Proposed U.S. fair value accounting will hit banks’ balance sheets: Fitch

Date: Friday, June 11, 2010
Author: Investment Executive

If the new fair value accounting treatment proposed by U.S. accounting standard setters is adopted, banks could face a heavy hit to their shareholders equity, Fitch Ratings says.

The rating agency says the most notable change in recently released proposals on financial instruments from FASB requires most financial instruments, including loans, to be measured on the balance sheet at fair value.

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

“From a regulatory standpoint, it remains to be decided what the capital impact will be; however, the total equity of most banks is set for more volatility,” Fitch says.

Fitch reports that in a December 2009 study of 20 large commercial banks in the U.S., loans made up 55% of total assets (although this figure would be higher for smaller and regional banks), and 98% of those loans are measured at amortized cost.

Based on Fitch’s review, if the new proposal for loans was adopted in the third quarter of 2009, it would result in a decrease in shareholder’s equity of US$130 billion (approximately 14% of the combined total equity of all the 20 banks reviewed).

Speaking at a conference of international securities regulators in Montreal this week, former head of the U.S. Federal Reserve Board, Paul Volcker, addressed the FASB decision, saying that he thinks it’s a mistake for the U.S. to deviate from the international position on this.

Volcker said he hopes that U.S. and international standard setters can resolve this disagreement soon, so as not to derail the planned convergence between them.

Also, Fitch says that it believes that an overhaul of disclosures on the fair value of loans is necessary to aid transparency. And, “given the potential for a lack of an active and liquid market for loans, disclosures of meaningful sensitivity analysis coupled with the methods and significant assumptions used in the valuation process would be needed to provide a robust and transparent presentation to be insightful to analysts and investors,” it adds.