Not that many years ago, in a knee-jerk response to the Enron/Tyco/WorldCom debacle, Congress passed the Sarbanes-Oxley bill.
Now, in yet another knee-jerk response, this time to the subprime mortgage disaster and the recent financial crisis, several of the same people and organizations are pushing to apply mark-to-market accounting to all financial instruments believing that will ensure asset values will not be overstated.
I'm skeptical. Catastrophes generally comprise a series of events that no one ever thought possible and for which there are rarely single solutions. Sarbox is a classic example of overreaction and lack of understanding of the problems and their root causes, and mark-to-market accounting falls into the same category. The Financial Accounting Standards Board recently proposed new rules that would require we apply mark-to-market accounting to commercial loans and core deposits as well. Now I'm worried.
I'm worried, because this is a one-size-fits-all solution and banks differ greatly in the markets they serve. In addition, doing so would likely cost our investors and commercial clients a lot of money. The loans we generate, unlike residential mortgages, are not saleable commodities and do not have a readily identifiable market. It would be difficult, if not impossible without a significant degree of judgment and expense to mark them to market. Further, because we are among a very few lenders in our rather small market, it is not clear that we could find a willing buyer quickly. Hence, they might be saleable at less than par on day one, if at all. Ironically, we have never sold a loan in our 27-year history (except for CRA loans) and always expect to hold the loan to maturity. Plus, our collection experience has been enviable, as have our returns.
If we were forced to mark them to market, and if our investors were to insist that we not generate loans that were worth less than par on day one, we would need to change our underwriting, dramatically. In doing so, the value that we bring to the clients we serve would diminish. In other words, to become a commodity would require that we ignore the expertise that we have developed in our 27 years of specialization. We would need to dumb down our underwriting to an extent that would allow enough other lenders to understand it to an extent that would enable them to become willing buyers. In short, being able to mark our loans to market without losing value would result in our no longer providing value.
And to what end? Not only have we had good credit experience with good returns over time, but we already account for any impairment through traditional accounting. That is, we risk rate our loans (well, I think, based on the assessment of both our auditors and regulators), and then reserve against them based on those ratings. This has served us and our investors well over time. What problem are we trying to solve? And at what cost?
