Cash Flow: a Better Way to Know Your Bank?

A study of commercial banks comes up with ways accounting for operating cash flow could be improved.
Sarah JohnsonJuly 9, 2009

If banks more consistently accounted for their operating cash flow, companies could gain a better grasp of their commercial banks’ financial health, two professors suggest in a report to be released later this week.

The results would be astoundingly different than what financial institutions’ statements of cash flows tell us today. In the course of an attempt to make the firms’ cash-flow reports more comparable – which entailed several adjustments to how banks classified their investments, accounted for non-cash transfers of their loans, and recorded cash flow from acquisitions last year – the researchers saw huge swings, both downward (Bank of America) and upward (KeyCorp).

As it stands now, banks can’t be reliably compared to each other by their recorded cash flow from operations, the researchers contend. Their observations stem from their study of the cash-flow reports of 15 of the largest independent and publicly traded U.S. commercial banks in terms of total assets as of December 31, 2008. “Right now, operating cash flow for a bank is basically meaningless,” says Charles Mulford, director of the Georgia Tech Financial Analysis Lab, who co-wrote the study with fellow accounting professor Eugene Comiskey.

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In BofA’s case, the bank reported operating cash flow for 2008 of $4 billion. But under the researchers’ method, the firm would have had an operating cash flow of negative $6.9 billion. Other financial institutions that saw a decline under the researchers’ calculations: J.P. Morgan Chase and Wells Fargo.

Some firms went the other way. These included Citigroup, Fifth Third Bancorp, PNC Financial, and SunTrust Banks. KeyCorp, which had reported $220 million in negative operating cash flow last year, could have had a positive $3 billion result if it hadn’t moved some loans out of the held-for-sale classification to the held-for-investment category.

To be sure, the banks that would have had better results may have been more concerned with the end product of other financial metrics and made changes to its investment portfolio for the benefit of its earnings results, rather than worrying about its operating cash flow, according to Mulford. After all, he noted, operating cash flow a figure largely ignored by analysts when it comes to banks.

Moreover, the researchers aren’t accusing the banks of doing anything wrong, since current accounting rules allow them to freely make non-cash transfers between investment classifications, a move which can have varying effects on how loans and securities are accounted for in cash-flow statements. Most likely, Mulford says, the firms that make these reclassifications are doing so for the good of their overall investment portfolio, which in turn could help their earnings in the near term.

Banks’ cash-flow reports differ among each other in other ways as well. They vary in how they designate their various cash flows as being from operating, investing, or financing activities. Perhaps, the researchers imply, those concerned with banks’ financial stability should demand that more attention is paid to the cash-flow statement to get the banks to be more consistent – and to give their investors incentive to give their cash reports as much credence as they would those of non-financial firms.

“For companies in general, cash flow is their lifeblood,” Mulford says. “Are they creating cash or consuming it? If they’re consuming it, then they have to find it somewhere, and may have to rely on the capital markets, which aren’t at a very friendly time right now.”

However, with banks, the cash-flow metric is overlooked, Mulford contends. The researchers don’t offer a solution or take a stance, but rather ask that their research be used by standard-setters and analysts to push for change. “Obviously something is wrong with [the structure of] cash-flow statements when nobody uses it for a particular group,” Mulford says, calling his report an “open invitation” to the Financial Accounting Standards Board.

“We wrote the study in the interest of building dialogue and possibly improving upon the usefulness of cash flow for commercial banks,” Mulford says.

The researchers question the usefulness of the current characterization of increases and decreases in deposits as financing cash flow. Instead, they believe customer-driven deposits should be accounted for under operating cash flow since “the very health of a bank’s operations depend on its deposit base and its ability to attract a growing stream of deposits.” The researchers admit their report’s final calculations are not fully accurate, partly because they didn’t have enough information to distinguish between brokered and consumer-driven deposits.

Stressing that they’re mainly trying to stir up public discussion about the problems in the financial reporting of banks’ operating cash flow, the researchers acknowledge that reports’ conclusions are far from perfect. After all, the researchers’ adjusted numbers give troubled Citigroup a relatively rosy picture of $159.4 billion in adjusted operating cash flow – compared, for example, to a negative $94.3 billion for J.P. Morgan.