Mark to Market Lending: FASB Dances on Banking's Toes

This column is not about banking's version of "Dancing with the Stars." Rather, the issue of mark to market may return to the table. Most observers, including yours truly, agree that the doomsday financial meltdown scenario has passed. With a few notable exceptions, the largest financial institutions have survived the crisis and are returning to profitability. However, many mid-size and smaller banks are still struggling. Now, the Financial Accounting Standards Board (FASB) may stomp (not dance) on every banker's toes. What if FASB rules that mark to market must be implemented for all loans, from credit cards with balances to $ billion leveraged buyout loans?Last week the Wall Street Journal reported that "... the Financial Accounting Standards Board is likely to propose that banks expand their use of market values for financial assets such as loans, according to people familiar with the matter. That departs from current practices in which banks hold loans at their original cost and create a reserve based on their own view of potential losses. The result, if the proposal flies, would be big changes to bank balance sheets, the shape of income statements and some of the metrics investors use to evaluate financial institutions." The four biggest US banks have a combined total of $2.8 trillion in loans that could be affected. As a former banker and an industry analyst, I know marking a loan portfolio to market will be bad for banking.

The mark to market ritual is applied to assets that are considered investments, including all securities and loans held for sale. Almost all of these assets (except for hard to value derivatives that caused problems for Lehman Brothers and others) can be valued, or marked up or down, based on market prices for equivalent securities or loans. Bankers are used to marking these assets to market on a regular basis. Apparently FASB believes that banks have ignored a hypothesis that loans can change in value between their funding and payoff, and therefore should be marked during the life of the loan, even when the loans payoff in full. If mark to market increases the cost of lending, how happy will borrowers be if they have to pay more to get a loan to cover future mark to market costs?

Figuring out how to value one loan that is still on the bank's books after it has been funded, let alone an entire loan portfolio, is not something any lender or analyst really wants to do. The problem starts with trying to answer simple questions. What is the market value if the loan is current and has always been current? Or, what loan underwriting variables need to be revalued - the borrower's capacity to repay, the borrower's latest credit score or rating, the value of the collateral underlying the loan, two of the three, or all three? Where would you start the mark to market process for a portfolio of loans? What technology applications might be useful? Will you have to use Excel spreadsheets? You can probably imagine what type of effort would be required by a bank to complete such an analysis, even if just a random sampling of loans is marked or re-valued periodically. For all this effort, the mark to market portfolio of loans will not produce any more cash income as long as the borrower complies with the terms of the loan.

Everyone but FASB and auditors with too much time on the beach should agree - this is wrong headed. If you know a banker who thinks all loans should be marked to market, please have him or her send me an email. I would like hear the rationale.

Bill Bradway, founder and managing director of Bradway Research LLC, analyzes the business strategies and IT investments of US banks and credit unions.