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Banking Accounting rule that made weak banks look healthier ended

Accounting rule that made weak banks look healthier ended

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An accounting rule that propped up bank earnings when times were tough and hurt profit when markets improved was eliminated by the U.S. body that sets bookkeeping standards.

The debt-valuation adjustment, or DVA, will no longer be included in net income, according to revisions to the fair-value measurement standard published by the Financial Accounting Standards Board Tuesday. Firms can now report changes in the value of their debt as part of “other comprehensive income,” which isn’t part of the bottom line that analysts and investors watch most closely.

The DVA rule increased net income when a bank’s bonds tanked, on the theory that the firm could buy back its bonds at a lower price and benefit from the decline in value. In practice, a financial institution in trouble, such as Lehman Brothers Holdings in 2008, is unable to buy back bonds because it can’t get fresh financing.

Most of the biggest U.S. banks already separately report earnings figures each quarter that exclude the impact of DVA. Although the revised standard goes into effect in 2017, the largest banks in the past have implemented some accounting changes ahead of schedule to satisfy analysts and investors keen to see the new standard in practice. The change is unlikely to affect 2015 fourth-quarter results, which banks begin reporting next week. The largest firms will probably start excluding DVA from income in their reports for the period ending in March, according to people familiar with the lenders’ plans.

The revised standard also expands the use of mark-to-market valuation of equity investments, a change that would have a bigger impact on insurance companies, which typically have more such holdings than banks.

It also requires valuing loans at exit prices — what they would garner if put on sale. The change only affects how loan portfolios are valued in quarterly disclosures and wouldn’t change the bottom line.

In its initial draft of the revisions published in 2010, FASB was demanding mark-to-market accounting for all financial assets — bank loans, stocks and bonds — with direct impact on the bottom line depending on price fluctuations. After a backlash from the banking industry and pressure from international standard setters, that idea was dropped in favor of smaller adjustments to how financial instruments are measured on balance sheets. The original proposal would have resulted in some $140 billion of writedowns on the loan portfolios of the nation’s largest banks, analysts estimated at the time.

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