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Mark to Market Matter That Much?

The Financial Accounting Standards Board has already altered so-called mark-to-market, or fair value rules. But analysts are still debating the changes.

One day after a modification to mark-to-market accounting rules, analysts continue to debate whether financial institutions will benefit from being granted more leeway to price troubled assets.

On Thursday, the Financial Accounting Standards Board voted unanimously to alter the definition of an "orderly" transaction to not include forced liquidation or distressed sale, which will allow assets to be valued differently. The changes will be effective for the second quarter of 2009, although first-quarter application will be permitted.

A separate vote to finalize new accounting guidance related to how financial companies write down other-than-temporarily impaired assets was passed 3 to 2. The new guidance for other-than-temporary impairments allows companies to separate the portion of those impairments in the portfolio that is due to credit deterioration vs. noncredit deterioration.

Many financial institutions have long complained about the regulation, FASB statement 157, which was implemented in 2007 to change the definition of fair value -- the measure of the worth of an asset on a company's books -- and the methods used to measure fair value.

The mark-to-market rules have led to assets being priced well below their real valuation to the current market value, making it impossible for banks to purge the toxic assets from their books at anything but deeply discounted prices.

Truth be told, the FASB had little choice but to change the rules as government officials were determined to make the change no matter what. When the FASB Chairman Robert Herz testified on Capitol Hill last month, chairman of the House Financial Services Subcommittee Paul Kanjorski (D., Pa.) told Herz that "if the regulators and standards setters do not act now to improve the standards, then the Congress will have no other option than to act itself."

House Financial Services Committee Chairman Barney Frank (D., Mass.) was one of the most vocal proponents of a change to mark-to-market rules, and he applauded the FASB's decision, which he says will make significant progress toward addressing inaccurate asset valuations in the markets.

"The FASB believes the rule can be applied more fairly and take into account the currently dysfunctional state of some markets," Frank said in a statement. "The integrity of the standard-setting process is preserved, while avoiding the pro-cyclical effects of improper valuation practices."

Some market observers agree with the government's view that the mark-to-market rule change will be a boon for financial companies. Some have stated that the rule modification could significantly change the earnings outlook for quarters to come.

Robert Willens, a former managing director at Lehman Brothers who runs his own tax and accounting advisory firm in New York, argues that capital levels could improve by more than 20% at banking names like




Bank of America



JPMorgan Chase



Wells Fargo



"Capital balances will improve by at least 20%, at a minimum, which is huge," Willens said. "The earnings will go up in the single-digit area, something in the order of 7% to 8%. But at this point, the capital balance is probably more important, from an investor point of view. From the banks' point of view, they could presumably step up lending if they have more capital."

Michael Zuppone, former branch chief for the

Securities and Exchange Commission

and current chairman of the Securities and Capital Markets practice at international law firm Paul Hastings, says this is a definitive recognition that blind faith in a market price in dislocated markets was misplaced under the old rules.


The FASB has made adjustments that will allow financial companies to have a more realistic ability to fair value their assets without having to place blind faith on prices in the marketplace that may be the result of distressed sale situations," Zuppone said.

The American Bankers Association, which has long championed for changes to fair value rules, was also pleased with the FASB's decision Thursday,

"We are pleased that FASB has now taken steps to improve the accounting for other than temporary impairment, which is generally agreed to have been problematic for many years' earnings," said Edward Yingling, president and CEO of ABA. "Requiring that credit losses be reported in earnings provides a more realistic picture of losses."

Market-to-Market Changes 'Completely Overblown'

Despite the loud celebration over the FASB's decision Thursday, there are still several voices that continue to assert that the mark-to-market changes will not fix what ails the financial sector.

Paul Miller, CFA with FBR Capital Markets, argued that the market's reaction to the FASB vote is "completely overblown," and that the benefits from these changes will "have very little impact on financial institutions' accounting practices."

"FASB did not 'change' the rules, but rather provided additional guidance to existing rules that gives companies more latitude in determining whether a transaction in an inactive market is distressed," Miller wrote in a research note Friday. "We do not expect this guidance to have a significant impact on earnings or capital levels."

Meanwhile, Patrick Finnegan, CFA and director of financial reporting for the CFA Institute Centre, states that investor confidence should be weaker, not stronger, after the rule change. He argues that investors should have concerns about the politicization of accounting standards and erosion of the credibility of the FASB.

"Investors object to the FASB flouting its own due process rules and requiring hasty and significant amendments," Finnegan said in a statement. "We propose that authorities focus on regulatory capital management to resolve the current pressures on financial institutions rather than subjecting the FASB to political pressures that force it to depart from its mission."

Even CreditSights, an independent credit research firm, acknowledges that the FASB rule change could be positive for banks, but analysts expressed fear that a good portion of the price declines in value for troubled securities is driven by fundamental deterioration in expected cash flows as a result of higher credit losses.

"It is important to point out that this change does not change the fundamental earnings challenges facing most all banks, especially as it relates to credit quality trends," David Hendler, analyst with CreditSights, wrote in a note. "We continue to view it as a difficult operating environment for banks, and expect to see pressure on credit quality and loss provisions through all of 2009."