Former FDIC Chairman Isaac Calls FASB Fair-Value Loan Plan `Destructive'

A U.S. accounting board’s proposal that would require banks to report the fair value of loans on their books will lead to reduced lending, a former chairman of the Federal Deposit Insurance Corp. said.

“This is a terribly destructive idea to even propose,” William Isaac said in a telephone interview today. Just by making the proposal, the Financial Accounting Standards Board will lead banks to quit making loans without an easily discernable market value, and keep the ones they do make to shorter maturities, Isaac said.

Banks would have to report the fair value and amortized cost of loans and some other financial instruments on their balance sheets under the new rules released by FASB for comment on May 26. 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.

Among U.S. banks, Regions Financial Corp. and KeyCorp may face the biggest initial impact from the proposal as they have the largest percentage gap between the carrying value and fair value of their loans of lenders analyzed by Jason Goldberg at Barclays Capital and David George at Robert W. Baird & Co., they said yesterday in notes to clients. FASB, which sets U.S. accounting standards, estimated that the new rules would take effect in 2013.

‘Worldwide Condemnation’

The proposal comes “in the face of worldwide condemnation,” Isaac said. It conflicts with the recommendations of the Group of 20 nations, the Basel Committee on Banking Supervision and the International Accounting Standards Board, according to the American Bankers Association, which also opposes the plan.

David Larsen, who serves on FASB’s Valuation Resource Group, said the volatility created by markets and fair value “is there whether or not it is measured.”

“It comes down to the question, is greater transparency of help to users of financial statements?” said Larsen, a managing director at New York-based Duff & Phelps Corp.

Mark-to-market accounting destroyed $500 billion of bank capital as traders marked down all assets during the crisis by a total of 27 percent, and many of those values have now returned to near par, Isaac said. “Now FASB is going to spread this disease throughout the system,” he said.

Checks and Balances

Loans should be evaluated using the current system of checks and balances including bank management, independent accounting firms, and outside bank examiners, Isaac said.

“This is a dramatic departure from past practices, and we caution it has the ability to create increased volatility in earnings and equity,” Goldberg wrote in his note. “One of our hopes coming out of the past couple of years was to reduce the pro-cyclicality of bank earnings. These proposals appear to take a step in the opposite direction.”

Regions carried loans at a mark 15 percent higher than fair value at the end of the first quarter, while KeyCorp’s were 12 percent higher, the two analysts wrote in their notes, citing company filings.

“We are currently reviewing the exposure draft, however in general we believe this is an ill-conceived concept,” Regions spokesman Tim Deighton said in an e-mailed statement. “Accounting is based on the core principles of relevancy and reliability, so the highly subjective and inconsistent nature of fair value makes it ill-suited to such an important application.”

Shrinking the Gap

Deighton said Regions’ gap had shrunk from 25 percent a year earlier. “We would expect that the level of discount would continue to improve in line with economic conditions prior to any proposed rule coming into effect,” he said in the statement. KeyCorp spokesman Bill Murschel said it was “somewhat premature” to comment on FASB’s proposal.

The median gap among the 26 large U.S. banks covered in Goldberg’s note was carrying value exceeding fair value by 1 percent. Some banks may have bigger gaps because of differences in how they determine fair value, Goldberg said.

The rule changes could have dramatic effects on banks’ balance sheets. The difference between carrying value and fair value at Birmingham, Alabama-based Regions and Milwaukee-based Marshall & Ilsley Corp. is bigger than those banks’ tangible common equity, Goldberg wrote. Tangible common equity is book value minus intangible assets such as goodwill.

Regulatory Requirement

Whether the new rules would force banks to raise capital would depend on regulators, who will be able to determine how the changes are treated in regulatory capital requirements, Larsen said.

FDIC Chairman Sheila Bair, speaking at a conference in September 2009, said she didn’t agree with the content of FASB’s proposal.

“When a bank is holding a deposit, a loan or a similar banking asset for the long term, it shouldn’t have to mark them to market values that may vary widely over time,” Bair said. “Extending mark-to-market accounting to all banking assets takes a good approach for market-based assets, like securities, but extends this to areas where it doesn’t accurately reflect the business of banking.”

Bank of America Corp., based in Charlotte, North Carolina, and San Francisco-based Wells Fargo & Co. had the largest absolute differences between carrying value and fair value, according to Goldberg and George.

Bank of America

Bank of America’s carrying value for some loans on 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 filing.

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, said FASB, which is based in Norwalk, Connecticut. Some financial instruments, including pension obligations and leases, would be exempt from the changes.

The new rules would be “an incremental negative if implemented,” George said. “While anything is possible, we do not expect this proposal will end up going through.”

To contact the reporters on this story: Dakin Campbell in San Francisco at dcampbell27@bloomberg.net; Michael J. Moore in New York at mmoore55@bloomberg.net.

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