Regulators appear ready to demand mark-to-market accounting for bonds.

WASHINGTON -- Action by the federal banking agencies on a controversial accounting change to regulatory capital guidelines appears imminent.

The proposal requires financial institutions to value debt securities that they trade at market value, a much more volatile measure than the amortized value currently used.

Because of the added volatility, bankers generally oppose the rule. They said in comment letters filed at the central bank that there is no need to adjust capital to market rates.

"Until a sale occurs, there is no change in Tier 1 capital, only the possibility of such a change,"' wrote Howard K. Loomis, president of Peoples Bank in Pratt, Kan. So why reflect the possibility of change m value, he asked.

Other bankers were less diplomatic.

"Enough is enough," wrote Patrick A. Wick, president of Bank of Turtle Lake, Wis., making liberal use of capital letters.

"Please leave current Tier 1 capital alone and take some imtiative to repeal FAS 115," he added.

State Street Boston Corp. senior vice president Steven C. Arst wrote that the accounting change would cause "distortions" in regulatory capital and lead to confusion in calculating capital adequacy. He wrote that every change in interest rates would force accountants and regulators to revalue entire portfolios.

He also said foreign banks would gain a competitive advantage because they could still value their securities at amortized rates.

Other bankers, including Union State Bank of New York chief financial officer James B. White, expressed fear that the rule might signal the start of an effort to include market-based accounting in all facets of regulatory accounting principles, or RAP.

The banking trade associations are united in opposition to the rule.

James R. Lauffer, president of the Independent Bankers Association of America, wrote that FAS 115 will result in less accurate reporting of financial data because the underlying values of an institution's securities will be constantly changing.

The American Bankers Association also weighed in. James D. McLaughlin, director of agency relations, wrote that the rule will force banks to mark securities as for sale even though the bank doesn't plan to unload them. The reason: Banks will fear losing the ability to sell these securities down the road.

The Savings and Community Bankers of America have their own proposal. Former government relations director Alfred M. Pollard wrote that if the agencies must adopt FAS 115, then they should use their discretionary power avoid citing some institutions that lose their capital overnight because of the change.

(Mr. Pollard has since left the thrift trade group for the Bankers Roundtable.)

Mr. White also wrote that the rule change will encourage banks to trade securities for profit because they will hold more securities in their trading accounts. That change will lead to more cherry-picking, not less.

In fact, the cherry-picking issue lies at the heart of the debate. FAS 115 seeks to prevent banks from selling securities that have increased in value without alio taking the loss for securities that have lost money.

To do this, the proposal requires financial institutions to divide their debt securities into three groups: held to maturity, available for sale, and trading.

Banks can continue to value securities in the held-to-maturity category at the amortized cost, a stable value. But, they cannot sell these securities except in extreme cases, such as the need to keep from failing. Changing interest rates are not considered an extreme situation.

The proposed regulation gives banks much greater freedom to sell the other two types of securities, But they must rate these at the fair value, which is quite volaflle because it reflects market changes.

Not everyone is opposed to FAS 115. Several bankers, especially those from larger institutions, wrote that the agencies should adopt FAS 115 because it complies with generally accepted accounting principles, the norms that accountants are supposed to follow.

"Given that generally accepted accounting principles are the standard by which most users of financial statements judge the accuracy of the amounts presented, I see no reason to create a RAP [regulatory accounting principles] and GAAP difference in this area," Central Arkansas Bancshares chief financial officer Mark Langston wrote: "These differences tend to be very confusing to financial statement users."

He also wrote that differences in accounting treatments always increase costs.

Officials at NationsBank and Chemical Bank made similar arguments.

The proposed accounting rule seeks to correct a problem discovered in the early 1980s when banks valued all debt securities at amortized cost. Regulators realized that banks were abusing this practice to inflate their profits and capital levels.

Specifically, banks were "cherry-picking"-- selling securities that had gained value so they could boost profits. But they also kept securities that lost value because those instruments could remain in the portfolio at their amortized price, which was considerably higher than their market value.

This situation distorted capital positions and inflated balance sheets because the banks were profiling from the bonds that went up without deducting for the bonds that went down.

The situation got so bad that if regulators had valued several banks' bonds at market levels, those banks would have failed.

The regulators finally said "enough" in 1988 when they first proposed a change in the accounting rules.

That proposal -- in effect a technical accounting change -- went to the American Institute for Certified Public Accounts, which referred it to the Federal Accounting Standards Board. FASB issued its final rule in May 1993.

The Fed staff has nearly completed a white paper addressing whether the agencies should apply the new standard. A central bank staffer said officials will deliver their report on whether to amend Regs. H and Y to incorporate Financial Accounting Standards Board Statement No. 115 to the governors and other chief regulators shortly, most likely in early fall.

The staffer said the governors and other regulators will dissect the report and propose a final rule by year's end.

The white paper, which does not take a position on the issue, will address the advantages and disadvantages of adopting, rejecting, or partially adopting the accounting change, the staffer said.

The staffer said the paper will include many of the 65 comments the Fed has received to date on the proposed changes.

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