doctrinal about this rule. In certain cases of dire economic stress that threatens systemic market failure, some degree of flexibility is required.

At this juncture, Bursa stocks are neither here nor there. This time around we were spared the volatility of 1997-1998.

But I maintain that some flexibility should be instituted on the application of FRS139 where there are irrational sentiments at play.

As to whether such irrational sentiments exist in the context of Maybank and its investments or the rest of the Malaysian banking community, which is the only sector that presently uses FRS139, I don't know.

What we do know is that Maybank has impairment pressures. I suspect CIMB also has impairment pressures. Other banks, I have no information on.

That is why Bank Negara is moving towards a flexible approach towards FRS139. Frankly, rather than take a doctrinal approach I would say that if being flexible on FRS139 is what it takes to ensure financial sector stability and capital market stability I say go for it. The alternative is a horrid scenario where the capital market suffers a massive irrational sell-down just like in the major global markets.

myop101 said...

dear de minimis,

i understand where you are coming from in terms of market stability but again, was the market rational when the oil and commodity prices, within 1 year shot up more than 100%?

was it really a real shortage of supply and somehow, an explosion in demand from China and India caused the prices to rise?

also, what is the factor that decided that perhaps, maybe oil prices should retreat to USD 70 today from USD147 just about 3 or so months ago? again...did the demand suddenly disappear or we found major oil discoveries.

just because the same irrational exuberance now turn into irrational panic, why should ask to calm the market by establishing an artificial floor when there weren't any artificial ceiling being put in place to halt it in the first place?

For tradable investments, FRS139 is meant to reflect the volatility in the books. i am sure during the irrational exuberance period, there are much reserves being parked which ended up making the balance sheet rosier.

But with the irrational panic period we see now, wouldn't these reserves now evaporate?

hence by placing notes to accounts and explanations as well as separate classifications in balance sheet, investors have no excuse to blame the preparers of financial statements from hiding these volatile investments.

the problem is again, not the accounting standards but rather irrational behaviours which was is now amplifying itself. all the self made prophecies have come home to roost.

let's look at it from a different perspective.

why are we handicapping rational investors who waited at the side by making a call for market stability by altering the rules?

in the first place, isn't all these irrational pricing caused by irrational behaviours?

aren't rational investors merely picking up the pieces of irrational ones which quit rather than stayed on for the long drawn fight?

when the irrational ones are making great profits in the period of irrational exuberance, the rational ones have chosen to stay at the sideline knowing it is not sustainable. is anyone going to compensate them for making rational decisions?

yes, perhaps you are right. i am being academic here and you are more of a pragmatic person. but like i said before, i subscribe to the small govt with little intervention mindset. i just feel it is not right to alter rules just so we help drama queens which caused all the havocs in the first place.

de minimis said...

myop101

I suppose you're approaching the issue from a rational investor's point of view while I'm approaching it from a policy-maker's perspective. If you care to read my earlier posts on the Wall Street market turmoil, you will see that I was taking the rational investor's standpoint and I had little good things to say about the events that led to the turmoil that has affected global economies.

Lately, as the panic has receded I have been inclined to look at the aftermath of the panic from the perspective of how to minimise the adverse impact of the economic turmoil on the Malaysian economy. There will be an economic contraction. But while I do enjoy gloating, that indulgence is a luxury that I feel that I cannpt afford.

Instead, I'm trying to apply what little is left of my mind to examining the possible systemic weaknesses in the Malaysian economy. From this perspective i'm less interested in the shenanigans of specific banks or corporations and their investment capers. Whether they should be punished by impairment or investigated the regulators is not relevant in this context. But, whether the shenanigans may result in a systemic failure is my focus.

Perhaps in future posts I may revisit issues like corporate governance which tends towards the "micro" issues. For now, my mind seems to be drawn to "macro" issues.

I guess we're approaching the same issue of FRS139 from different angles. It reminds me of the story of the blind men examining different parts of a pachyderm only to arrive at different conclusions about what an elephant looks like! Great discussion, though.