Financial Restatement 2009 Was a Stellar Year

Financial Restatement

2009 was a stellar year in terms of corporate financial restatements; just 630 U.S. companies reported 674 accounting problems serious enough to warrant a restatement, a dramatic 24% decline from the number of companies with accounting problems in 2008" (Krantz, M. March 1, 2010). However, for Citizens First Bancorp Inc., 2009 was not a year in which to celebrate. In the first and second quarters Citizens was forced to restate their earnings based on two separate incidents, the first involving "an accounting error on a $7.5 million impairment of its deferred tax valuation allowance" (Barba, R. October 20, 2009). Second a regulatory action by the Federal Deposit Insurance Corporation (FDIC), which involved allegations of "inappropriate behavior at the company, including removing unfavorable appraisals from the loan files, in an attempt to avoid the recognition of additional loan losses" (Barba, R. October 20, 2009). The FDIC required Citizens to increase their loan loss allowances by 52% from their reported 35.3 million levels. "The two actions together moved the bank from adequately capitalized to undercapitalized" (Barba, R. October 20, 2009). Examining both of these restatements will allow for the explication of the specific accounting principles involved, and the subsequent effects which the restatements have on the company's financials and stockholders.

The first quarter restatement involving the accounting error on deferred tax valuation "represents timing differences in the recognition of certain tax benefits for accounting and income tax purposes, including the expected value of future tax savings that will be available to the Company to offset future taxable income through the carry forward of net operating losses" (GlobeNewswire. October 6, 2010). Succinctly, Citizens initially overstated their tax deferred asset allowance, and now "it must essentially write down the deferred tax asset, which it does by creating a "valuation allowance" on its balance sheet. That valuation allowance cuts into income reported to investors and can hit a portion of a bank's regulatory capital, as well" (Alloway, T. November 4, 2010). The write down presented the problem for Citizens. Amidst the tumult of the financial crisis and its aftermath, banks are being forced to hold more tier one capital. A problem though is that "DTAs grew in dollar terms by nearly 300% over the 12-months to June 30, 2009 and now account for 10.7% of equity for U.S. banks, on average" (Alloway, T. November 4, 2010). The FDIC is now keeping a much closer eye on banks levels of tier one capital, and for Citizens the restatement pushed their capital levels below what is considered well capitalized.

The second restatement regarding the increased loan loss provision deals with recognition that the assets on their books were not valued accurately, loans did not have adequate collateral backing them, and that future defaults on loans would be greater than originally anticipated. Citizens Bancorp is not alone in the increases in loan loss provisions. "Many community banks have failed to come to terms with the true value of their assets" (Barba, R. October 20, 2009). As with the write down of the tax deferred assets, the increase in loan loss provision also affects the tier one capital ratio which the FDIC monitors closely. If the capitalization ratios indicate a financial institution is undercapitalized, invariably the bank will have to raise more capital either through a stock issuance, or an increase in their asset reserves to bring the capitalization ratio to acceptable levels.

Regarding the financial statements both the write down of the tax deferred asset and the increase in loan loss provisions are non-cash charges. On the filed SEC 10-Q for Citizens the Consolidated Balance Sheet reflects loans less allowance for loan losses of 1.3 billion dollars (SEC.gov. August 8, 2009). The Consolidated Income Statement reflects the increase in loan loss provision which reduces net interest income and ultimately net income as reported to shareholders. The loss per share for the second quarter of $2.73 is also indicated on the Consolidated Income Statement (SEC.gov. August 8, 2009). The impairment of the tax deferred asset is likewise recorded in the Consolidated Balance Sheet and Consolidated Income Statement. The loss is also carried over to the Consolidated Statement of Stockholder Equity. Lastly, the Consolidated Statement of Cash Flows operating activities reflects both the increase in loan loss provision and the tax deferred asset write down.

Shareholders have not been treated to an enjoyable ride in regards to Citizens Bancorp stock. The three-year chart indicates a fall from the high stock price of $14.37 to the now current trade of .02 cents (CNBC.com). Certainly the restatements did not help the stock price or the earnings situation however, the real issue for smaller banks including Citizens is the toxic mortgage assets which they are holding, coupled with declining tier one capital ratios. This last point is critical for investors because undercapitalized banks "with that designation are not allowed to pay dividends" (Barba, R. October 20, 2009).