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Recent accounting changes, for the first time, permit the use of fair value in the primary financial statements for held-to-maturity (HTM) bank loans. While the use of fair value has historically attracted significant discussion and debate, there is little information in the public domain on how banks would measure fair value or use it in loan management. This study presents and analyzes results from in-depth discussions with seven large internationally-active banks on their fair value use and measurement for HTM commercial loans and commitments. The objectives of the discussions and those of the study are to: identify the extent to which fair value is used for HTM commercial loan facilities and how it is used; describe valuation methodologies used and consider the roles of market price sources and modeling and their relative importance in fair value estimation; consider model validation and price verification; draw conclusions as permitted and suggest areas for future research.
Abstract: Recent accounting changes, for the first time, permit the use of fair value in the primary financial statements for held-to-maturity (HTM) bank loans. While the use of fair value has historically attracted significant discussion and debate, there is little information in the public domain on how banks would measure fair value or use it in loan management. This study presents and analyzes results from in-depth discussions with seven large internationally-active banks on their fair value use and measurement for HTM commercial loans and commitments. The objectives of the discussions and those of the study are to: identify the extent to which fair value is used for HTM commercial loan facilities and how it is used; describe valuation methodologies used and consider the roles of market price sources and modeling and their relative importance in fair value estimation; consider model validation and price verification; draw conclusions as permitted and suggest areas for future research.
This dissertation utilizes empirical methods to shed light on the current debate over whether to adopt fair value accounting for loans held for long term. Proponents of fair valuing loans argue that reporting loans at their fair values enhances the overall transparency of financial reporting. In contrast, opponents are against applying fair value accounting to loans because fair values cannot be measured reliably in the case of loans held for long term. Therefore, the key question here is whether loan fair values are sufficiently reliable to provide more relevant and transparent information compared to traditional measurements of loans. To explore this, I compare fair value disclosures of loans under Statement of Financial Accounting Standards No. 107 (SFAS 107), Disclosures about Fair Value of Financial Instruments, with traditional measurements of loans reported on balance sheets. More specifically, this study asks two research questions; (i) whether loan fair values provide more relevant information about future loan losses compared to traditional measurements of loans and (ii) whether banks intentionally manage their fair value estimates of loans when they are financially distressed. SFAS 107 mandates the disclosure of fair values for financial instruments with the objective of providing investors with more relevant information about firms' future cash flows. However, the results show that fair value measurements of loans explained variation in future loan losses, which capture cash flows from loans, less than traditional cost-based measurements of loans. In addition, I find evidence suggesting that financially distressed banks overstated the fair values of their loan portfolios and that fair values of loans in the aggregate lagged considerably behind the market values of loans during the recent credit crisis. Overall, my results suggest that fair value disclosures in bank loan portfolios contain relatively less information about future cash flows because they are measured unreliably and they suffer from a similar lack of timeliness as reported carrying values.
This paper shows that banks use accounting discretion to overstate the value of distressed assets. Banks' balance sheets overvalue real estate-related assets compared to the market value of these assets, especially during the U.S. mortgage crisis. Share prices of banks with large exposure to mortgage-backed securities also react favorably to recent changes in accounting rules that relax fair-value accounting, and these banks provision less for bad loans. Furthermore, distressed banks use discretion in the classification of mortgage-backed securities to inflate their books. Our results indicate that banks' balance sheets offer a distorted view of the financial health of the banks.
Developed for preparers of financial statements, independent auditors, and valuation specialists, this guide provides nonauthoritative guidance and illustrations regarding the accounting for and valuation of portfolio company investments held by investment companies within the scope of FASB ASC 946, Financial Services —Investment Companies, (including private equity funds, venture capital funds, hedge funds, and business development companies). It features16 case studies that can be used to reason through real situations faced by investment fund managers, valuation specialists and auditors, this guide addresses many accounting and valuation issues that have emerged over time to assist investment companies in addressing the challenges in estimating fair value of these investments, such as: Unit of account Transaction costs Calibration The impact of control and marketability Backtesting