For Major Banks, New FASB Rules Present Welcome Change

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By Steve Burkholder

Jan. 8 — The vast number of U.S. banks won't experience appreciable change in accounting from new rules on financial instruments issued by the Financial Accounting Standards Board, accounting professionals in the banking industry, a bank analyst at a rating agency, and standard-setting sources tell Bloomberg BNA.

The new FASB accounting standards update, issued Jan. 5, doesn't amend existing standards for recognizing and measuring loans and investments in debt securities.

Shift in FASB Thinking

However, major-player banks will welcome the advent of a notable change in generally accepted accounting principles that especially affects holdings in debt instruments measured under what is called “the fair value option.”

The shift in formal FASB thinking on the optional treatment—adopted before the onset of the financial crisis—will remedy what, in the view of big banks and a number of analysts, is inappropriate reporting of gains in the event of losses of credit standing and, conversely, losses as credit standing improves.

Adjustments to explain such a “counterintuitive” treatment in the eyes of a majority of FASB members and others won't have to be made any longer. Such changes in values will in the future go to “other comprehensive income,” a line item that doesn't affect a company's bottom line and earnings per share.

A relatively small number of banks, including smaller savings institutions, also could be affected by FASB's new prescription on equity securities, according to financial reporting executives at the American Bankers Association (ABA) and Independent Community Bankers of America. The new standard—ASU 2016-01, or Accounting Standards Codification 825-10—will have equity securities undergo reporting that requires changes in fair value to be recorded in net income.

In addition, community banks likely will be affected most significantly by a change in footnote disclosures on fair values of loans, said Michael Gullette, American Bankers Association's vice president for accounting and financial management. The new rules call for use of an “exit price” in the disclosure rather than an “entrance price,” which is easier to gauge, he said.

Limited, Targeted Improvements

Leslie Seidman, a former FASB chairman, summarized Jan. 8 the magnitude of change presented by the standards that generally become effective in 2018. She looked to the next shoe to drop on financial instruments accounting in a few months—a new FASB standard on credit impairments, which includes loan losses.

“This new standard represents some important, but fairly targeted changes for equity securities and the fair value option, rather than the overhaul that was originally proposed,” Seidman, executive director at Pace University's Center for Excellence in Financial Reporting, told Bloomberg BNA.

“There's another important change coming down the road—the accounting for loan losses—which represents a significant change for all banks and other lenders,” she wrote.

Many banks are paying closer attention to this forthcoming standard that the Norwalk, Conn.-based FASB hopes to issue by March 31. This standard will require an earlier and likely larger, up-front recognition of expected losses in portfolios of loans and from other credit impairments.

Own Credit Issue

At Moody's Investors Service, analyst Mark LaMonte said of FASB's change on the fair value option/own credit issue: “That's an area that I find particularly helpful.”

LaMonte, managing director and chief credit officer for Moody's global financial institutions group, said the change in generally accepted accounting principles “will eliminate the need to make adjustments to unwind the effect” of changes in a banks's own credit and “bring reported numbers closer to the actual numbers that investors and other users of financial statements are using to make decisions.”

“Otherwise,” LaMonte said of the new FASB rules, “it's largely business as usual.”

ABA's Gullette appeared to downplay the impact of the change in accounting principles on own credit and the fair value option. Banks could apply that change in accounting as early as fourth-quarter reporting and in 2015 annual reports.

“The ‘own credit' fair value adjustment issue for debt is not a big deal because banks have been backing those effects out for years now within their earnings announcements and it gets backed out for regulatory capital purposes,” he wrote in an e-mail message Jan. 6. “So, GAAP will now match practice.”

FASB Language on Own Credit

In the new standard, FASB spotlighted the issue having to do with own credit and use of the fair value option. The board noted a “significant concern” raised by stakeholders about gauging financial liabilities at fair value and those values being affected by changes in “instrument-specific credit risk.”

“If those changes are reflected in the fair value of a financial liability, an entity reports a gain from an increase in credit risk and a loss for a decrease in credit risk related to the underlying instrument,” FASB stated.

“Many stakeholders consider recognizing a gain due to a decrease in credit standing to be potentially misleading because an entity often lacks the ability to realize those gains,” according to the standard. “Many also do not consider it useful to recognize a loss as credit standing increases.”

FASB Lacks Unanimity

However, several veterans of standard-setting in Norwalk disagree.

One is Harold Schroeder, a board member with extensive experience as a banking analyst. He, along with two other members of the seven-person FASB, Thomas Linsmeier and Marc Siegel, formally dissented to issuance of the ASU.

Schroeder said “changes in fair value of liabilities often reflect market perceptions of changes in the fair value of assets held by the entity,” he wrote, adding that he disagrees with the “misleading” conclusion.

Rather, he sees the “gain” as a consequence of the related decline in asset values, and “the converse is also true,” Schroeder wrote.

In addition, reporting the changes going forward in other comprehensive income may mask the link between changes in fair value of financial assets and liabilities, he wrote.

Significant Change

Gullette wrote that the most significant change ABA sees in the new FASB rules pertains to the amended disclosure prescription for loans.

“The biggest thing we see in the new standard is the ‘exit price' requirement on fair value disclosures on loans,” he told Bloomberg BNA. “It replaces a much easier ‘entrance price' notion.”

That change will affect community banks the most because their loans tend to be more specialized, Gullette wrote.

To contact the reporter on this story: Steve Burkholder in Norwalk, Conn., at sburkholder@bna.com

To contact the editor responsible for this story: Ali Sartipzadeh at asartipzadeh@bna.com

For More Information 
The new FASB standard is at http://src.bna.com/bWF