When controversial accounting rules effectively jeopardized a pending acquisition, Investors Bancorp Inc. in Short Hills, N.J., got angry.
Now Domenick Cama, the $7.2 billion-asset thrift company's chief operating officer, is one of many bankers cheering the Financial Accounting Standards Board's proposed rule changes.
The proposals would allow more flexibility in calculating the value of illiquid assets and reduce the scale of other-than-temporary impairment charges — like the one that sent Investors' stock tumbling recently.
"I think it's a positive that FASB has finally decided, I guess with some congressional arm-twisting, to take a closer look at this," Cama said. "It was a baloney kind of issue."
Though some questioned how much difference the changes would make, most bankers expressed relief at any easing of the rules, which have led to massive — and, they contend, unwarranted — writedowns across the industry.
The bankers favor basing the value of the investments on their actual credit performance, instead of their distressed trading prices. The benefits of that approach range from stronger capital ratios to an improved ability to attract investments from private equity, they say.
Michael Moderski, the chief financial and risk officer of First Federal Bankshares Inc. in Sioux City, Iowa, says potential accounting losses have been a major concern for private-equity investors.
The $525 million-asset First Federal is seeking capital, at the behest of regulators.
It has $18.6 million of unrealized losses in its investment portfolio, mainly from pooled trust-preferred securities.
It warned in a securities filing last month that its Vantus Bank could become undercapitalized if regulators required recognizing those losses. It needs to raise $5.1 million to boost its capital ratios to the elevated levels that regulators imposed.
The proposed changes would energize those capital-raising efforts, Moderski said; instead of just making sure securities losses do not wipe out its capital, the company could talk up its growth potential.
"This has the potential to have a great benefit for us at Vantus," Moderski said. "It could effectively remove some of the question marks."
The current mark-to-market accounting rules work in a normal market, but not in the current climate, he said.
"I have had to write down securities 50 cents on the dollar for something I know I am going to get all of my principal and interest on in the future," Moderski said.
"When you are in a market where there is no liquidity and total gridlock in terms of pricing, mark-to-market and OTTI doesn't work. You end up overstaing losses."
The FASB expected to release its proposals for public comment late Tuesday, with the comments due April 1. The board said it hopes to make a final decision April 2.
A proposal related to mark-to-market rules would enable companies, under certain circumstances, to avoid a full hit to earnings and capital.
If a market is determined to be inactive, and the recent prices are on distressed transactions, a company can ignore those transactions and focus on future cash flows for determining the value of a security.
A company also would have more leeway in deciding when an other-than-temporary impairment has occurred. A full market loss that affects earnings and capital would be required only when a company cannot hold the security to maturity or does not intend to do so.
In cases where the security would be held to maturity, the amount of the loss would be split, with a credit-related portion to be reported in earnings and the remainder reported in other comprehensive income.
Banking trade groups support the proposed changes but argue that they should go even further.
"What they have done so far will give a better reflection of earnings," said Donna Fisher, a senior vice president of tax and accounting at the American Bankers Association.
"Banks will be able to provide a truer picture of what their earnings are, but because they didn't go far enough, equity will still be distorted."
The proposed changes also would preserve regulatory capital ratios, Fisher said.
"This provides regulators with a truer picture of capital, because they do not include the market losses, but under old rules, it all went under earnings and had to include those market losses."
Still, bankers worried that accountants might need even more of a push to effect real change; accountants did nothing to dispel that worry in discussing the proposals Tuesday.
Dorsey Baskin, a partner in the professional standards group at Grant Thornton LLP, said the requirement that there be "few" trades in a security, making it eligible for an internal estimate of value, is too vague for an auditor to be able to test.
"Management would assert there are few transactions," he said. "Who knows what 'few' means? And they would assert that price fluctuates a lot over time. It's hard to audit that assertion."
Baskin also said the proposed changes on other-than-temporary impairment would be a "180 degree flip" from what is currently required.
As the rules are now, a bank must say it is holding a security until maturity.
With the proposed changes, the assumption would be that the bank is holding the security, unless it states an intent to sell.
"This says it triggers other-than-temporary impairment only if you intend to sell or you can't hold it to recovery," Baskin said.
The proposed changes would be too late for California United Bank in Encino, which revised its fourth-quarter results after taking a $1.4 million impairment charge. It swung from a $156,000 profit to a $624,000 loss.
The $378 million-asset bank announced Monday that its auditors had forced it to take the charge, even though its investments continue to perform as they should.
"Our initial conclusion didn't support the impairment charge," said Robert J. Dennen, California United's chief financial officer.
"They took an interpretation that we didn't agree with."
A little over a year ago it bought eight triple-A private-label collateralized mortgage obligations for $9 million. The bank bought the shortest-term tranches with a 9% credit support cushion to protect against losses.
A third party analyzed the portfolio in recent months and found that a worst-case scenario — in which 35% of the borrowers would go into foreclosure over the next six years — would cost California United roughly 1% of its principal, or $80,000, Dennen said.
Still, auditors looked at the portfolio and required California United to mark the securities to their estimated fair value of $5.1 million.
"The auditing firms interpret much more aggressively," Dennen said. "They look at everything from a litigation and liability standpoint. They are always going to interpret things for the worst case."
That just might be the problem with the proposed changes, he said; unless the FASB is very specific and leaves little room for interpretation, auditors likely will not stop requiring companies to mark securities to market prices.
Cama said the current rules create a vicious cycle, where writedowns in and of themselves can lead to more writedowns.
Investors Bancorp took a pretax other-than-temporary impairment charge of $152.8 million on its investments in pooled trust-preferred securities for its fiscal second quarter, which ended Dec. 31.
The banks issuing those securities have to do the same, taking their own hits to earnings, he said. Those losses might cause more banks to have to defer payments and affect the performance of the securities. And that, in turn, could force yet more writedowns by the banks that hold those securities as investments.
Without the charge, Investors Bancorp would have reported a profit instead of an $83 million loss for the quarter, Cama said.
Because of its pending deal for the $622 million-asset American Bancorp of New Jersey Inc., Investors Bancorp decided to be aggressive when it marked down the value of the securities it holds from $173.6 million to $20.8 million.
"During the second quarter of this year the American shareholders will be voting on this transaction, and the last thing we wanted hanging over our head is the possibility that there was another OTTI charge in the offing," Cama said.
The hefty loss contributed to a drop in Investors Bancorp's stock price, though. And that decline technically gave American Bancorp the option to walk away from the deal.
It chose not to, after the terms were tweaked Monday to a payment of 65% in stock and 35% in cash, instead of the original 70%-30% ratio, reducing the downside risk to American Bancorp.
With that change, the price works out to $99 million, or $9.11 a share.
But Cama said the chain reaction set in motion by the securities writedown could have cost Investors Bancorp the deal, even though the fundamentals of the company remain unchanged.