The Financial Accounting Standards Board broke the logjam over valuation of securities when it agreed unanimously last week to permit reporting at amortized cost only for those securities "that management has the intent and ability to hold to maturity."
That clearly doesn't include most mortgage-backed derivatives, according to Robert C. Wilkins, FASB project manager. "Securities that could be sold in response to change in interest rates, changes in prepayments, increases in loan demand or other similar factors would not be considered as held-for-investment under this approach," he said.
Securities that aren't held for investment would be classified either as "available-for-sale" or held-for-trading" and reported at market value. Unrealized gains and losses for securities available for sale would be reported as a separate component of shareholder equity. Unrealized gains and losses on securities held for trading would be included in income.
This has major implications for banks and thrifts, whose regulators have sided with them in opposing market value accounting for all securities. Whether last week's compromise will cause the regulators to accept the FASB decision is not known.
"We'll have to take a close look at this," said Robert Storch, chief accountant for the Federal Deposit Insurance Corporation. "The question is whether institutions will make decisions on holding securities to meet accounting rules that would cause them to manage their assets in an unsafe or unsound manner."
The American Bankers Association Accounting Committee met July 17 with FASB to, among other things, express objections to the adoption of market value accounting made two days earlier.
Wilkins said even the exception for securities that will be held to maturity might not be of much use to large institutions, since they hold so many securities of different types it would be difficult to identify those that for certain would be held to maturity.
Under the plan agreed to by FASB, losses on securities classified either as held-for-investment or available-for-sale would be recognized in earnings. Transfers between categories would be accounted for as sales and repurchases at fair value.
For sales or transfers of securities classified as held-for-investment, disclosure of the cost basis, realized gain or loss, and the circumstances leading to the decision to sell or transfer must be disclosed.
Wilkins said he expects FASB to vote on a formal proposal for public comment later this summer.
In a letter sent earlier this year, FDIC Chairman William Taylor advised FASB to be extremely cautious before mandating changes.
"We would stress that many issues need to be examined and debated before market-value accounting, as it relates to financial institutions, can or should be adopted," he wrote. "The FDIC has several concerns regarding market-value accounting. First, many assets and liabilities of depository institutions simply cannot be readily marked to market. The fluctuation of depository institutions in the intermediation process is, in great part, to develop lending and deposit relationships that organized markets cannot support. Thus, the act of ascribing a ~market value' to these relationships and related financial instruments would require making a guess as to how a market, if it existed, would determine value."
Federal Reserve Board Chairman Alan Greenspan has been outspoken against market value accounting for financial institutions. He has cited a failed attempt to impose such a standards in the 1930s.