Whether bankers like it or not, market-value accounting moves one giant step closer to reality next quarter.

Beginning then, banks with at least $150 million in assets will have to disclose in annual financial statements the "fair value" of a variety of assets, liabilities, and off-balance-sheet instruments. Fair value is the same as market value, only it includes estimates for assets for which no market exists.

Changing Investor Perspective

The new disclosure will show how parts of the balance sheet gain or lose value because of changes in credit quality and interest rates. As a result, investors may view banks as riskier ventures than they do at present, which could hurt their stock prices and ability to raise capital.

"This disclosure could be considered a stalking horse for market value accounting -- it could be a useful test for what mark-to-market would look like," said John Leonard, banking analyst with Salomon Brothers Inc.

The new requirements were mandated by the Financial Accounting Standards Board last year as part of a comprehensive project to overhaul how companies account for financial instruments.

Traditionally, banks have accounted for most assets and liabilities at the originally stated value. Thus, no matter how interest rates or credit quality change, the reported values remained constant.

Early Warning System

In the aftermath of the thrift crisis and the depleted Bank Insurance Fund, Congress and the Securities and Exchange Commission are pushing for market-value accounting as an early warning system to highlight deterioration in asset quality or irresponsible management.

To date, banks have mainly felt the heat in terms of accounting for their securities holdings. Banks have traditionally held the bulk of their securities at historical cost, with a smaller portion earmarked for trading and marked to market.

With securities trading becoming an increasing source of income for banks, the SEC has wielded its power over stock and bond offerings to require a number of banks, including Nations-Bank Corp. and First Union Corp., to value bigger portions of their portfolios at market prices. Seeing the writing on the wall, J.P. Morgan & Co., Bankers Trust New York Corp., and Norwest Corp., have revalued securities without SEC pressure.

Unlike the SEC actions, the new disclosures, required under Financial Accounting Standards Board Statement 107, will not affect earnings or capital.

Credit Quality Assumptions

Fair-value estimates will be based on discounted cash flow models using assumptions about credit quality and future interest rates. Even a small change in assumptions can have a big impact on the fair value of an asset or liability.

In addition, because FASB did not provide specific guidance on how to make fair-value calculations, accountants predict that it will be difficult to make comparisons among banks.

The industry is unlikely to see even a rough standard for calculating fair values until next year, said M. Scott Reed, a partner at the accounting firm Grant Thornton.

"There will be an awful lot of -- in effect -- caveats thrown in with the disclosures to show that this is breaking new ground," said Craig Wood, senior vice president with Olson Research Associates, a consulting firm based in Columbia, Md.

Bank commercial loan portfolios will be difficult to report accurately because there is no active market for them that can provide guidance.

Nonperforming loans may be the most difficult asset to value. A survey this year by KPMG Peat Marwick and sponsored by the Association of Reserve City Bankers found a huge difference in the fair values given for delinquent commercial loans.

As a result, banks may find that fair-value portrayals raise questions about the adequacy of a stated reserve for loan losses, said John T. Smith, a partner at Deloitte & Touche.

In financial statements, banks need to reserve only for "probable losses that have been incurred and can reasonably estimated," while fair value approximates the price of a loan agreed to by hypothetical sellers and buyers. There buyers would also be looking at future losses.

Asset-Backed Assistance

In contrast, bankers can easily check the fair value of credit card, mortgage, and consumer loans against the market prices of securities backed by these loans.

Residential mortgages are one asset group in which fair-value reporting could shed light on the health of a portfolio, Mr. Leonard of Salomon said.

The rule does not require disclosure of the fair value for demand deposits, which have no stated maturity. Banks may decide to report a fair value for these deposits anyway, to give shareholders a more complete picture of the balance sheet, said P. Woodbridge Wallace, a manager at Coopers & Lybrand.

Low-cost demand deposits would rise in value with rising interest rates, offsetting the fall in value of fixe-rate assets.

Costly for Smaller Banks

Large banks have the ability to readily implement the disclosure requirement. Some smaller banks are concerned about the costs.

"It's going to be horrendous," said Kerby Crowell, chief financial officer of Stillwater National Bank and Trust Co. in Stillwater, Okla.

He said the disclosure will raise his bank's reporting costs in the first year by $30,000 to $35,000 or about 50%.

In addition to buying software, priced at $7,500 to $10,000, banks must pay for independent valuations and audits, and increased internal staff time.

Reliability Questioned

Beyond the problems entailed by implementing the disclosure, some bankers doubt whether the information will be reliable.

"The question will be: Can you make it work, or do you make a hash of your numbers?" said Mr. Leonard.

Bankers had unsuccessfully argued that calculating these values involves so many subjective assumptions as to render the information useless.

Because of questions about the accuracy of the fair-value numbers, many bankers fear that investors will use the disclosures for their own models of capital levels, which will show much greater volatility than in banks' own financial statements. "It doesn't take a rocket scientist to use fair-value information to come up with an imputed value of equity," said Mr. Wood of Olson Research.

Educating Shareholders

As a result, banks "are going to have to educate our shareholder base," said Orlando Hanselman, chief financial officer of USbancorp, a $1.2 billion banking company based in Johnstown, Pa. USbancorp worked with FASB earlier this year to test how the new disclosure rule would look in practice.

Still, many bank managements seem to be putting their heads in the sand rather than face up to fair value. "I am absolutely astounded at what we see among bankers, who think that somehow this disclosure is not going to unfold," said Mr. Wood. "It's already the eleventh hour and beyond," for managements to face up to the issue and begin talking with their directors, said Mr. Wood.

The new disclosure is not the last step in the movement toward market value accounting.

Next Stop: Bottom Line

FASB is moving ahead with a proposal that will require banks to value a much greater portion of their securities portfolios at market values. This proposal, expected to take effect no earlier than next year, will affect the bottom line.

Next, a section of the Federal Deposit Insurance Corporation Improvement Act of 1991 mandates some form of fair-value accounting in quarterly call reports.

"I believe the regulators will be looking at the quality of information coming out of FAS 107," said Mr. Wallace of Coopers & Lybrand. "If they don't like what they see, they may come out with standards that are more onerous."

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