FASB approves changes for mark-to-market

The Financial Accounting Standards Board today approved proposals that would give firms more leeway in valuing troubled assets.

But fund industry observers and participants have mixed reactions as to whether the changes will be an improvement.

The proposals affect mark-to-market accounting, which requires financial institutions to report the value of their holdings based on current market conditions. The market downturn caused many financial institutions to take significant write-downs due to holdings of so-called toxic assets.

The Norwalk, Conn.-based FASB voted unanimously to approve a proposal that offers a framework for measuring fair value. It offers also guidance in determining whether a market is active or inactive and whether a transaction is distressed.

A second proposal, passed with a vote of 3 to 2, would require banks to separate debt losses related to credit deterioration from those related to other market factors on their income statements. It would require quarterly reporting and increased disclosure as to how those amounts were determined.

In a letter to the FASB dated Tuesday, the Washington-based Investment Company Institute said the proposals are too restrictive.

“We believe the proposal will, in certain instances, require funds and other reporting entities to disregard market quotes that may be the best indicator of fair value in favor of alternative valuation techniques,” Gregory Smith, director of operations/compliance and fund accounting at ICI, wrote in the letter.

“We believe that the proposal is too prescriptive in its presumption that transactions in inactive markets are distressed. We favor the current requirements in Statement 157 that allow for the reasonable application of judgment.”

But some money managers say change was needed.

“I think some adjustment is the right answer,” said Kevin Conn, a U.S. financial services analyst at MFS Investment Management Inc. of Boston, which had $134 billion assets under management as of Dec. 31.

“Many pieces of the bond market are broken, and we cannot get clear prices on assets.”

Current law already gives managers some discretion about determining whether a market is illiquid, he wrote.
“If the managers don’t see an active market, they can take the asset to a level III [designation], but I think many don’t use that more often because they are afraid that if they change their method, they’ll be sued,” Mr. Conn continued.

“This is a cleanup initiative and very positive for the bankers,” said Robert Morrison, president of AFBA 5Star Fund Inc., the $170 million asset management arm of the Armed Forces Benefits Association, based in Alexandria, Va.

The current accounting requirements combined with market conditions have caused banks to chew through capital, said Matthew Warren, associate director of equity research and manager of the banking team at Chicago-based Morningstar Inc.

“You could have lesser write-downs [with the changes],” he said. It will be positive for earnings power and capital strength and make it easier for banks to get out of trouble.”

But whether investors flock to financials depends on their investment strategy.

“It could muddy the water a little bit if there is more mark-to-model, as opposed to mark-to-market,” Mr. Warren said. “It may affect the ability of investors to compare one institution to another. It might make investors less likely to wade into these types of institutions.”

“But for the long-term investor, it gives the bank a better chance to earn their way out of their problem,” he said.

The rules go into effect June 1 and firms have the option of early adoption as of March 15 for first-quarter results.