New FASB Proposal Nixes Participant Loans for 401(k) Plans

In an August proposal, the Financial Accounting Standards Board (FASB) unveiled plans to no longer include participant loans as part of a corporate 401(k) or other scheduled contribution plan.

Michael Gonzalez, FASB associate practice fellow for the accounting revision project, explains that currently, “Participants are borrowing from their own account. They own themselves.” As such, these loans are different from true credit, Gonzalez said.

The FASB feels that the new proposal will allow plans to more accurately report the value of these loans. From the FASB proposal, “[under the current system] most participant loans are carried at their unpaid principal balance plus any accrued but unpaid interest, which was considered a good-faith approximation of fair value.” However, the proposal cites questions about how well these approximations conform to a true fair-value measurement including “observable and unobservable inputs such as market interest rates, borrower’s credit risk, and historical default rates to estimate the fair value of participant loans.”

This proposal is up for comment through September 7^th, 2010.

Darling: Fair-Value Changes Will Be the End of Fixed-Rate Loans

In an editorial submitted to the ABA Banking Journal, George Darling, CEO of Darling Consulting Group, says that new Financial Accounting Standards Board (FASB) fair value accounting rules would spell the end of fixed-rate loans, among other negative ramifications for the banking industry.

According to Darling, fixed-rate loans would end because banks obviously would not want to mark their loans higher if interest rates rise. This would have a significant effect on American industry. Implementation of the new rules – especially when it comes to coding banking software – would be cost-prohibitive for most banks. Darling also says that comparing financial institutions’ financial statements would become impossible. “The models used to calculate the fair value of each financial institution’s assets and liabilities would differ in logic and scope. Each bank would have different risk ratings for loans and different models for calculation of core deposit values.” He goes on to say that fair-value assessments won’t accurately reflect the business model of many financial institutions, rendering their financial statements useless to investors.

The FASB proposal is up for comment through September 2010. Isn’t it ironic that the university professors and accountants want “pure” mark-to-market, and the real market participants, and tenured regulators (Volcker) warn that it is the wrong path? Which way should we go – theory or practice?

Figueredo: FASB Changes Will Affect Both Large and Small Business

The Financial Accounting Standards Board’s (FASB) proposed changes to fair value accounting will affect more than just big business, says Daniel Figueredo, a Manager at Burr Pilger Mayer, a San Francisco-based accounting and consulting firm. In an article published in Smart Business — Northern California, Figueredo explains that while the new fair value accounting rules will greatly increase transparency in accounting, businesses should not underestimate the amount of work required in preparing financial statements.

“The new standards in the exposure draft will help converge the U.S. generally accepted accounting principles (GAAP) with international financial reporting standards (IFRS),” says Figueredo. “It’s a pretty robust draft with many new disclosure requirements. If it’s issued as is, it will be challenging for businesses.”

The most significant changes will come from a requirement to report a sensitivity analysis, quantifying the volatility of “Level 3” fair value measurements, which are things like mortgage-backed securities that require the most judgment of value.

Figueredo explains the challenges: “It is not information that is readily available, and it is very judgmental. It will require significant time to be incurred, especially for companies that have a significant number of level 3 assets and liabilities…[such as] a financial institution.”

Investors and business have until September 7^th to submit comment letters to the FASB.

Alternative Funds Wary of Fair-Value Changes

The new Financial Accounting Standards Board (FASB) proposals for fair-value accounting has managers of alternative funds – private funds such as private equity and venture capital – wary of tougher rules. Under the new proposal, managers of these funds would be subject to more stringent requirements on explaining and reporting how an asset is valued.

John Hildebrand, a partner with PricewaterhouseCoopers, explained to Pensions and Investments that private equity funds are generally valued on “internally developed information or…unobservable inputs,” resulting from a manager’s best estimate. The FASB’s proposal would require a transparent valuation practice, which many private equity managers are reluctant to adopt.

Mr. Hildebrand said that the fear among alternative fund managers is the exposure to legal issues resulting from disagreements about how they value certain aspects of funds. Additionally, fund managers say they are unclear on how the FASB would require them to apply the standards and make the calculations, and that compliance with the new rules will require a significant amount of work on their part.

Banking Industry Adds Email Campaign to Oppose FASB’s New Proposal

The American Bankers Association recently launched an email campaign seeking support among the investor community for their opposition to the Financial Accounting Standards Board’s proposal to expand fair-value accounting to include loans as well as securities.

In a message sent to at least 15,000 investors, Washington-based ABA encouraged them to become involved in the opposition. The email included a link to their website, where recipients found “Guidance for Investors Regarding FASB’s Mark-to-Market Proposal,” along with an example letter to the FASB. On the web page, the ABA encourages investors to write their own letter as opposed to copying the form letter, as “the FASB does not appreciate ‘form’ letters, and often discounts them in their analysis.”

The American Bankers Association says that opposition to the new FASB proposal is necessary to keeping the banking industry’s business models intact, and that the new rules would make strong banks such as Citigroup Inc. and Wells Fargo write down billions of dollars in assets and appear undercapitalized.

French Official Says Fair Value Proposals Will Discourage Long-Term Investors

French Treasury official Jacques de Larosière says proposed changes to financial regulations and accounting rules will put long-term investors at risk and seriously reduce access to capital.

Speaking at a conference in Rome, Larosière said that in the coming years competition for capital will be intense in the global market and there is an “absolute need to avoid regulatory disincentives for long-term investment.” He conceded that fair-value rules are prudent for investment banks and trading houses but “irrelevant” for long-term investors.

Larosière, who wrote the European Union draft for integrated financial supervision, added that regulation such as Solvency II rules risk reducing demand for equity if shareholders have to make repeated balance-sheet adjustments. Thank heavens. Sanity from the Continent. You know when the French protest about too much regulation that it’s bad.

Fitch Says Bank’s Shareholders Equity Will Suffer

According to Fitch Ratings, under the proposed fair value accounting laws banks will need to brace for a volitile impact to shareholders equity.

Fitch director Olu Sonola says, “This is a profound accounting change that will affect the reported balance sheets of most banks in a very significant way, with possible repercussion on bank analysis and reported bank capital.”

In a hypothetical scenario, the Fitch review found that in a study of 20 large U.S. commercial banks, shareholder equity would have decreased by $130 billion, or about 14% of the combined total equity of the banks, if the new proposal for loans had been adopted in the third quarter of 2009. Perfect! Government solution to nonexistent problem (MTM on loans) causes massive unintended consequence. It will probably be adopted…

Survey Reveals Investors Reject Fair Value Proposals

Findings from a new PricewaterhouseCoopers (PwC) survey indicate that investors do not prefer mark-to-market accounting for long-held financial assets.

After conducting interviews with 60 leading U.S. and international investors, PwC found that amortised cost accounting for loans and deposits is preferred because the information “better reflects an entity’s underlying business and economic reasons for holding an instrument.”

Respondents indicated they considered fair value relevant but said it was “not necessarily the key consideration in their analysis of an entity.” Instead, investors said that when evaluating the value of a bank, for example, they would rather have more emphasis placed on its credit history and return on equity. Maybe regulators and legislators should listen to the actual participants.

Our Reaction to FASB Recommendation

See the link below for comments on the FASB recommendation for “fair value” accounting for level 3 assets. Over 750 response letters so far.  Lots of energy on this topic, and rightfully so!

The FASB’s recommendation is to fair value all assets on the balance sheet.

This is an incredibly bad idea. This will lead to an increase in asset repricing frequency, which leads to a short term holding mentality. Banks will hesitate to lend long-term if they know that shortly after they make a loan, they could be forced to mark the loan down to its “market value.”

Going hand in hand with this is that short-term market value write-downs – on long-term assets – will decrease capital at banks, which will in turn decrease their capacity to lend.

We want longer management of longer term assets. Let financial institutions carry assets at whatever level they fully disclose, and force them to footnote the “market value.” Full disclosure will provide investors with all of the information they need to make decisions. This improves disclosure and transparency without draining capital out of the banking system.

Comments on FASB Recommendation – www.FASB.org

Bankers React to FASB’s Proposed Change in Fair Value Accounting

Lobbyists and bank CFOs have been voicing their opposition to the Financial Accounting Standards Board’s new exposure draft on accounting for financial instruments. They warn that it could have adverse consequences for commercial banks.
“This is really a jaw-dropping proposal,” says Donna Fisher, senior vice president of tax and accounting at the American Bankers Association.
Bankers have taken particular issue with the requirement that even “plain vanilla” loans held for collection be marked to market. They believe this runs the risk of damping origination of long-term, variable-rate loans, as well as scaring off bank investors and increasing procyclicality in the financial system.
In an effort to ease the transition proposed by the exposure draft, the Board will give nonpublic banks with less than $1 billion in total consolidated assets an additional four years to adopt the new fair value accounting requirements

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