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Accounting Board Issues Proposal Requiring Banks to Book Loans' Fair Value

The Financial Accounting Standards Board is seeking public comment on a proposal that would require banks to report the fair value of loans on their books and accelerate recognition of credit losses.

The proposal, which also seeks to simplify accounting of hedges, was released for comment through Sept. 30, FASB said yesterday in a statement. The Norwalk, Connecticut-based panel, which sets U.S. accounting standards, estimated that the rules would go into effect in 2013, according to a summary of the proposal.

Banks would have to report both the fair value and amortized cost of loans and some other financial assets and liabilities on their balance sheets under the new rules, FASB said. Changes in fair value would in most cases be recognized in other comprehensive income, the panel said. That could cause swings of billions of dollars in the book values of some of the nation’s biggest lenders.

“The proposal would impact the reporting by financial institutions and all other entities that have financial instruments as the goal of greater transparency in financial statements is pursued,” FASB Chairman Robert Herz said in the statement. “The FASB will ensure that it obtains and considers a broad range of input on this important proposal.”

Book Value

While changes in the fair value of loans probably wouldn’t show up in banks’ earnings, their book values could fall when demand for loans declines. The American Bankers Association, the industry’s trade group, said the proposal would increase “pro- cyclicality” in the financial system.

“This will help to exacerbate downturns, not help to curtail them,” said Robert Willens, president of Robert Willens LLC, a consulting firm that advises investors on tax and accounting rules. “It would simply cause unnecessary alarm on the part of financial-statement users if the loans, at least temporarily, have lost value and that decline in value has to be reflected in the lender’s shareholder’s equity, and the lender looks undercapitalized.”

In April 2009, FASB approved changes to fair-value, or mark-to-market accounting, allowing companies to use “significant” judgment in gauging prices of some investments on their books, including mortgage-backed securities. The change came after banks and politicians said the mark-to-market rules fueled the financial crisis, and industry executives urged FASB to allow more flexibility.

Fair Value

The fair value of all financial instruments is relevant because it reflects the true shareholder value of a company, said Sandy Peters, head of the financial reporting policy group at the CFA Institute.

“The pro-cyclicality argument is that when you give people information, they act on it,” Peters said. “Banks don’t like the volatility it presents and what it might do to the share price, but it’s still relevant information.”

Banks including Bank of America Corp., based in Charlotte, North Carolina, and San Francisco-based Wells Fargo & Co. already report the fair value of their loans in the footnotes of their quarterly reports to regulators.

Bank of America’s carrying value for some of its loans at March 31 was $908 billion, or $23.9 billion more than the fair value, the company said in a regulatory filing. The fair value of Wells Fargo’s net loans was about $21 billion less than the amount at which the bank reported them in the first quarter, according to a regulatory filing.

Citigroup, JPMorgan

Citigroup Inc. carried its loans at $670 billion at March 31, about $12 billion more than the estimated fair value, the New York-based bank said in a filing. JPMorgan Chase & Co. said in a filing that the reported value of loans on its books at the end of the first quarter was $900 million more than fair value.

“FASB’s proposal for mark-to-market accounting presents significant problems, not only for banks, but also the general economy,” Edward Yingling, chief executive officer of the American Bankers Association, said in a statement yesterday. “The proposal would greatly undermine the availability of credit by making it difficult to make many long-term loans, the value of which, even if performing perfectly, would likely be reduced on the day a loan is made.”

While banks don’t report the market value of loans on their balance sheets, they set aside funds to cover expected loan losses. The median loan-loss reserve at 157 large banks represented 1.96 percent of total loans at the end of the first quarter, KBW Inc. analyst Melissa Roberts wrote in a May 6 note.

“I would suggest instead looking more closely at the loan- loss reserves, and maybe standardizing the way in which you make your additions to the reserve,” Willens said. “The loan-loss reserve doesn’t reflect the fair value of loans, but what it does reflect is the amount the bank is expecting to collect. I think that’s a pretty important measure.”

Non-public companies with less than $1 billion in consolidated assets would be allowed a four-year deferral past the effective date to make the changes, FASB said. Some financial instruments, including pension obligations and leases, would be exempt.

Julia Tunis Bernard, a spokeswoman for Wells Fargo, and Citigroup spokesman Stephen Cohen declined to comment on the proposal, as did JPMorgan spokesman Joe Evangelisti and Scott Silvestri, a spokesman for Bank of America.

To contact the reporter on this story: Michael J. Moore in New York at mmoore55@bloomberg.net.

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