March 30 (Bloomberg) — Four days after U.S. lawmakers berated Financial Accounting Standards Board ChairmanRobert Herz and threatened to take rulemaking out of his hands, FASB proposed an overhaul of fair-value accounting that may improve profits at banks such as Citigroup Inc. by more than 20 percent.
The changes proposed on March 16 to fair-value, also known as mark-to-market accounting, would allow companies to use “significant judgment” in valuing assets and reduce the amount of writedowns they must take on so-called impaired investments, including mortgage-backed securities. A final vote on the resolutions, which would apply to first-quarter financial statements, is scheduled for April 2.
FASB’s acquiescence followed lobbying efforts by the U.S. Chamber of Commerce, the American Bankers Association and companies ranging fromBank of New York Mellon Corp., the world’s largest custodian of financial assets, to community lender Brentwood Bank in Pennsylvania. Former regulators and accounting analysts say the new rules would hurt investors who need more transparency, not less, in financial statements.
Officials at Norwalk, Connecticut-based FASB were under “tremendous pressure” and “more or less eviscerated mark-to- market accounting,” saidRobert Willens, a former managing director at Lehman Brothers Holdings Inc. who runs his own tax and accounting advisory firm in New York. “I’d say there was a pretty close cause and effect.”
Willens, investor-advocate groups including the CFA Institute in Charlottesville, Virginia, and former U.S. Securities and Exchange Commission Chairman Arthur Levitt oppose changes that would enable banks to put off reporting losses.
“What disturbs me most about the FASB action is they appear to be bowing to outrageous threats from members of Congress who are beholden to corporate supporters,” said Levitt, now a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News.
FASB spokesman Neal McGarity said the proposal allowing significant judgment was “in the works prior to the Washington hearing and was merely accelerated for the first quarter, instead of the second quarter.” The plan on impaired investments “was an attempt to address an important financial reporting issue that has emerged from the financial crisis,” he said.
Mary Schapiro, sworn in as SEC chairman in January, testified to Congress on March 11 that the agency recommends “more judgment in the application, so that assets are not being written down to fire-sale prices.”
Goldman Sachs Group Inc. investment strategist Abby Joseph Cohen andNouriel Roubini, the New York University professor who predicted last year’s economic crisis, made bearish forecasts last week about the outlook for the banking industry. Cohen says banks aren’t yet “in the clear,” and Roubini expects the government to nationalize more lenders as the economy contracts. The 24-member KBW Bank Index rose 21 percent in March, after slumping 75 percent during the prior 12 months.
By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s change could boost bank industry earnings by 20 percent, Willens said. Companies weighed down by mortgage- backed securities, such as New York-based Citigroup, could cut their losses by 50 percent to 70 percent, said Richard Dietrich, an accounting professor at Ohio State University in Columbus.
“This could turn net losses into significant net gains,” Dietrich said. “It may well swing the difference as to whether bank earnings are strong this quarter, or flat to negative.”
Citigroup had $1.6 billion of losses last year for so- called Alt-A mortgages, according to the company’s annual report. That loss would be erased with the new FASB rules, Dietrich said.
Bank of America Corp. in Charlotte, North Carolina, reported “income before income taxes” last year of $4.4 billion. The FASB proposal on impaired securities would increase that figure by about $3.5 billion, or the amount of “other- than-temporary” losses that the company recognized, Dietrich said. The new rule would mean the loss would be stripped out of net income, boosting earnings, though it would still be reported in financial statements.
While helping lenders report higher earnings, FASB’s changes may hurt Treasury Secretary Timothy Geithner’s plan to remove distressed assets from bank balance sheets, Dietrich said. Allowing companies to hold on to assets without writing them down could discourage them from selling the securities, which would work against Treasury’s objective to resuscitate markets, he said.
“It’s one of the unintended consequences of having the FASB bow to political pressure,” Dietrich said.
Fair-value requires companies to set values on most securities each quarter based on market prices. Banks argue that the rule doesn’t make sense when trading has dried up because it forces them to write down assets to less than they’re worth.
Conrad Hewitt, a former chief accountant at the SEC who stepped down in January, said representatives from the ABA, American International Group Inc., Fannie Mae and Freddie Mac all lobbied him over the past two years to suspend the fair- value rule.
Executives “would come to me in the afternoon with the argument, ‘You’ve got to suspend it,’” Hewitt said in a March 25 interview. The SEC, which oversees FASB, would reject their demands, and “the next morning their lobbyists would go to Congress,” he said.
‘Is That Fair?’
AIG’s near-collapse in September prompted a $182.5 billion government rescue of what was once the world’s largest insurer. Earlier that month, the Federal Housing Finance Agency put Fannie Mae and Freddie Mac under its control after the worst housing slump since the Great Depression threatened the survival of the mortgage-finance companies.
Banks and insurers wanted to value securities at prices they bought them for, Hewitt said. His response: “If you carry them at 100 percent of what your purchase price was and they are worth 50 percent, is that fair to the investor?”
Hewitt said nothing the SEC and FASB did curtailed the lobbying by financial companies, including issuing guidelines on how to price assets when no market exists and conducting a congressionally mandated study of fair-value accounting.
“I don’t think there was anything that would have pacified them,” short of a suspension, he said.
Bank of New York
Efforts to change accounting rules continued after the election of PresidentBarack Obama. Bank of New York Chief Executive Officer Robert Kelly spoke with Gary Gensler, a Treasury official during the Clinton administration who was asked by the transition team to evaluate the SEC. Kelly said in an interview that while he opposes suspending mark-to-market accounting, he discussed with Gensler ways to lessen its impact. Gensler, who has since been nominated to chair the Commodity Futures Trading Commission, declined to comment.
Bank of New York would be one of the biggest beneficiaries of FASB’s proposed changes, said Jeff Davis, director of research at Chicago-based brokerage Howe Barnes Hoefer & Arnett. The company’s earnings were reduced by $1.6 billion last year from writedowns for mortgage-backed securities, according to its annual report. The bank, which said it expects to ultimately lose about $535 million on the assets, blamed the disparity on “market illiquidity.”
At a March 12 hearing of a House Financial Services subcommittee, lawmakers showed impatience with FASB.
“You do understand the message that we’re sending?” panel chairman Paul Kanjorski, a Pennsylvania Democrat, asked Herz.
“Yes, I absolutely do, sir,” Herz replied.
After hesitating, Herz said he would try to get a new fair- value rule finished within three weeks.
“The financial institutions and their trade groups have been lobbying heavily,” Herz said in an interview after the hearing. “Investors don’t lobby heavily.”
The political action committees of banks including Citigroup, Bank of America, Bank of New York Mellon, Wells Fargo and banking trade groups contributed money to Kanjorski’s re- election campaign last year, according to the Federal Election Commission. Citigroup gave $6,500, Bank of America $7,000, Bank of New York $8,000 and Wells Fargo $13,000.
Kanjorski spokeswoman Abigail McDonough didn’t return calls seeking comment.
Three days before the hearing, 31 financial-industry groups sent a letter to committee chairman Barney Frank and Alabama Representative Spencer Bachus, the panel’s ranking Republican, emphasizing “the need to correct the unintended consequences of mark-to-market accounting.” The organizations included the ABA, the National Association of Realtors and the 12 Federal Home Loan banks, the government-chartered cooperatives owned by U.S. financial companies.
The Federal Home Loan Bank of Atlanta, which Kanjorski cited at his hearing as an institution hurt by fair-value accounting, would also stand to gain from FASB’s proposals.
The company, one of 12 regional institutions that provide low-cost financing to 8,000 member banks, absorbed an $87.3 million writedown on three mortgage-backed securities after determining it would not collect all the cash the assets were supposed to generate, according to a November SEC filing.
Under the FASB proposal, the reduction in the bank’s earnings would be much closer to the $44,000 that the company expects to lose, according to Brian Harris, a senior vice president at Moody’s Investors Service in New York.
“It potentially moves the accounting closer to where we saw the economics of these transactions,” Harris said in a March 24 interview. “We don’t see a risk to their debt securities.”
Also endorsing the letter was the Pennsylvania Association of Community Bankers. Thomas Bailey, the group’s chairman and CEO of Brentwood Bank in Bethel Park, Pennsylvania, told the subcommittee that using fair-value accounting “in these times, is much like throwing gasoline on a raging inferno.”
Among the banks most negatively affected by unrealized losses are Wells Fargo, PNC Financial Services Group Inc. in Pittsburgh, Minneapolis-basedU.S. Bancorp and M&T Bank Corp. in Buffalo, Robert W. Baird & Co. analystDavid George wrote in a March 20 note to clients.
FASB’s proposals, he wrote, would “potentially provide cover for some banks that might otherwise need to raise government capital.”