Accounting standard-setters issued new rules Wednesday that could have profound effects, not just on how assets and liabilities get valued but on how banks do business.
The Financial Accounting Standards Board wants to vastly expand the use of mark-to-market accounting. In a draft ruling posted on its Web site late Wednesday, the FASB proposed that banks value unfunded loan commitments and loans they plan to hold to maturity in the same way they currently value loans they intend to sell. The rule also would change the way deposits are valued.
The proposal would be "the biggest accounting event we have ever seen," said Donna Fisher, a senior vice president with the American Bankers Association.
If approved, she said, the new rule could alter the banking landscape by steering the industry away from products with greater potential for volatility in their market price and in their impact on the numbers in banks' financial statements. For instance, banks might decide to scale back issuance of 30-year, fixed-rate mortgages. Instead they might push products with shorter maturities or variable rates, which theoretically would have less price volatility in the markets because the duration or interest rate risks have been reduced.
The industry is bracing for change at the conclusion of a drawn-out debate that heated up dramatically as the financial crisis raised concerns on both sides of the argument, calling into question whether banks' stated loan values could be trusted and whether it is wise to peg loan values to markets proven vulnerable to wild mood changes.
The bank lobby has strenuously opposed efforts to broaden the implementation of mark-to-market accounting, arguing that the value of assets that banks are holding for the long haul should not be subject to the vagaries of the markets.
"We've had discussions with them [the FASB] for 20 years now about how accounting should follow the business model, so that if you're buying and selling loans you should mark them to market, but if you're not, having the swings in market value flowing through to your financial statements is misleading," Fisher said.
FASB officials on Wednesday were attending the final portion of a two-day trustee meeting and were not available to comment on the contents of the proposal.
Opponents of the FASB's thinking will have one more chance to influence it, during the public comment period that will end Sept. 30. Public roundtables will be held in October. Once the comments are in, the FASB will deliberate again before releasing any final rule changes.
FASB officials have argued that mark-to-market accounting gives investors a clearer picture of a company's worth, and makes it easier to compare financial statements across an industry. But making mark-to-market the default accounting method for financial instruments arguably conflicts with the desires of bank regulators and the Group of 20 to reduce pro-cyclicality, so that market forces don't whip up too much froth in the financial system during boom years or exaggerate the crash in crisis periods.
FASB Chairman Robert Herz, who said last summer that any rule changes on mark-to-market would not be adopted until 2011 at the earliest, has acknowledged the competing interests of accountants and regulators.
"It may not be possible [for accountants and bank examiners] to find common ground in every case, not because we aren't communicating but because our different missions take us down different roads," Herz said in a December speech to the American Institute of Certified Public Accountants. "[Bank] regulators should have the authority and appropriate flexibility they need to effectively regulate the banking system."
Currently, loans and debt securities that banks plan to hold to maturity are recorded at amortized cost, though so-called fair values based on mark-to-market accounting methods are disclosed in footnotes to the financial statements.
The FASB proposed Wednesday that all loans and debt securities get recorded at fair value on the balance sheet, as would most financial liabilities.
For hold-to-maturity instruments, the proposed guidance "would recognize the utility to financial statement users of both fair value and amortized cost information by requiring a reconciliation from amortized cost to fair value on the face of the statement of position," according to the 214-page exposure draft detailing the FASB's proposal.
"By presenting both fair value and amortized cost information on the face of financial statements for instruments that are being held for collection or payment of contractual cash flows, investors can more easily incorporate either or both in their analyses of an entity," according to the FASB draft document.
Core deposit values would be based primarily on present value, and would not reflect intangible values to the extent typically considered by banks when they decide how much of a premium to pay for deposits in an acquisition.
The valuation of deposits has long been a sticking point in the debate over mark to market. Those who oppose applying the method to all loans have argued that it is unfair to use mark-to-market on only one side of the balance sheet. But arriving at fair value for deposits is no simple task; in the early 1990s the FASB determined that fair-valuing core deposits was unworkable, and left them out of a rule addressing accounting and reporting requirements for investments.
The solution the FASB has come up with for deposits is "more of a present value of future cash flow," Fisher said. "It's not full-fledged fair value. It's not the same thing as if the bank went out and got a market price for its core deposits. It's partway between the two. That's illogical to a lot of people, but it becomes more logical as you move to a fair value model" for other parts of the balance sheet.
Also under the proposal, the "other comprehensive income" portion of financial statements would be affected by credit impairments, interest income or expense, and realized gains and losses on financial instruments.
The board will establish the effective date of the requirements when it issues the final ruling. Nonpublic entities with less than $1 billion in assets would be granted a four-year deferral to allow them time to refine capabilities for valuing loans, loan commitments and core deposit liabilities.
If adopted, investors say, the new rules would leave them with just as many questions as they have about the current standards for valuing loans.
"The old method, at least I know how to adjust for it. If I have to deal with a new standard, I would implore the FASB to list [values under the old method and the new one] side by side," said Joshua Siegel, managing principal at StoneCastle Partners LLC, which invests in midsize banks. (The FASB draft indicated that data using both standards would be provided.)
Siegel said he generally opposes the idea of expanding mark-to-market accounting for banks. But if the FASB changes the rule, and banks display both sets of numbers, at least then he can measure how exposed each bank is to market volatility, and use the data as a basis of comparison among institutions. "That's something that is useful to me," he said.