Student: Bank of America and Cash Earnings Essay

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Bank’s ‘manipulate’ cash earnings

Bank’s ‘manipulate’ cash earnings
PUBLISHED: 20 Sep 2012 PRINT EDITION: 20 Sep 2012 John Kehoe Banks are under pressure over remuneration policies which allow bankers to boost their pay artificially and potentially fork out unsustainable dividends, investors and analysts argued. Frustrated senior fund managers said on Wednesday they had lobbied bank boards to overhaul the use of “cash” or “underlying” earnings when determining senior banker remuneration. The financial measurement allows profits to be massaged by stripping out negative one-off items and removing costs reported in statutory accounts. Cash profit, which was first devised by former Commonwealth Bank of Australia chief executive officer David Murray in 2000, can deviate by as much as 30 per cent from other profit measures. The heated debate over executive pay was extended to banks yesterday, following the publication of a report by analysts at Citigroup who called into serious question the use of cash earnings to determine remuneration and dividend payments. The report’s findings were backed by institutional investors who said the major banks used accounting techniques, such as booking restructuring costs and software expenses “below the line”, so they did not negatively impact on cash return on equity. Westpac Banking Corp, National Australia Bank and Australia and New Zealand Banking Group said last night their executive remuneration was not solely based on cash or underlying earnings and they used other metrics. “Cash earnings is one of several inputs we use in determining our dividend policy,” an NAB spokeswoman said. Citigroup analyst Craig Williams said cash profit had “serious deficiencies” and 17 per cent of cash profit never flowed into bank capital, a benchmark that determines shareholder wealth. “Much of the capital ‘leakage’ has been represented by managements’ so-called below-the-line items and mark-tomarket balance sheet movements which are not captured in cash profits,” Mr Williams said in a note. After accounting standard revisions in 2002, “the ‘cash profit’ metric became a creature of bank management’s own creativity. It is neither reliably measurable, nor is it auditable”. Capital leakage is defined as the part of cash profits which do not flow into common equity Tier 1 regulatory capital. Westpac and NAB’s remuneration policies are partly based on cash earnings. Citigroup said it was possible that CBA and ANZ did likewise. ANZ later confirmed “underling (its cash equivalent) earnings” were one of 20 metrics for short-term incentives. NAB has the poorest track record in “below the line” adjustments according to Citigroup, a result of its troubled past of business restructures and write-downs. NAB’s so-called RAP has been 30 per cent less than cash profit, the analysts calculate. “Accordingly, dividend payments have been set at unsustainable levels [NAB has paid out about 100 per cent of common equity Tier 1 generated in the past two-and-a-half years as dividends] and capital generation is most modest,” Mr Williams said. The head of one fund manager said yesterday cash earnings could be “manipulated” by management and it was a perennial problem for investors trying to validate how banks adjusted statutory earnings to cash earnings. “When you’re running a bank there are plenty of levers to pull to deliver a cash-earnings number,” he said. “The problem is choosing a better yardstick to measure performance objectively and that is not easy.” Citigroup said management should be remunerated on regulatory capital generation, best measured by so-called regulatory adjusted profit, to properly align interests with shareholders. Head of research at governance advisory group Ownership Matters, Martin Lawrence, said there were good reasons for deviating from statutory profit. “But companies have to be consistent and avoid the impression of earnings minus the bad stuff,” he said.