Friday, April 03, 2009

Temporarily Impaired

Many Americans find themselves unemployed, unable to keep up mortgage and credit card payments - “temporarily impaired” in accounting terms. With their backs against the wall it is not surprising that their putting pressure on their Congressional representatives for relief. There is a universal appeal to get banks back in the business of lending and out of the insidious racket of simply leveling exorbitant service fees and fines.

It is not surprising then that Congress responded by doing something that has become second nature. They passed the buck right on to the Financial Accounting Standards Board (FASB) that sets accounting standards for all public companies, including financial institutions.

FASB cried fowl but passed a new rules on April 2, 2009, that eases mark-to-market accounting for financial institutions. Give banks some relief from mark-to-market accounting rules that require loan assets to be revalued each quarter at current market prices - potentially wiping out lending reserves! Smaller companies may benefit almost immediately from the rule change as they in particular are dependent upon banking lending for working capital and investments.

One of the changes is the definition of “other than temporarily impaired” - a condition about which that the average Joe and Jane on Main Street has become painfully familiar. Under the new, relaxed rule banks will have more latitude to determine whether to write down the value of a loan asset on their books. Banks will have the chance to carry the loan at book value until it has a chance to recover. This avoids the quarterly boom and bust atmosphere that developed in late 2008 as the credit market system itself began to fail.

Many believe the inception of mark-to-market accounting in December 2007, contributed to the credit market collapse in 2008. No one has argued mark-to-market is a bad idea in principal. However, in my view, it was several years to late in application. Had FASB been timely in promulgating the necessary standards in the first place, the necessity of marking-to-market might have served as a deterrent to the egregious leveraging and risk taking that went unchecked at financial institutions around the country.

In the Crystal Equity Research coverage universe, Reed’s, Inc. (REED: Nasdaq) is a perfect example. Reed’s is an emerging producer of distinguishing non-alcoholic beverages and specialty candies and ice creams. Reed’s appears to be more firmly established in the natural beverage market than ever. The Company recently announced expanded relationships with Ralph’s and Ingles Markets that put more of Reed’s products on shelves in both the natural foods and mainstream beverage aisles. That is all good, but the growth puts pressure on working capital.

Seasonally higher sales in the June quarter and the anticipated launch of the new energy drink in the middle of 2008 are likely to present even more pressure than ever on working capital resources. To support operations in 2008, the Company drew down a line of credit by $1.4 million and increased long-term debt to $1.7 million. The Company is getting by because management has been successful in reducing costs by renegotiating supply agreements and cutting operating expenses. However, access to credit would allow the Company to move more aggressively at a time with the market is most receptive to the Reed’s beverages.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. Crystal Equity Research has a Speculative Buy rating on REED.

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