Accounting Guidance Smiles on Banks

Financial institutions are excused, once again, from fair value accounting.

Without fully suspending fair value accounting to help banks weather the credit crisis, regulators and standard setters are now making it clear that financial institutions can avoid the so-called mark-to-market methodology — at least some of the time.

The latest clarification released by the Securities and Exchange Commission and the Financial Accounting Standards Board points out that banks that issue stock warrants to the government, as part of the Treasury Department’s Capital Purchase Program, will not have to value the warrants using fair value accounting. As a result, banks won’t have to absorb potential losses if the market value of the instruments decline.

The Capital Purchase Program, which is part of the broader federally-mandated Troubled Asset Relief Program (TARP), allows banks with liquidity problems to recapitalize their balance sheet by selling warrants to the Treasury Department in exchange for a cash infusion. So far, nine banks have signed up to participate in the warrant program, including Bank of America, Bank of new York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, Wells Fargo, and Merrill Lynch (see chart).

The warrants have 10-year terms and are immediately exercisable. But the Treasury Department has agreed not to exercise its related voting power. According to the program’s terms, the Treasury Department can buy warrants from “qualified financial institutions,” that give it the right to purchase shares of common stock in the institutions. The aggregate market price of the warrants will equal 15 percent of the senior preferred amount on the date of the investment.

“The accounting authorities, as expected, have rendered a favorable opinion with respect to the classification of these warrants,” tax expert Robert Willens told CFO.com. Willens, who heads tax consultancy Robert Willens LLC, cites an Oct. 24 letter sent by SEC deputy chief accountant James Kroeker and FASB technical director Russell Golden, as evidence that the two agencies “will register no objections” if the warrants are classified as permanent equity under U.S. generally accepted accounting principles.

Treasury’s Capital Purchase Program
All purchases were made on October 28, and comprised preferred stock with warrants.
Bank City Price paid
Bank of America Charlotte $15 billion
Bank of New York Mellon New York $ 3 billion
Citigroup New York $ 25 billion
Goldman Sachs New York $10 billion
JPMorgan Chase New York $25 billion
Morgan Stanley New York $10 billion
State Street Boston $ 2 billion
Wells Fargo San Francisco $25 billion
Merrill Lynch New York $10 billion
Source: U.S. Department of the Treasury, November 5, 2008

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