Federal regulators have arranged a raft of bank takeovers since the onset of the financial crisis in 2008. Finding takers for insolvent banks usually requires that the Federal Deposit Insurance Corp. promise to cover most of a failed institution's future losses on its bad loans. That led banks to develop a confusing array of accounting practices to assess the value of those guarantees. Now, the Financial Accounting Standards Board, or FASB, is trying to bring some uniformity to the divergent valuation methods.
Some banks will be fine with that. Others, not so much.
Since the loss-sharing program began in 1991, the FDIC has entered into 291 shared-loss agreements guaranteeing potential losses on $120 billion in loans. Such arrangements, known as indemnifications, typically call for the FDIC to assume 80% of losses arising from the acquired loans. An acquiring institution is allowed to record the indemnification as an asset based on the amounts expected to be received from the FDIC for projected future losses.
As actual losses are realized, the acquiring institution is required to adjust the value of the indemnification asset to reflect the change in expected cash flows. When actual loan losses are less than expected, the value of the acquired loans increases, but the value of the indemnification decreases.
When there is such a change, some institutions amortize it over the term of the indemnification agreement with the FDIC. Others amortize the change over the life of the loan. Some institutions immediately write off the value of the indemnification if loan performance improves, the FASB says.
The variety of treatments is a problem: Investors in banks that have acquired failed institutions find it hard to compare how they are likely to perform once the acquisition accounting has ended. To make the accounting more consistent, FASB's Emerging Issues Task Force in April proposed that the amortization of changes in indemnification value should not exceed the length of the loss-sharing agreement with the FDIC. Any amortization of changes in value would be limited to the lesser of the term of the agreement or the remaining term of the indemnified assets.
"The Task Force believes the proposed guidance would address the diversity in practice by requiring these assets to be measured on the same basis as the change in the assets subject to the indemnification, and any amortization of the changes in value of the indemnification asset would be limited to the contractual term of the indemnification agreement," says Susan Cosper, FASB technical director and chairman of the task force.
Under the proposal, if a loan's remaining term is 10 years but the indemnification agreement's remaining term is only four years, then the allowable time to amortize a change in value would be four years. Fred Peterson, a partner at Seattle-based accounting firm Moss Adams LLP, says 90% of banks that have acquired indemnified assets are already compliant with FASB's plan.
But the few banks that have been amortizing the change in value over the life of the loan "will probably suffer some heartburn," Peterson says.
Comments on the proposal are due July 16, and the task force will review them and recommend changes by September. It's unclear when the plan will be implemented.
BB&T Corp. has already weighed in. The company said it supports FASB's approach and said the plan is consistent with how BB&T valued a $3.1 billion indemnification asset created when it acquired Colonial Bank in 2009.
"The approach provides for an appropriate degree of symmetry between the accounting for the acquired loans and the related indemnifications assets while at the same time reflecting the contractual limitation associated with the underlying loss-sharing agreement," wrote BB&T assistant corporate controller Henry Sturkie III.
BB&T did ask for more technical guidance on how to account for cumulative cash flow changes. The company also urged the accounting standards board to apply the same standard to both public and nonpublic companies.
Bill McConnell is The Deal magazine's Washington bureau chief.