Institutional investors reject fair value for bank loans

New York, NY — October 19, 2010 — More than two-thirds of large U.S. institutional investors oppose a proposal by the Financial Accounting Standards Board (FASB) that would mandate fair value accounting treatment for most bank loans, according to a study released today by Keefe, Bruyette & Woods (KBW) and Greenwich Associates.

The study was commissioned to gain insights into large institutional investors' understanding of and support for a series of recent FASB bank accounting proposals. Among the key changes proposed is an expansion of fair value accounting rules that would require banks to report the value of most loans on their books at estimated fair value alongside the current cost accounting valuations.

According to the study, 66% of institutional investors say they are either strongly or very opposed to the proposal. Only one in five (20%) are in favor of the FASB's recommended changes. Despite the clear opposition, many of the institutional investors surveyed concede that current accounting standards are inadequate and need to be revised.

"The FASB's mission is to provide useful information to investors, and the current proposal to expand fair value reporting on bank balance sheets is intended to improve the quality of information available to investors," said Thomas Michaud, President of Keefe, Bruyette & Woods. "However, the results of this study demonstrate that a large majority of U.S. institutional investors think FASB is taking the wrong approach."

Institutions' primary objections to fair value accounting appear two-fold. First, they believe mark-to-market valuations would not be helpful in making investment decisions because fair market values for loans held on banks' books and other infrequently traded financial instruments would not be reliable. In fact, up to 45% say the expansion of mark-to-market rules for bank loans would cause them to reduce their level of investment in U.S. banks. Second, they fear that variations in reported fair market values will magnify cyclicality in bank earnings and the economy as a whole. "The fact that U.S. institutional investors overwhelmingly oppose the fair value proposals should give FASB board members cause to rethink their approach," says Greenwich Associates consultant Don Raftery. As an alternative, institutions say they prefer changes that would increase transparency and provide enhanced disclosure of information on specific bank portfolio holdings. Also, 70% of respondents would favor an alternative proposal that would require banks to include enhanced disclosures about fair value in 10Q/10K reporting, but not on the balance sheet. Other key study findings include:

  • 7% oppose fair value accounting for bank deposits
  • 55% oppose changes in interest income recognition
  • 45% oppose changes to the allowance of credit losses
  • 40% oppose changes to the credit impairment framework

About the Study:
From September 8th to September 20th, Greenwich Associates and KBW surveyed 62 U.S. institutional investors about the FASB proposals. More than 40% of these institutions have assets under management of $30 billion or more. Institutions participating in the study manage more than $1 trillion in aggregate.

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