WASHINGTON – NCUA and bank regulators called on the Financial Accounting Standards Board to scrap its proposal to extend fair value accounting, also known as mark-to-market, to all of an entity’s assets, including loans, saying such an approach would not faithfully reflect the financial positions for credit unions and banks.
The proposal, said the regulators in a comment letter sent to FASB, would wreak havoc on the thousands of smaller institutions, many of whom do not prepare financial statements separate from the regular call reports they submit to regulators. “As a consequence, the FASB’s proposed financial instruments accounting standard would apply to the balance sheets and income statements that all financial institutions supervised by the agencies prepare for regulatory reporting purposes, even if they do not otherwise issue a full set of financial statements,” wrote the regulators.
“Although fair value accounting is appropriate for trading activities and derivative instruments, it is generally not appropriate for financial instruments held for collection or payment purposes,” said the regulators, which include Debbie Matz, chairman of NCUA, Ben Bernanke, chairman of the Federal Reserve, and the heads of the FDIC, the Office of the Comptroller of the Currency and the Office of Thrift Supervision.
Disclosures of fair value information, they said, would be better provided as footnote to balance sheets.
The proposal has received widespread condemnation from credit union executives, and from bank executives and accounting practitioners.
The proposal comes a little more than a year after the controversy over mark-to-market accounting came to a head as banks and credit unions, especially corporate credit unions, were forced to wipe out billions of dollars in value of their investments. The credit union and bank regulators referred to this.
“During the financial crisis, fair values for many financial instruments diverged significantly from expected collections of future cash flows,” the regulators wrote. “The lack of market confidence in fair value estimates undermined financial stability and fostered pro-cyclical economic effects as fair value ‘marks’ spiraled downward. The same could be said of overly optimistic fair value measurements prior to the crisis, which were a byproduct of short-term risk taking and market exuberance. This illustrates the shortcomings of extending the use of fair value to measure financial results of financial institutions whose business strategies are not predicated on the sale of financial instruments.”
“Fair value measurement would not faithfully reflect these institutions’ financial position because their business strategies are not predicated on the sale or transfer of these instruments, but rather the collection and payment of contractual cash flows,” wrote the regulators. “Amortized cost is generally a more representative measurement for financial instruments held for collection or payment purposes because it best reflects the expected receipt or payment of future cash flows. This would include loans, core deposits, and an entity’s own debt.”
“Presenting fair value estimates in the primary financial statements for illiquid instruments such as loans may create a false sense of precision or raise significant questions among users regarding these inherently subjective estimates,” commented the regulators. “During periods of market dislocation or periods of economic expansion, estimates of fair value for loans can fluctuate widely based on the perceptions and risk aversion of market participants. These fair value estimates could result in business or investment decisions based on false signals or result in overreactions to short-term market movements. For these reasons, we believe the required use of fair value as the primary measure for nearly all financial instruments would reduce the quality and undermine the efficacy of the primary financial statements for the broad range of financial statement users.”
The mark-to-market proposal is part of a broader project being conducted by the FASB that was put out for a 90-day comment period that expired last week. The project is titled: Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities.
