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Mark-to-market accounting: "The battle will take place this year" E-mail

Controversial accounting concept heads for climax. Who will win?


By Steve Cocheo, executive editor, This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
ABA experts say outcome may bring biggest changes to bank accounting yet seen


In 1988 Donna Fisher came aboard at ABA to open up a new front. The formerly quiet area of financial accounting had begun to stir, and Fisher brought expertise on the subject. Unlike many other issues, the front lines for hers weren’t in Washington, necessarily, but in Connecticut, home of the Financial Accounting Standards Board.

Not long afterward, FASB began a push for an accounting philosophy that was initially referred to as “mark-to-market,” and, later, as “fair-value accounting.” (For the most part, the terms are interchangeable.) Fisher, ABA senior vice-president for tax and accounting, has been handling this controversial issue ever since, initially as ABA’s sole accounting specialist and then, as the issues grew broader and deeper, with associates.

Along the way, as financial regulation and accounting policy development took an increasingly international viewpoint, ABA expanded its work to include the Basel regulatory apparatus and the International Accounting Standards Board (IASB).

But 2010 promises to mark a major escalation in the long debate.

While wranglings over fair-value accounting have gone on for years, “the battle will take place this year,” says Fisher.

“It’s coming to Waterloo,” says Mike Gullette, ABA vice-president for accounting and financial management, continuing the military theme. Whose Waterloo, exactly, is not yet clear, adds Gullette [pronounced, “Gull-et”].

Even though the capital impacts of fair-value accounting, for bank-held securities, has mainly affected only instruments classified as “available for sale” and trading securities, all securities can be subject to fair-value accounting because of “other than temporary impairment” (OTTI) rules. The recent increase in the numbers of securities subject to OTTI rules was brought on by the financial crisis and resulting troubled markets. If the fair value of a security is lower than its book value, then OTTI is examined.


The long-running war over mark-to-market accounting—under multiple names—heads for a climax this year. ABA’s Mike Gullette and Donna Fisher are on the front lines with accounting policymakers in the U.S. and on the international level.

This issue has never been the only accounting matter in play, and isn’t now, but it is certainly the centerpiece. ABA Banking Journal discussed the fair-value-accounting debate and other issues with Fisher and Gullette in late January.

Outlook for fair-value accounting
FASB has set a major push for 2010. “They’re wrapping everything up into one package,” says Gullette. “It will include what gets mark-to-market treatment; how banks can calculate their loan loss reserves; and how to handle hedge accounting for any derivatives your bank may hold.”

“The major item will be FASB’s approach on accounting for loans,” says Fisher. “How they are recorded on the balance sheet, how loan losses are estimated—it’s all up for grabs.”

“FASB wants to put loans—or any asset that the bank intends to hold for the long term—on the balance sheet at fair value, something that does not at present exist in GAAP,” says Gullette.

ABA has long maintained that mark-to-market accounting doesn’t reflect how banks do their traditional business, and believes the goal of transparency is best served when accounting matches an industry’s business model. On the other hand, the association has supported marking trading securities to market.

Stepping on the gas

ABA also supports some accounting changes. Improved treatment for loan loss reserving, for instance, has been a major goal for the association. Overall, a good deal of what’s been on the FASB docket for a number of years in regard to financial instruments is being pulled together for accelerated consideration.

Calls for change in loan loss reserve methodologies from the G20 (Group of 20 Finance Ministers and Central Bank Governors) have been taken by accounting rulemakers as an opportunity to expedite their accounting proposals on financial instruments, says Fisher.

“FASB wants to resolve the accounting for all financial instruments at the same time,” Fisher explains, “while the International Accounting Standards Board (IASB) is focusing on specific items and proposing them separately.”

“A major ABA concern about changes to the accounting for loan loss reserves—expressed to both FASB and to banking regulators—is transition,” says Fisher, “especially given the current stage of the credit cycle.” Although ABA supports efforts to reduce procyclicality in accounting for loan loss reserves, the timing of changes to loan loss reserve accounting is tricky, says Fisher.

If the industry’s standards were shifted from reserving for incurred losses to reserving for losses expected over the entire life of a loan, for instance, banks, in this period, could be accruing more loss. Yet ABA has been calling for change for some time. This was prompted in part by notable cases where institutions were accused of over-reserving, allegedly to “manage” earnings.

“Since then, FASB and the Securities and Exchange Commission seemed to be on a mission to make loan loss reserves more volatile, rather than less volatile,” says Fisher. “And so the industry found itself in the midst of a financial crisis wishing it had been able to have some of those reserves.”

ABA also hopes that FASB will subject the changes coming for financial instrument accounting to field testing.

“We hope that FASB will allow management to use its knowledge of the business cycle, as well as of individual companies,” says Gullette. “This would allow them to use more judgment, as opposed to the rigid analytical approach reserving often consisted of.”

There is also concern that however final standards come out, “heaping all of that onto the banking industry at one time—and at this point, even though many agree we ought to be able to recognize more loss—is really terrible timing,” says Fisher.

There is also the issue of how reserve standards are applied. Gullette points out that even now much hinges on how audit firms interpret standards and the Securities and Exchange Commission’s acceptance of the firms’ interpretations.

Gullette says that bankers should look for an exposure draft of the major FASB financial instruments package in the next couple of months, with a three-month comment period likely. It’s anticipated that a final standard will be published by yearend. If that schedule is maintained, Gullette believes the new standards will likely be effective in 2012.

Congressional developments
Something ABA hopes will survive in pending financial reform legislation is the proposed Systemic Risk Council’s duty to comment on pending accounting issues.

“We think it will be really tough for accounting policymakers to ignore the systemic risk regulator,” says Fisher.

Fisher and Gullette offer some advice for bankers taking part in the FASB comment process. It is a different playing field than sending letters to Congress, where sheer numbers count, and form letters by the sack can help turn an issue.

When the right time comes, says Fisher, “sacks and sacks of mail to FASB is what we’ll want. But, each will have to be written in the banker’s own words. And it will have to be clear that the bankers understand the proposed standard under comment and how it will affect their bank.”

This is critical, warns Fisher: “If it’s clear that the banks writing don’t understand the issue, FASB will just discount what they say. And it will annoy them. We will be working closely with our members to ensure that doesn’t happen.”

Impact of convergence

FASB and IASB agreed in 2002 on efforts to “converge” accounting standards— “Generally Accepted Accounting Practices” and “International Financial Reporting Standards.” Convergence, in this sense, describes cooperation to develop parallel standards, though not necessarily adoption of IFRS. (There would ultimately be one accounting standard that each company would use, no matter where it was based.) Gullette notes that while SEC has set timetable targets for this convergence in a proposed “road map,” total convergence is likely some time off.

More than 100 countries permit or require use of IFRS for their domestic companies. Others, like the U.S., embrace convergence. In early December 2009, in an industry speech, SEC Commissioner Elisse Walter said that the agency was still evaluating comments on the proposed road map, and that further action on the road map was anticipated for sometime in 2010.

ABA doesn’t object to this in concept, but the application will be in the details. “We have some concerns about how IFRS might be applied in the U.S.,” says Fisher. “IASB says that its rules are principles-based, rather than rules-based, as our GAAP is.”

Fisher says that a concern is that the SEC, while officially accepting principles-based accounting, will not agree with how it is carried out. “Will SEC be sending comment letters on company financial statements, making institutions restate, because it doesn’t agree with numbers? That is the number-one issue,” she says.

But a second issue is significant, as well. “In our litigious society, the question is, can we handle principles rather than rules?” says Fisher. “It seems like it could open up the door for litigation. There can be many gray areas that wouldn’t be a big deal in other countries, but that would be for us.”

In addition, asks Fisher, “what’s in it for the small banks?” She explains that large banks may welcome convergence because, having foreign operations already, or foreign investors, they may prefer having comparability to peers. On the other hand, community banks will need to learn an entirely new set of standards.

Fisher adds that it is unclear at this point what impact convergence would have on regulatory accounting.

As a result of these factors, she said, ABA is spending more and more time on IASB matters, and Gullette will be devoting more time to getting to know IASB staff.

“With the stated intentions to converge, FASB certainly takes a very hard look at anything that IASB does, for the sake of attempting to move in a similar direction,” says Gullette. But he and Fisher point out that FASB has a much stronger inclination towards fair-value accounting.

Treatment of financial instruments is the critical area for banking institutions. Last fall, IASB issued its amendment to the overall accounting model for which financial instruments are subject to mark-to-market. FASB anticipates finalizing its proposals in a new standard by the end of the third quarter.

“There are certain circumstances where IASB’s proposed model might require companies to put some loans or securities that are not now marked to market into that category,” says Gullette. “But overall, you see much less mark-to-market thinking in the IASB model than you would see in FASB’s pending model,” says Gullette.

“IASB seems to be holding steady, but FASB really seems to be pressing the IASB more towards fair value,” says Fisher.
Uncoupling RAP from GAAP
In early December, FASB Chairman Robert Herz floated a controversial idea—uncoupling accounting standards for investors, under GAAP, from regulatory accounting, RAP.

Actually, “we’ve already ‘been there, done that,’ and no one liked it—including FASB,” says Fisher.

“We used to have RAP-GAAP differences,” she continues. “At this point the industry would much prefer to keep its books based on GAAP, both for the primary financial statements and the call reports. FASB seems to be ignoring the fact that the banking regulators are huge users of our financial statements.”

Where did Herz’ point come from then? Fisher theorizes that FASB may be frustrated with having to address not only industry objections to its proposals, but regulatory arguments as well. One example is pronouncements by the G20 after its April 2009 summit, calling for accounting standards setters to avoid procyclical accounting rules, i.e., regarding loan loss reserves.

While FASB clearly wants to have free rein on what the accounting should be, Gullette warns that decoupling would be risky.

“This would get at issues such as, ‘What is a loss?’ or ‘What is the value of this?’,” says Gullette. “These are basic issues. If the public became confused, it would undermine confidence in both sets of books, RAP and GAAP.” BJ

ABA: Tell us what accounting issues you’re facing
ABA Senior Vice-President for Tax and Accounting Donna Fisher and Vice-President for Accounting and Financial Management Mike Gullette encourage member banks to contact them when accounting issues surface. 
E-mail them at This e-mail address is being protected from spam bots, you need JavaScript enabled to view it and This e-mail address is being protected from spam bots, you need JavaScript enabled to view it


The electronic version of this article available at: http://www.nxtbook.com/nxtbooks/sb/ababj0210/index.php?startid=4

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