Proposal Would Force Bank Loan Write-Downs

The proposal appears likely to lead to greater write-downs — and thus earlier losses — than one being considered by international rule makers.

“The global financial crisis highlighted the need for improvements in the accounting for credit losses on loans and other debt instruments held as investments,” said Leslie F. Seidman, the chairwoman of the board. The proposed model from FASB (pronounced FASS-bee) “would require more timely recognition of expected credit losses and more transparent information about the reasons for any changes in those estimates.”

The new rules, which are unlikely to actually take effect for several years, were initiated by complaints that banks were unable to write down the value of loans as soon as they should have as the financial crisis was growing. Under the exposure draft issued by the board, banks would frequently evaluate the expected cash flows from groups of loans and securities they owned, and take write-downs to the extent they expect the cash flow to be lower than called for in the loan documents.

As a practical matter, it seems likely that any bank making a loan would almost immediately have to write down the value of the loan, even though nothing indicated that particular loan was likely to go bad, simply because experience would indicate that some percentage of similar loans do wind up defaulting.

The value would then be adjusted each quarter, based on changes in conditions. An improving economy might make defaults seem less likely and cause banks to write up the value of loans on their books, thus raising reported profits.

But the initial write-down could mean that banks with limited capital would be constrained from making as many loans as they otherwise would make.

The International Accounting Standards Board plans to propose its rule early next year, enabling people to compare them when they file comments. The principal difference is that the rule that board plans to propose would limit the initial write-down to the losses expected during the first year the loan was outstanding, rather than over its entire life.

The two boards had reached agreement on the set of principles contained in the I.A.S.B. proposal, but the American board backed away from them in a joint meeting in July, leaving Hans Hoogervorst, the chairman of the international board, sputtering with frustration.

The Americans switched course at least partly because bank regulators feared that under the agreement banks might be too slow to write down the value of loans that could go bad, making the banks appear to be better capitalized than they really were.

The international regulators privately argued that the pricing of loans reflected the degree of loss expected, therefore there was no need for an initial write-down. They agreed to the limited first-year write-down in what they saw as a compromise with the Americans, only to have the Americans walk away from it.

Under either rule, the change in accounting will be significant. Current rules refer to “incurred losses,” in which loans are written down as it becomes clear that a particular loan is likely to default.

Those rules stemmed from what were seen as abuses in a previous era, as banks used loan loss reserves to smooth reported profits. Now banks will have more flexibility.

The American board said it expected the rule to cover bonds as well as loans, but some details remained vague and were likely to be fleshed out after the two boards considered public comments.

The comment period for the American proposal will end April 30.

Article source: http://www.nytimes.com/2012/12/21/business/proposed-accounting-rule-would-force-earlier-write-downs-by-banks.html?partner=rss&emc=rss