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By Matthew Quinn
Once all this nonsense about compensation dies down, expect banks to turn their full attention to a proposal the Financial Accounting Standards Board is expected to unveil in the first quarter of 2010.
The proposal would require banks to measure all financial instruments at fair value on their balance sheets, a move that would wipe out $130 billion in shareholder equity at the 20 largest U.S. banks if it were adopted in the third quarter of 2009, according to new research from Fitch Ratings. That works out to roughly 14 percent of the combined total equity among those banks.
The impact is overstated because the reduction excludes offsets from applying fair value to the liabilities that fund the loans. But it is still significant and could be even more so depending on the regulatory response to any accounting change, Fitch noted.
Banks can account for loans in three ways: held for sale, held for investment or at fair value. The first two options let banks measure loans at amortized cost.
The fair value option is little used currently. Loans made up an average 54 percent of the total assets of the 20 banks reviewed, with less than 2 percent of total loans outstanding currently measured at fair value.
Over the years, Fitch noted, that disparity wasn’t really a big deal because the fair value of loans was generally higher than the carrying amount. But that, like many things in banking, changed during the financial crisis. “[T]he significant market deterioration over the past two years has led to a significant downswing in the fair value of many banks’ loan portfolios relative to their book value, net of allowance for loan losses,” Fitch analysts Olu Sonola and Dina Maher wrote in the report.
By examining the fair value disclosure of bank loans over the past 10 years, Fitch found the weighted average fair value of loans for the 20 banks in Fitch’s sample declined from a multiyear high of 102.5 percent of net book value at the end of 2002, to a multiyear low of 95.4 percent as of June 30, 2009.
Of course, some banks would be more impacted than others. Fitch found that as of Sept. 30, 2009, the fair value of loans ranged from 81 percent (Regions Financial) to 100.9 percent (Bank of New York Mellon).
The fact that the values can fluctuate so much should only spur banks to fight the accounting change more fervently.
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