Banks get an accounting boost

Rulesmakers set to ease rules on fair value accounting just in time for this month's first-quarter profit reports.

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Colin Barr, senior writer

Could an accounting rule tweak help Citi's first-quarter numbers?

NEW YORK (Fortune) -- Rules makers adopted guidelines Thursday that give financial firms more latitude in applying so-called mark-to-market accounting, just in time for what is shaping up as another tough earnings season.

The Financial Accounting Standards Board, the private sector body that sets U.S. bookkeeping rules, moved Thursday to adopt a rule that makes clear that firms need not write down the value of their assets based on so-called distressed sales of similar assets by other banks.

FASB members discussed the change earlier Thursday morning and reached an agreement on the new rule.

The decision, which will apply to the numbers banks report for the first quarter ended earlier this week, comes amid pressure from Congress over the supposed role of mark-to-market accounting in the financial crisis.

Numerous legislators called on the FASB in hearings last month to ease so-called fair value rules to ensure that banks aren't being forced to take excessive writedowns at a time of economic stress. Just days later, the five-member FASB put the proposal up for comment.

Members of Congress and some bankers have been sharply critical of what they call the FASB's foot-dragging on the fair value issue. But David Larsen, a managing director at valuation consultant Duff & Phelps, said last month that the release of the current FASB proposal amounted to "the second-quickest issuance of accounting guidance in history."

The rule changes come just as big U.S. banks are preparing to issue their first-quarter results. Analysts are expecting another rough quarter for big institutions such as Citigroup (C, Fortune 500), Bank of America (BAC, Fortune 500), JPMorgan Chase (JPM, Fortune 500) and Wells Fargo (WFC, Fortune 500), as a soaring unemployment rate and tumbling house prices should translate into higher loan losses.

The new FASB rules could help boost banks' earnings by making it clear that institutions can account for mortgage-backed securities and other assets based on their internal estimates of cash flow and other factors, rather than relying on sales prices in largely inactive markets.

But observers such as Larsen note that the latest guidelines only confirm what careful readers of the FASB's fair value rules have known all along, that fire sales aren't meant to be the main determinant of value.

Thus, if the banks have been following the rules as intended all along, there could be little effect on the earnings.

The FASB, which sets the guidelines under the aegis of the Securities and Exchange Commission, on Thursday also tweaked the rules for how banks may account for securities such as bonds that aren't expected to be repaid in full, but whose market value has been depressed as markets have grown less liquid.

Under the new rules, these so-called "other-than-temporary" impairments will be divided into two buckets, one that reflects the expected credit losses tied to a security and another that accounts for other declines in value, which may be tied to market uncertainty.

Shares of the big banks rose sharply on the news Thursday, as the broader market rallied on the backdrop of plans for increased global funding for the International Monetary Fund. Bank of America and Citi, two of the most troubled banks, were each up nearly 10% in mid-morning trading.

The moves Thursday represent the latest twist in the long-running struggle between accounting rules makers and foes of fair value accounting.

The latter, led by the likes of former bank regulator Bill Isaac and onetime Federal Reserve official Bob McTeer, argue the fair value rules have deepened the economic crisis by reducing bank capital and constraining lending. They have called for the rules to be completely repealed.

But proponents of fair value rules champion the transparency they provide to investors and say changing the rules wouldn't solve problems that are mostly driven by a collapse of underwriting standards during the credit boom.

Larsen, for one, likens a move away from fair value accounting to "taking the freshness date off the milk bottles. Does it really address the real problem?"  To top of page

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