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U.S. bank accounting rule has big earnings impact

* Sheds light on deteriorating credit-worthinessBy Nanette ByrnesOct 17 (Reuters) -- A $1.9 billion accounting gain by Citigroup , more than half of the $3.8 billion net income it reported for the third-quarter, highlights a controversial accounting rule that analysts say is adding volatility to many large banks' reported earnings.They expect it to continue to be a factor as more banks report earnings in the coming weeks.Last week, JPMorgan Chase & Co reported an identical gain. Other banks that use the same accounting treatment include Goldman Sachs , Morgan Stanley , Bank of America , HSBC , Barclays and many German banks, according to Moody's senior credit officer and bank accounting specialist Donald Robertson.The rule allows banks to value some types of assets and liabilities on a mark-to-market basis. In the case of JPMorgan and Citigroup, a weakening of the banks' debt relative to U.S. Treasuries is what has led to these reported gains.As their debt lost value, it became cheaper for the banks to retire the debt if they chose to do so. The chance to retire debt at a price below its issue price produced the gain Citi and JPMorgan are reporting, and the boost to reported earnings."It just creates noise when trying to compare one bank to another," said Moody's Robertson.The rule makes it harder to compare companies because banks have wide discretion on how they apply it. They can use it on financial liabilities with some exceptions, including deposit liabilities or deferred tax liabilities. Or they can use it only for certain individual instruments, and not for others.It's a degree of latitude that makes it difficult to compare one bank with another and to predict how big an impact it will have on a bank prior to its reported earnings.Once a bank chooses to use the rule, it must stick to mark to market valuation until the liability in question expires or otherwise disappears.'UNIVERSALLY DESPISED'"This is the most vilified accounting rule I've ever seen. It's amazing how universally despised it is," said Robert Willens, author of the Willens Report, which analyzes corporate accounting and tax matters.It does have some supporters, however, and they argue that the rule highlights valuable information that otherwise would be absent from quarterly reports. In Citibank's case, it is the bond market's view that its bonds are getting riskier."There is good information in these gains," Jack Ciesielski, an independent accounting analyst and publisher of The Analysts' Accounting Observer told Reuters by email."They are telling you the degree of faithlessness existing in the bond market for these companies. The fact that we see them in a big way for the first time since the credit crisis is disconcerting," he said.In practice, analysts tend to knock these figures out of their earnings analysis, arguing that a gain or loss this period may be reversed in the future, said Ciesielski, and that the figures don't pertain to ongoing profitability.Of the 1,000 banks Moody's tracks globally, about 70 use this accounting, including many of the largest banks, Robertson said. Moody's analysts strip it out of their earnings figures.With controversy swirling, rulemakers are considering changing the rule, according to Robert Stewart, a spokesman for the Financial Accounting Foundation, an overseer of rule-making for U.S. accounting.The original aim of the rule, which went into effect November 2007, was to address the mismatch between assets, which financial companies often carry on their books at fair market value, and liabilities carried at cost, Stewart noted.

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UPDATE 2-Austria's Volksbanken revamps to bolster capital

* Plan would boost capital, avert more state aidBy Michael Shields and Angelika GruberVIENNA, Oct 13 (Reuters) - Oesterreichische Volksbanken AG , the Austrian bank that failed this year's European stress test, will post a 2011 loss and reorganise to shore up its balance sheet, the country's fourth-biggest lender said on Thursday.Vienna-based Volksbanken announced after a supervisory board meeting that it aims to form a mutual liability association with its main regional bank shareholders, as financial sources had earlier told Reuters.The plan -- modeled on Dutch lending cooperative Rabobank -- would let Volksbanken consolidate the regional banks' capital while keeping them separate entities, allowing it to avoid more state aid.Volksbanken received 1 billion euros ($1.37 billion) in nonvoting state capital during the financial crisis. It now will not repay a 300 million-euro tranche due this year, it said.After writing down the book value of its Investkredit Bank and Romanian units by around 700 million euros and absorbing other one-off costs, Volksbanken AG alone expects to lose around 900 million euros this year, it said.On a consolidated basis, it is set for a loss of 500 million to 750 million euros according to IFRS accounting standards, it added."The current conditions on financial markets force us to revalue our participations and to bring them in line with the current developments on the markets," it said, adding it expected the financial crisis to last for some time."In our view, these steps were necessary in order to prepare ourselves for the tough economic conditions," Chief Executive Gerald Wenzel said.Its regulatory capital base will fall by around 200 million euros as a result of the move.WEAK FINANCESVolksbanken is the second big Austrian bank to clean up its balance sheet this week. Erste Group Bank said it would lose up to 800 million euros this year and omit a dividend after writedowns in eastern Europe.Volksbanken has been trying to use asset sales to shore up its balance sheet and comply with Basel III capital rules.But it received less than it wanted for selling its VBI Eastern European arm to Russia's Sberbank and has been unable so far to sell its minority stake in peer Raiffeisen Zentralbank as planned.In April it had said its main shareholders would chip in money to help repay the 300 million euro aid tranche due this year, but that plan did not pan out.Volksbanken had already issued a profit warning and said it was unlikely to make 2011 payments on shares and hybrid or supplementary capital.Failure to make repayments gives Austria the right to convert aid into equity and nationalise a third bank, a step Finance Minister Maria Fekter says she would prefer not to take.Regional banks own 60.8 percent of Volksbanken. Germany's DZ Bank Group owns 23.4 percent, Victoria Group 9.4 percent, Raiffeisen Zentralbank 5.7 percent, and others 0.6 percent.