Mark-To-Market May Affect Defined Benefit Plans

The Organization for Economic Cooperation and Development (OECD), a 32-country (including the United States) organization committed to protecting democracy and the market economy, has pointed to mark-to-market accounting rules as a primary factor in their review of defined benefit pension funding.

The OECD has sought to reform regulations on defined benefit funding, as the tide has increasingly flowed towards defined contribution plans. Juan Yermo, head of the private pensions unit of the OECD’s financial affairs division, and Clara Severinson, a division administrator, suggest in their recent document various reforms such as “reducing the reliance on market values of assets and liabilities in determining contribution levels, limiting sponsoring companies’ ability to tap surpluses or take contribution holidays and setting minimum funding levels.”

While the document agrees that mark-tomarket accounting has helped increase transparency and comparability in corporate financial statements, it “may increasingly dominate over other arguably more fundamental issues … as the biggest driver behind how and in what manner corporations remunerate their employees,” according to Yermo and Severinson.

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.

Mark to Market Changes Could Spur Transactions in the Hotel Industry

At a July conference, members of the Industry Real Estate Finance Advisory expressed their views that proposed accounting changes will result in a boon for hotel investors as lenders become more willing to part with assets.

“If mark-to-market is going to go back into effect, then you’ll see a flush of hotels become available,” said Mark Elliott, a senior managing director with the brokerage firm Hodges Ward Elliot. Jackson Hsieh, real estate vice chairman for UBS, noted that while in 2009 most banks didn’t have the ability to take a write-down on an asset, “this year [they] made a lot of money” and will be able to do so.

Conference moderator Chuck Henry, president of Hotel Capital Advisers, echoed the sentiments by the panelists and said the time is right for investment in the hotel industry. “Absolutely it’s time to invest,” he said.

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.

FASB Hires Mark Schroeder to Oversee New Standards

The Financial Accounting Standards Board announced on July 14 that they had hired Mark Schroeder as a post-implementation review leader in light of the upcoming rules and standards changes. Schroeder (now a retired senior partner at accounting firm Deloitte & Touche), in addition to his role at the FASB will have a similar position for the Governmental Accounting Standards Board.

This is another large step by the FASB to formalize its review process, especially in light of the new rules on mark-to-market accounting. Banks and investors alike had cried foul against the FASB, saying that the new mark-to-market accounting rules contributed to freezing the credit market in 2008 and 2009 and there was no formal process for review.

In 2008, an advisory committee to the US Securities and Exchange Commission recommended that the FASB establish a formal review process once the rules were established.

Mark-to-Market Impact On Munis is Positive

Municipal bond specialist James A. Klotz, has a bright outlook for Muni investors because of mark-to-market.

As a rule, municipal bond buyers are long-term investors.  Mark-to-market values are depressed and are driving rates higher. Because investors are rarely forced to sell their bonds, market-to-market is irrelevant and they are enjoying the higher yields. From their view, this is a unique opportunity to purchase high quality assets with a tax equivalent return of over 9.00% for those in the higher tax brackets.

Investors see a “yield to maturity” value in their bond portfolio that is not available in other investments. More and more new buyers are entering the municipal market, attracted by these higher yields, combined with the security that municipal bonds have always represented.

Aflac Sells Greek Sovereign Debt

Aflac Incorporated has announced that it has sold its holdings of Greek sovereign debt and reduced its investment exposure to “hybrid” securities through two separate transactions. Their waning value, when marked to market, led to the decision.

In a press release, the insurance company declared it sold its entire holdings of Greek sovereign debt, which totaled $270 million of par value at March 31, 2010.  The company will incur a realized after-tax investment loss of approximately $67 million on a generally accepted accounting basis in its second quarter financial statements as a result of the sale. Aflac also exchanged a perpetual, Upper Tier II security of a European issuer for a higher-rated, fixed maturity, senior debt instrument.

Commenting on the transactions, President and Chief Financial Officer Kriss Cloninger III said, “As a result of extensive credit analysis, we believed it was prudent to trim our exposures to Eurozone sovereign debt. As we’ve done in the past, we also concluded it was in our best interest to take advantage of opportunities to selectively reduce our holdings of perpetual securities.”

Arrowhead Credit Union Seized by Regulators

Regulators at the end of June seized the assets of Arrowhead Credit Union, one of the largest credit unions serving the Inland Empire region of southern California. Citing a “declining financial condition,” the seizure was part of an increased effort by federal officials to shore up institutions afflicted by the mortgage bust and the Feds to assessment of an institution’s solvency using mark to market accounting

John J McKechnie III, spokesperson for The National Credit Union Administration, said “We’re being more aggressive in our examination process. We want members to be sure that their credit union operations are safe and sound.” In a letter to its members, Jane A. Walters said, “Be assured NCUA’s actions will not affect the safety of your savings or the array of services to which you are accustomed.”

Arrowhead has $876 million in assets with over 24 branches across the Inland Empire. It was the second largest credit union to be seized by federal officials, following last year’s take over of the Eastern Financial Florida Credit Union, which was worth $1.6 billion.

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.

BNY Mellon CEO Rails Against Mark-to-Market

In an interview with CNBC, Bank of New York Mellon Corp Chief Executive Robert Kelly asserted his opinion on the Financial Accounting Standards Board (FASB) mark-to-market accounting proposal.

Kelly said that requiring financial institutions to operate under mark-to-market rules for all loans and securities might be one of the “dumbest things in the galaxy,” and would affect a very limited number of banks. He further warned that proposed capital ration regulations could put American financial institutions at a significant disadvantage.

Nonetheless, Kelly feels that stricter regulation of U.S. financial markets will be a positive for the economy overall and he expects the changes to be enacted “quickly.”

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