Standards Could Harm Community Banks | Plante Moran
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Plante & Moran Partner Says Proposed Accounting Standards Could Harm Community Banks

SOUTHFIELD, Michigan — Proposed changes to accounting standards for financial institutions could hinder recovery for community banks, according to a partner at Plante & Moran, PLLC.

The rules proposed earlier this month by the Financial Accounting Standards Board would significantly change the ways that banks have to value loans on their balance sheets — a move that could further discourage community banks from lending, according to Brian Pollice, partner and leader of the firm’s financial institutions practice. He notes the exposure draft released by FASB, “Accounting for Financial Instruments,” may well be the biggest change ever to accounting standards for financial institutions.

“We are still in a period where community banks in Michigan are struggling to deal with economic issues,” Pollice explained. “These new accounting rules will only add to their challenges, creating yet another financial burden instead of encouraging banks to make business and consumer loans and get our economy going again.”

The proposed changes, which the banking community can comment on until September 30, would affect all banks. FASB has yet to specify an effective date, though a final statement is expected in late 2011. Non-public banks with assets under $1 billion will have until 2013 to comply.

Specifically, the new rules propose two major changes to community banks’ balance sheets. The first and most controversial is expanding mark-to-market rules to require that all financial instruments be recorded at “fair value” on the balance sheet. Pollice said banks have traditionally recorded the amount of a loan on their books at face value at the time the loan is made. A loan is subsequently carried at its amortized cost as payments are made.

The new mark-to-market requirements would require banks to change loan values on their balance sheets as market conditions change. A temporary interest rate change could have a negative impact on a bank’s balance sheet though no real change occurred. He explained that the new FASB standards could force a bank that has made a fixed-rate loan to immediately come up with a fair-market value for that loan – which could instantly create an income statement loss in a declining interest rate environment.

“What banker is going to want to make a loan on a new commercial building and face an immediate write down?” Pollice said. “If enacted as written, this new standard will create major headaches for banks, particularly the community banks that should be the engines of loans for small- and mid-sized businesses.”

Pollice also noted that there is often no secondary market for these loans, so determining fair-market value will not be a routine exercise. Banks will need new systems to value the loans and their auditors will spend more time scrutinizing them — all of which will place a greater financial burden on community banks.

Banks financial statements already have a footnote that includes estimated fair value information. There has been no groundswell calling for the information to move to the balance sheet, Pollice noted.

The second proposed FASB change is on loan loss reserves. Under the new rules, Pollice said that banks would be required to change the method they use for establishing loan loss reserves — a move that could needlessly tie up capital and erode the balance sheet. The current incurred loss model will be changed to an expected loss model.

“The new rules would require banks to set aside loan reserves on an ‘expected loss’ basis rather than the existing ‘incurred loss’ basis,” Pollice noted. “There are lots of problems inherent in this approach. Not only does it have the potential to drive a bigger wedge between bankers and regulators, it also creates new requirements for portfolio valuation that, again, will be costly and difficult to comply with.”

Another complication caused by this proposal is the lack of conformity to international accounting standards. The FASB and the International Accounting Standards Board, or IASB, have a convergence project whose goal is to have a uniform set of worldwide accounting standards. The current U.S. standard calls for banks to carry most loans at amortized cost. The IASB has just proposed adopting the U.S. approach for banks whose business is to collect the loans from customer payments instead of selling them. The FASB proposal goes the wrong way in the spirit of convergence, Pollice said.

“Community banks are different than the money center banks,” Pollice noted. “They make loans in their communities to support local business. The loans are generally held until maturity, recording a hypothetical ‘fair value’ on the balance sheet does not add value to a bank’s financial statements.”

About Plante & Moran, PLLC
Plante & Moran is among the nation’s largest certified public accounting and business advisory firms, providing clients with tax, audit, risk management, financial, technology, business consulting, and wealth management services. Plante & Moran has a staff of more than 1,600 professionals in 21 offices throughout Michigan, Ohio, and Illinois with international offices in Shanghai, China; Monterrey, Mexico; and Mumbai, India. Plante & Moran has been recognized by a number of organizations, including FORTUNE magazine, as one of the country’s best places to work.

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