More on the Proposed Expansion of Fair Value Accounting

7/22/2010

By Joseph M. Press, CPA, CFE

In our June 10, 2010, newsletter, we introduced you to FASB’s Proposed Accounting Standards Update Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities. Among other things, that article stated that a bank would need to measure deposit liabilities, including core liabilities, at fair value. A closer reading of the proposal shows that non-core deposit liabilities would be measured at fair value while core deposit liabilities would be valued under the remeasurement approach.

The remeasurement approach is defined as the present value of the average core deposit during the period discounted at the difference between the alternative funds rate and the all-in-cost-to-service rate over the implied maturity of the deposits. Luckily, the proposal contains a Glossary to help us understand some of the above terms:

Core Deposit Liabilities

Deposits without a contractual maturity that management considers to be a stable source of funds, which excludes transient and surge balances.

Alternative Funds Rate

A rate associated with the next available source of funds if core deposit liabilities are not an available source of funds. The alternative funds source must be cost effective and sufficient in volume and duration to replace the core deposit liabilities as a source of funds. A blended rate may be used if one source alone is not sufficient in volume.

All-in-Cost-to-Service Rate

A rate that includes the net direct costs to service core deposit liabilities, including all of the following:

• Interest paid on the deposits;
• The expense of maintaining a branch network; minus
• Fee income earned on the deposit accounts.

Implied Maturity

For a core deposit liability, management’s assessment of the average life by account type. Management may make that assessment on the basis of either an analysis of internal data or an analysis of peer information.

Because determining the value of these terms will require a substantial amount of management’s judgment, the proposal calls for disclosure of the inputs and assumptions (qualitative and quantitative) for all of the following by type of deposit:

• The calculation of the average core deposit balances
• The determination of the implied maturity period
• The alternative funds rate used and the reasons for its use
• The all-in-cost-to-service rate

Any one of these items presents a variety of challenges, however, for illustration purposes, consider the all-in-cost-to-service rate.

The proposal offers the following guidance for determining the all-in-cost-to-service rate.

In determining the all-in-cost-to-service rate, management should consider direct income and expenses to service the core deposit liabilities, including interest expense, branch maintenance expense, and fee income. For purposes of this measurement, branch maintenance expense includes overhead (building rent, building depreciation, utilities, administrative support, and executive salaries) and selling costs (advertising, promotional expenses, and salaries of branch employees).
Even with this guidance, the following questions would need to be addressed:

• Many branches are full service – how shall branch maintenance expenses be divided between core deposits and non-core deposit functions?
• Much advertising and promotional expense is aimed at name/brand recognition. How should it be allocated?

Reasonable assumptions will vary from bank to bank which will serve to frustrate the goal of comparability.

Whereas all community banks are required to maintain their books and records in accordance with generally accepted accounting principles, community banks would be subject to this proposal, if adopted as proposed. This valuation process would need to be performed on each reporting date, which presumably is quarterly.

This article has devoted much space to the detail of part of a proposed accounting change that would not become effective for several years. The purpose of the article is to inform and encourage interested parties to comment on this proposal. This part of the proposal alone would cause thousands of community banks to devote countless hours of time and effort to develop information of limited, if any value. Our June 16, 2010, newsletter article took issue with the proposed changes in the area of fair valuing loans.

FASB invites individuals and organizations to send written comments on all matters in the Exposure Draft of the proposed Accounting Standards Update. Responses from those wishing to comment on the Exposure Draft must be received in writing by September 30, 2010. Interested parties should submit their comments by email to director@fasb.org, File Reference No. 1810-100. Those without email should send their comments to “Technical Director, File Reference No. 1810-100, FASB, 401 Merritt 7, P.O. Box 5116, Norwalk, CT 06856-5116.” Do not send responses by fax.

An electronic copy of the Exposure Draft is available on the FASB’s website until the FASB issues a final Accounting Standards Update.