The Financial Accounting Standards Board’s new exposure draft on accounting for financial instruments, if adopted, could have adverse consequences for commercial banks, according to lobbyists and bank CFOs who are assessing its ramifications. Almost immediately after the proposal was published last Thursday, bankers began questioning its logic, particularly the requirement that even plain-vanilla loans held for collection be marked to market. Bankers say the ripple effects are numerous and include damping origination of long-term, variable-rate loans; spooking bank investors; and increasing procyclicality in the financial system.
“This is really a jaw-dropping proposal,” says Donna Fisher, senior vice president of tax and accounting at the American Bankers Association.
The proposed accounting changes, which would take effect in 2013 for banks with assets of more than $1 billion, would force companies to use market prices to value almost all financial instruments, including loans to corporations and consumer loans such as credit-card debt, and record any changes on the balance sheet. That’s a significant departure from current accounting practice for banks, which record held-to-maturity loans on the balance sheet at amortized, or historical, cost.
The changes to fair value will not flow to net income, FASB says. The changes would appear as a separate line on the balance sheet and in the statement of comprehensive income alongside amortized cost. Currently, components of other comprehensive income (OCI) are usually displayed in notes to financial statements. The proposal would also require banks to be more forward-looking in their estimation of credit losses.
“The objective…is to provide financial statement users with a more timely, transparent, and representative depiction of an entity’s exposure to risk from financial instruments,” FASB says.
But commercial bankers say the rules are antithetical to the business model of holding on to a loan and collecting the payments rather than selling it to a third party. “Our business is not buy and sell,” says Fisher. “If the cash flows are from the customer, there’s no reason to have those market fluctuations. You don’t want that craziness in your financial statements.”
How banks would perform such valuations is also under question. “We have a $5 billion investment portfolio and we can value it using Bloomberg,” says Michael Hagedorn, CFO of UMB Financial, a $12 billion (in assets) commercial bank. “But we would have to fair-value our loans using different discount rates and various assumptions, and I don’t see how that improves transparency.”
“[FASB] is trying to get to where any user can pull up a balance sheet and truly see on a mark-to-market basis the value of a company’s equity,” says Mike Rossi, finance chief at Dallas-based NexBank. “But what they will end up with is a situation where there is a ton of judgment involved.”
In an extreme situation, fair-value accounting might force a bank to take a market loss on the day it makes some loans, says Fisher. “Bankers know the borrower’s credit history better than the market does,” she comments. Even if a loan is fully performing, it will be worth more to the originator than to the market, she says. “They’re going to discount it.”