The most difficult to value opaque assets on a bank’s books – called Level 3 assets – rose by more than 20% for lenders like Barclays Plc, Citigroup Inc., BNP Paribas SA and Societe Generale SA during the first half of 2020.
These sometimes illiquid and difficult to value trades are now worth a cumulative $250 billion, according to Bloomberg. Level 3 assets can include distressed debt, some mortgage backed bonds, high risk loans and derivatives linked to things like interest rates and corporate debt.
Even better? Nobody can explain the jump in the value of assets, which are marked to market using discretionary estimates that have been, in the past, at the center of several fraud stories (like Allied Capital). Banks value these assets “based on historical trends and their own risk assumptions” which has, naturally, given the category the label of “mark to myth”.
Some are explaining the rise as “a natural consequence of pandemic turmoil” while others state that the assets may have been added to by banks “after seeing the potential for a windfall in the chaos” that arised during the pandemic.
Jerome Legras, managing partner at Axiom Alternative Investments, said: “Banks need a little bit of complexity to actually make a lot of money. Clearly, there is a link with record profits.”
The increase is hard to ignore: it was the largest increase in the value of these assets in a half decade.
As Bloomberg notes, these assets are greater than 30% of the common equity Tier 1 capital at banks like Deutsche Bank AG, Credit Suisse Group AG, Barclays, Societe Generale and Credit Agricole SA.
Michael Huenseler, who helps oversee 28 billion euros at Assenagon Asset Management in Munich, said: “Level 3 assets have a reputation as toxic, loss-prone assets which are hidden to the public.”
Level 3 assets played a major role in the Great Recession, where banks were have found to assigned unrealistic valuations to billions in investments.
Kathryn Judge, a law professor focused on finance at Columbia University, commented: “This year’s increase means banks’ Level 3 assets are almost the same size as the gross domestic product of Finland —