The Financial Accounting Standards Board (FASB) provided additional guidance to companies regarding the application of mark-to-market accounting rules on Monday, via a FASB Staff Position (FSP)……..( zzzzzzzz…..zzzzzzz…….zzzzzzz )
Look, these people are boring, but it’s worth understanding the issue at hand here.
Note: the rules apply to securities, NOT loans, when market value drops below the recorded book value and the securities are deemed “impaired”.
A two-step model for guidance was developed to address the issues.
Step 1: Determine if there are factors present to indicate that there is no active market for the asset at the measurement date. These factors would include:
1. Very few transactions, based on the volume and level of market activity.
2. Quotes are not current (several hours to days to weeks)
3. Price quotes vary “substantially” among market makers
4. Recent non-correlation to an index by an asset that has historically been highly correlated to an index
5. Significant widening of bid-ask spreads
6. Little or no public information available on the security.
7. Abnormally high liquidity risk premiums or implied yields when compared to reasonable estimates of credit for the asset.
Step 2: Determine if a recently quoted price is, or is not, associated with a distressed sale. The reporting company can always presume that the quoted price is associated with a distressed sale, unless both of the following are present:
——there were multiple bidders for the asset
——there was a period of time, prior to the measurement date, that allowed for usual and customary sale of the asset or liability. (An example would be that there was not a regulatory requirement to sell the security.)
There was also guidance given regarding “Other-Than-Temporary-Impairments” (OTTI). The current rules require an entity to examine and assess whether it has the intent and ability to hold a security for a sufficient period of time to allow for recovery. This is the litmus test to determine if an impairment is other than temporary. The proposed FSP would change that rule as follows:
1. If an entity intends to sell a security, or if it is likely that it will be required to sell the security prior to recovery of the cost basis, the entire impairment loss would be recognized in earnings as “OTTI”.
2. If the entity does not intend to sell a security, and it is not likely that it will be required to do so before recovering its cost basis, only the portion of the impairment loss that represents credit losses would be recognized in earnings as OTTI. The balance of the impairment loss would be recognized as a charge against other income.
3. …..nevermind. I won’t bore you with the rest of it. If you happen to read the rest of the FSP, you could also interpret the guidance on the measurement of OTTI write downs to be limited to losses from the weakened credit of borrowers that back the securities, and not from market illiquidity. It will be interesting how this will play out.
THE BOTTOM LINE is that this new guidance on Mark-to-Market from FASB will have the greatest impact on those institutions with very sizable portfolios of Level 2 and Level 3 securities that have large negative marks and have not already been marked down. (As a refresher, Level 2 assets are those where price quotes are from markets that are inactive. Level 3 assets have prices or valuation techniques that require inputs that are signficant to the fair value measurement AND are unobservable.)
The comment period is 15 days, and ends on April 1st. If the FASB Board finalizes the FSP, it will probably be effective for the interim and annual periods ending after March 15, 2009.
Just in time for Q1 reporting! (Gee, fancy that!)
The entities that stand to benefit the most are the usual suspects: GS, MS, C, BAC, and JPM. (Gee, who knew?)
This is basically smoke and mirrors. While it might help to relieve some of the recent stresses on bank capital, the fundamental issue is still nonperforming assets that are rising in number, in an economy that is headed for something between the 1974-75 recession and the Great Depression.
I fully expect bank stocks to eventually head lower again at some point. But, with Q1 reporting only a month away, we could see this rally extend into Q2, as bank asshat hopefuls slice and dice this thing with a Slap Chop. Who knows?
If you’re playing the bounce in the banks, get ready to take profits at the drop of Bernanke’s hat (which, unlike vain bald men, he nevers wears). You also might want to think about getting out a little early before the rest of the crowd hits the exits.
Just saying…………….
Comments »
