The FASB released two proposed staff positions (FSPs) on Tuesday as expected to provide application guidance on determining fair value in inactive markets and on accounting for securities that are other than temporarily impaired. The FASB is seeking comments through April 1st on both proposals with the goal of finalizing at an April 2nd board meeting.
Information from the FASB and the FSP’s on the process can be found here:
The two proposals can be found here:
Jonathon Weil wrote a commentary for Bloomberg on March 18th titled “Accounting Brothel Opens Door for Banker Fiesta” where he calls the new FSP’s the dumbest, most bankrupt proposal of the “Fraudulent Accounting Standards Board’s” 36 year history. However, the basis for his conclusion is based on a misinterpretation of the proposals. Weil writes, “So, if these rules had been in place last year, a company that still owned shares of AIG or Fannie Mae, for instance could exclude those stocks’ price declines from net income entirely. It would make no difference that the companies were seized by the government last year, or they are both penny stocks. The loss would get buried away from the income statement, in a balance sheet-sheet line called “accumulated other comprehensive income.”
This is wrong. Actually, any loss related to an other than temporary impairment (OTTI) stays right on the income statement in the new proposal. In fact, the new proposal provides more transparency as the components of the loss are broken out between credit and non-credit components. Any investor would certainly find that information more meaningful. Read more
Recently, there was a very insightful op-ed article in the WSJ, [$$] How Geithner Can Price Troubled Bank Assets by Peter J. Wallison, involving the difference between the value of what mortgage-backed securities are trading at and the value of their cash flows. The conclusion drawn by Mr. Wallison is that since the net realizable value of the cash flows exceeds the market bids for the securities due to the distressed and illiquid market, the government can purchase the assets at the net realizable value and still be a net benefit to the taxpayers and the bank. The US can hold the securities and earn a positive return and the banks can free up their balance sheet without impairing their capital. The classic win-win. Mr. Wallison argues that no major accounting policies need to be changed, as the seller could liquidate their positions at a price they feel represents the value and not significantly reduce their capital. We don’t disagree. However, the same could be accomplished without major changes to accounting standards, but providing simple clarity to the existing accounting standards. Mr. Wallison writes the following: Read more
The FASB recently announced a new project to improve the fair value measurements and disclosures of financial instruments. This was expected and is in response to recommendations from a SEC study on mark to market and input from the FASB’s Valuation Resource Group. The article, Mark-to-Market Changes Fail to Rally Stocks, notes that the announcement did little to move the market as “its promise has been thwarted by government initiatives that could actually prevent a market recovery.”
More significantly, it did not spark a market rally as the measurement of fair value is not the primary concern among financial institutions. The primary concern is when they are required to mark assets down to fair value and that is when the asset is deemed to be Other Than Temporarily Impaired, or OTTI. One of the misunderstandings in the media and general public is that a new accounting rule (SFAS 157) requires every asset to be marked to market. SFAS 157 was issued in 2007 but only provides guidance on how to measure fair value. Other accounting standards already in place determine when an asset should be marked to market and some of those reasons include whether an asset is placed in a trading account or whether it is held for sale or if they are determined to be OTTI. SFAS 157 did provide the OPTION to use fair value for most financial assets but very few institutions chose that option because of the earnings volatility it would cause. And this was understood even before the credit crisis.
Today, financial institutions hold mortgage-backed securities that despite the real estate market are backed by a substantial percentage of performing mortgages. Further, many of these securities are senior securities that won’t incur a loss until a junior security has absorbed all the losses in the trust. However, many of these securities are trading at significantly discounted prices due to a combination of real credit fear and the accounting rules. If cash flow projections indicate a probability of even a minor dollar loss on the security in the future, the accounting rules could consider the security OTTI. But instead of writing off the projected dollar loss, accounting rules require you to write it down to fair value which in a distressed market can turn a $5 dollar loss into a $10,000 dollar loss. Read more
Ed Yingling, President of the American Bankers Association (ABA), released a statement yesterday expressing concern that Other Than Temporary Impairment (OTTI) is being overlooked. In our opinion, he hits the nail on the head with his comments. The real issue surrounding mark-to-market accounting is OTTI, which is an accounting rule that in some cases can force banks to write down performing securities to the liquidation value which in a distressed market is far less than their intrinsic value.
We concur with Ed’s statement that the OTTI model used by international accounting standards is superior to the U.S. approach and consistent with all other financial assets. While the Financial Accounting Standards Board (FASB) is in the process of reviewing mark-to-market rules, they should give this topic of OTTI full consideration. We’ll take it a step further by adding that U.S. GAAP and the International Accounting Standards Board (IASB) have already committed to “converging” their rules over time. Read more