Financial institutions won a major concession today in their effort to obtain relief from national mark-to-market accounting requirements, which some commercial real estate owners say has forced them to devalue millions of dollars worth of assets.
The Financial Accounting Standards Board (FASB) agreed to adjust guidelines on the mark-to-market accounting rules, giving banks more flexibility in valuing their assets in credit-strapped markets. The changes take effect in the second quarter for most companies, but can be applied to the first quarter with certain restrictions.
Financial organizations including the Commercial Mortgage Securities Association (CMSA) have pressed Congress to change the mark-to-market rules, saying that they impose hardship on the $3.4 trillion commercial mortgage market at a time when participants already are hampered by the distressed economy and scarcity of credit.
Mark-to-market accounting requires valuing assets at current market values under rules set by FASB, which the U.S. Securities and Exchange Commission has tasked with setting standards for financial reporting. The mark-to-market rules have spurred complaints from companies that claim they have been forced to value performing assets at fire-sale prices during market lows. Long-term valuations of commercial real estate assets will rise as the capital markets recover, say many companies.
“Our decisions rarely please everyone, but we believe we have helped market participants this week with these actions to provide application guidelines on existing standards,” said FASB spokesman Neal McGarity. “These are extraordinary times, and the FASB has responded swiftly to the critical needs of capital market participants after an intensive due process.”
The changes will allow companies, including financial institutions, to exercise greater judgment in determining the fair value of the assets they hold. But FASB will also require more stringent and detailed financial reporting on a quarterly, rather than an annual basis, board members said. The board plans to continue to study comments made on the fair value standard, known as FAS 157.
As expected, today’s actions upset some observers, including Christopher Grey, a managing partner and co-founder of Third Wave Partners, an investment and restructuring advisement firm based in El Segundo, Calif. The move by the standards board could stifle transactions and artificially prop up failing assets, which in turn could delay the commercial real estate industry’s recovery from recession, he says.
“By not marking the values to market, that allows [companies] and institutions that own these problem assets to delay taking any action to deal with the assets or sell the assets. It will also prevent insolvent institutions and other companies from being liquidated, which will further prolong the economic downturn,” says Grey.
“What you’re doing by allowing companies to avoid valuing assets at market, you are encouraging companies to do nothing. You are allowing companies that are insolvent to stay in business, which should not happen. You are preventing transaction activity, which is essential for the market to bottom and for any recovery to begin,” says Grey.
In the 1990s, banks in Japan were allowed to avoid taking losses and write-downs, he says. “The result of that was an entire decade of stagnation.” The steps by FASB could create a parallel situation in the United States, Grey believes.
Watering down the fair value reporting requirements could also hinder the Federal Deposit Insurance Corp. (FDIC) in liquidating failed banks because of the difficulty in pinpointing assets’ true value, Grey adds. His firm has done some work for the FDIC, an independent agency created by Congress to maintain stability in the nation’s financial system by insuring deposits and supervising financial institutions. “The increased lack of transparency is going to make it more difficult for the FDIC to do their job.”
For its part, the commercial mortgage backed securities (CMBS) industry took a cautious approach to FASB’s decisions. “There are components of today's vote that we can see as positive, but we remain very concerned about the volatility that accompanies mark-to-market accounting and the current haze of what truly determines fair value,” says Kenneth Reed, managing director of CMSA.
“In any way it can, FASB should provide meaningful guidance that jibes with ongoing government relief efforts and, at the same time, be very mindful that legacy-asset efforts by Treasury and the Fed aren't undermined,” Reed adds.
Turmoil in the financial markets has brought CMBS lending to a virtual standstill. That is a far cry from 2007, when CMBS funded nearly 50% of all commercial lending with $240 billion in U.S. issuance. In 2008, CMBS financing plunged to less than $13 billion in U.S. issuance, the association reports.
While CMBS investors and other groups seek relief from the mark-to-market reporting requirements and fear that they may unjustifiably harm the value of an asset, auditors have warned of the consequences of changing the national standard. The Center for Audit Quality, representing leading auditors and investors, says the standard protects the nation’s economic health by requiring accurate reporting on the value of assets owned by financial institutions in current market conditions.
After FASB announced its decision, stocks soared, with the Dow gaining more than 216 points, closing at just under 8,000 for the first time since early February.