Bankers Get Off Easy in Accounting Compromise: Jonathan Weil

You’ve probably heard the adage about what’s most important in real estate: location, location, location. It’s just as true for the numbers that show up in corporate financial statements.

Witness the outrage professed by William Isaac, the former chairman of the Federal Deposit Insurance Corp., after the U.S. Financial Accounting Standards Board unveiled its proposal to expand the use of fair-market values for financial instruments, so that loans would have to be shown on lenders’ balance sheets at fair value.

“This is a terribly destructive idea to even propose,” Isaac told Bloomberg News in a May 28 interview, the same day Fifth Third Bancorp named him its new nonexecutive chairman. Isaac claimed banks would quit making loans that lack easily discernable market values. The same talking point appeared in an American Bankers Association press release on May 26.

On this issue, the question isn’t whether such information should have to be reported, but where it should appear. Check the footnotes to Fifth Third’s last quarterly report, and you’ll see the bank disclosed that its loans had a fair value of $70.4 billion as of March 31. That was $3.2 billion less than their carrying amount on the bank’s balance sheet, a gap equivalent to 24 percent of Fifth Third’s $13.4 billion of shareholder equity.

A more extreme example is Regions Financial Corp., which said its loans were worth $12.8 billion, or 15 percent, less than what its March 31 balance sheet showed. And that was before the BP oil spill hit the Florida Panhandle, where Regions is a major lender. The fair-value gap was equivalent to 73 percent of Regions’ shareholder equity.

Buried Values

By burying the fair-value estimates in the footnotes, where they don’t count against book value or regulatory capital, these and similarly situated banks get to portray themselves as more stout than they actually are. So it’s no surprise that bankers are whining about the proposed rule changes. A Regions spokesman, Tim Deighton, called the FASB’s proposal “an ill- conceived concept.”

In reality, the industry is getting off easy. Under the FASB proposal, loans and many debt securities would be shown on the balance sheet at both their amortized cost (which includes adjustments for principal repayments and write-offs, among other things) and their fair value. Banking regulators could continue ignoring fair values for such assets when setting capital standards, if they remained so inclined. Investors could focus on whichever numbers they want.

Expected credit losses would count in net income. However, other types of fair-value fluctuations wouldn’t. These instead would get put into a separate bucket called comprehensive income, which for the first time would appear on the bottom of the income statement, not just on companies’ equity statements.

‘Bottom Line’

This would make comprehensive income the new “bottom line,” so to speak. Still, the FASB’s proposal gives companies an opportunity for public-relations spin there, too, because they wouldn’t have to present this figure on a per-share basis the same way they do with net income, reducing its prominence. In effect, the FASB is giving companies cover to claim that the items excluded from net income don’t matter as much as the ones that are included.

The board for years has used comprehensive income as a dumping ground for items that it has deemed too politically radioactive to include in net income, often because they tend to show volatility. These include changes in the values of corporate pension plans and foreign currencies, as well as certain derivative instruments and other investments.

Bigger Bucket

The FASB’s new plan expands that bucket. Qualitatively, though, the distinction between what gets included in net income and what’s relegated to comprehensive income remains arbitrary. Moving comprehensive income to the same page where net income appears would give it greater visibility. Yet it still wouldn’t have equal standing.

Those criticisms aside, the FASB’s proposal goes further in requiring fair-value measurements on the balance sheet than do the proposals offered by its overseas counterpart, the London- based International Accounting Standards Board. This has led to questions about whether the two organizations can reconcile their pronouncements to form a single set of global standards, as has been their goal for the past decade. Until last month, their stated deadline for accomplishing this had been June 2011. Both boards now say they won’t make it by then.

For a rough idea of how far apart they remain, the FASB released a summary comparing the two boards’ proposals on financial instruments so far. The list of bullet points ran 14 pages, mainly pointing out differences. If the boards can’t agree on this one standard now, it suggests the prospects for international convergence may be dwindling.

This might prove to be a blessing. The primary objective of financial reporting under U.S. standards is supposed to be about serving the needs of investors, not financial regulators or corporate managers, much less a political body such as the European Commission or the Chinese Communist Party. At least now when the FASB blows it, it’s easy for U.S. investors to contact the board’s offices and complain. That’s a level of influence and access they shouldn’t forfeit easily.

Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Jonathan Weil in New York at jweil6@bloomberg.net

To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net

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