Revised Fair-Value Rule Is Weaker: Moody’s

It's harder for investors to compare banks' financial statements now that IAS 39 lets them decide whether to reclassify "held for sale" assets as "held to maturity," the rating agency says.

The effects of a fair-value accounting rule change are popping up in the third-quarter earnings reports of banks — and at least one credit-rating agency thinks investors were better off before the revision.

In a report issued Friday, Moody’s Investors Service analysts take issue with changes to IAS 39, the international accounting standard related to valuing financial assets. The changes, issued last month, allow companies to reclassify “held for sale” assets as “held to maturity.” The switch eliminates the need to record the instruments at fair value, and instead allows banks and other companies that reclassify financial assets under IAS 39 to carry related gain or loss at amortized cost, unless the asset is impaired.

The altered rule mirrors an existing U.S. standard, FAS 115, allowing financial assets to be reclassified “in rare circumstances.” According to the International Accounting Standards Board, rare circumstances may include the deterioration of the world’s financial markets during the past couple of months.

Reclassifying assets could be a big boost for banks that hold in their trading books billions of dollars worth of illiquid securities that under fair-value accounting would have had to be written down.

The reason for the rule change, according to the IASB, was twofold. The board wanted to better align IAS 39 with U.S. generally accepted accounting principles, and it also was keen on changing the rule before officials at the European Commission pushed through their own revision that omitted important disclosure provisions.

Along with the reclassification rule, the IASB issued IFRS 7 — a disclosure rule — to make sure that any assets shifted to the “held to maturity” category are highlighted and explained in the financial-statement footnotes. U.S. GAAP also requires proper disclosures for reclassification.

But IAS 39 diverges from its American counterpart in one important way, says the Moody’s report: companies are permitted to retroactively reclassify financial assets at their July 1, 2008, value, in what the credit-rating agency calls a “look-back option.”

The look-back option “allows managements to essentially ‘cherry-pick’ which assets to reclassify and, in some instances, avoid the recognition of markdowns on assets that declined in value since that date,” notes senior accounting analyst Wallace Enman, a report co-author. Moody’s vice president J.F. Tremblay, another co-author, explains that the main difference between FAS 115 and IAS 39 is that the American standard requires companies to price the reclassified assets on the day the decision is made.

Moody’s laments the IASB change, saying that in some important respects IAS 39 was a better standard than FAS 115. “We believed that IAS 39 was moderately stronger regarding this particular issue, because no transfers were allowed, whereas under GAAP transfers were allowed in infrequent circumstances,” Enman tells CFO.com. He explains that allowing companies to move assets between categories “can potentially inhibit comparability and consistency.” In fact, Moody’s would rather see investment banks marking assets to market through the profit-and-loss statement, “as this treatment better matches the business model of the banks,” asserts Enman.

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