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Bank Of America: Shortcut Gone Wrong & Long

Feb 22

Written by: Jack Ciesielski
2/22/2006 8:58 AM

One of the biggest banks in America has become one of the biggest companies to restate its financials due to the improper use of the "shortcut method" of testing for hedge effectiveness in its use of derivatives. The bank monolith filed a non-reliance 8-K this morning which "neutralized" its financial statements for the first three quarters of 2005, and for the full year financials stretching all the way back to December 31, 2001.

Shortcut testing, you'll recall, allows a firm to skip the onerous proof of whether or not its hedges using derivative instruments have been effective for Statement 133 accounting purposes. The problem we've been seeing, at firms like CIT Group, General Electric, and recently, many smaller banks, is that the shortcut method was never really the right way to approach effectiveness testing for these firms. To get the shortcut treatment, there's a very black-and-white set of criteria to be met - otherwise the rigorous "long-haul" testing needs to be performed. Firms are now realizing, either with help from the SEC or their auditors, that they shouldn't have used the shortcut and need to restate.

That's what Bank of America is doing now. The numbers are pretty small: in 2005 diluted EPS, a reduction of $.10; in 2004, a reduction of $.05; in 2003, a reduction of $.02; in 2002, an increase of $.10. (No per share figures given for 2001, as it'll be a prior period adjustment in the restated financials to be published by March 16.)

There's been speculation as to whether or not the "shortcut failure" issue will become a restatement virus like last year's lease restatement issue. When the smaller banks suddenly began reporting restatements a few times a week, it certainly seemed like it would - then the restatements went cold. Does the BofA restatement mean that the virus is alive and spreading? The first reflex is that yes, they're back - but not necessarily. The smaller financial institutions that were announcing restatements in the last couple months of 2005 were likely to dope out the extent and consequences of dumping the shortcut method a lot more quickly than a giant like Bank of America. One guess: BofA has probably been working on these shortcut problems as soon as the issue surfaced, so they're remedied in time for the current 10-K filing. It could very well be that there are other giant financial services companies out there who needed the time to get this evaluation complete - and we could be seeing a spate of shortcut-related restatements coming from them. Still, there's no catalyst like last year's letter from the chief accountant of the SEC to the accounting profession that would spark a total frenzy like last year's lease restatements.

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