A big bank’s balance sheet can be a dark and scary place. Some of the world’s smartest investors have sworn off allocating any of their dollars to the financial behemoths. Some of these concerns are legitimate, but some of this resistance comes from fund managers dreading the conversations with their investors if another financial crisis emerged. One can imagine that hardworking doctors and lawyers might not be too happy if told that their investments eroded because their advisor was overweight in financials, again.
One of the most opaque elements of an institution like Bank of America Corp (NYSE:BAC) or JPMorgan Chase & Co. (NYSE:JPM) is the constantly changing nature of its balance sheet as a result of broader market changes. Due to some relatively new and incredibly fascinating accounting rules, banks are required to carry some of their assets as fair value. Obviously, some assets that are highly liquid, think U.S. Treasuries or corporate bonds, are easily recorded at a reliable market value. However, some assets on bank balance sheets that were acquired before the financial crisis in markets that have since dried up — think exotic collateralized debt obligations (CDOs) — are not easily valued.
Every bank now follows this structure in terms of classifying its assets that are recorded at fair value on a recurring basis:
The most common recurring fair value asset level at the largest U.S. bank is level 2. Bank of America Corp (NYSE:BAC), JPMorgan Chase & Co. (NYSE:JPM), and Citigroup Inc. (NYSE:C) all have at least 87% of fair value assets in this bucket. It may come as a surprise to some that Wells Fargo & Co (NYSE:WFC), typically seen as the safest and most reliable of all of the big banks, has the largest portion of these assets in the Level 3 bucket with over 12% at the end of 2012.