Relying too heavily on reported numbers and statistics can lead to damaging conclusions and misinterpretations.
As example, I always use the story of the man who finds that the chances of someone bringing a bomb on a plane he is flying are 1 in 38,967. Thinking this is too risky for comfort, he inquires what the chances are that two people will bring a bomb on the same plane at the same time.
The statistician replies: "Statistically impossible."
So after that, wherever he goes, he takes his own bomb along.
What brings this to mind was a release by Veribanc Inc., a bank-rating service based in Wakefield, Mass., commenting on recently instituted accounting rules requiring banks to report unbooked-losses on securities they plan to hold to maturity.
Taking these unbooked losses, and comparing them to reported capital, Veribanc revealed that nine banks have unrealized losses of more than 50% of their capital, while 67 banks had losses of over a quarter of their equity.
Not only were all nine banks with the 50% unrealized loss community institutions, but worse, a report on the study in this newspaper quoted experts saying that community banks "lack the expertise in managing interest rate risk that larger institutions have."
Naturally this brought heated response, including that of one of the nine: James O. King Jr., president of the Peoples State Bank of Chaplin, Ky. Mr. King replied that the numbers were inappropriate because they did not include the tax implications. Had the tax savings from reporting these losses been deducted from the loss figure, so that losses were calculated after taxes in the way equity is, the loss would have been far smaller.
The response of Veribanc was that since some banks do not have profits from which the losses could be deducted, it is impossible to give a standard after-tax number and making only the unrealized loss figure significant for comparison.
But what really bothered some observers about the issue was the assumption that community bankers don't have the ability to handle interest rate risk.
"You have to know the whole bank- not just the value of long-term securities in 32nds of a point to evaluate performance," one irate observer, Richard Olstein, partner in Sandler O'Neill & Partners of New York, explained.
"The release totally ignores the effect or rising rates on the liability side of the balance sheet and that a bank's rate-sensitivity position is more important to the safety and soundness of the institution than the maturity characteristics of just one piece of its earning asset base," adds Kenneth Pughsi, a managing director of the same firm.
In effect, what bothers these two observers and many others is the assumption that community bankers just sit and take whatever securities they are offered and don't know what is happening in their whole bank This is far from the truth.
This controversy should show nothing new to community bankers who have already understood the one-sidedness of FASB 115 -- the new mark-to-market accounting requirement.
But it should serve as a strong warning that community banks have to do a lot better at explaining to interested observers what the numbers they are required to report really mean.
Even the OCC has announced that while banks will have to report market value of securities rather than cost under FASB 115, it will make an exception in requiring banks to maintain enough capital to cover possible losses on loans and other investments.
The fear was that a sudden plunge in securities' values would send a bank's capital below regulatory minimums, thereby forcing a governmental takeover.
In essence, the OCC is saying that numbers must be taken with a grain of salt and a deeper look is needed at what caused the numbers to change.
The OCC's statement should provide a good precedent for accountants, statisticians, and other observers who often just see the numbers without digging into their real meaning.
In doing so, they are like the man who just plays E-flat on his cello all day.
When asked why he just plays one note instead of lots of them, he replies "Everyone else is looking for the note. I found it."
Similarly bankers must get the public the lawmakers, and the analysts to realize that they play lots of notes and the one note security prices -- cannot be the be-all and end-all of value determination.
Mr. Nadler is a contributing editor of American Banker and professor of finance at the Ruggers University Graduate School of Management.
