A proposed change to how banks value loans and other assets on balance sheets might lead to major changes in book value, and possibly impacting capital levels in unpredictable ways.
IN PICTURES: 10 Ways To Prepare For Nature's Worst

The proposal by the Financial Accounting Standards Board (FASB) would require banks to report loans and other financial instruments on its balance sheet at fair value. The FASB is currently accepting public comments on the proposal, and if adopted it would go into effect in 2013.

The FASB itself even recognizes the potential change that this proposal may have, and has included a four year deferral on adoption for non public banks that have less than $1 billion in assets. This would apply to approximately 90% of all banks in the United States, but only 10% of all financial assets. Most banks currently measure the value of their loan portfolio at amortized cost, not fair value. Regulatory filings usually have a footnote disclosing the fair value of loans just for informational purposes.

Advocates of the change argue that it would increase transparency in financial reporting and might provide an early warning on future credit cycles. Opponents feel that it would introduce too much volatility into quarterly results.

Fitch Study
Some analysts have tried to put numbers on the impact of the change if it is implemented. Fitch Ratings did a study and concluded that if the proposal had been in effect for reporting the third quarter of 2009, a decrease of $130 billion in stockholders equity would have been realized. This represented 14% of the total equity of the 20 banks reviewed.

The Fitch Ratings study showed that two of the worst hit banks were Regions Financial (NYSE:RF) and Huntington Bancorp (Nasdaq:HBAN). The fair value of loans for Regions Financial in the third quarter of 2009 was only 81% of book value, while the fair value of Huntington Bancorp's loans were only 87% of book value. The three banks that were least affected were Comerica (NYSE:CMA), BB & T Corp (NYSE:BBT) and U.S. Bancorp (NYSE:USB), which all reported the fair value of loans close to 100% of book value.

It's clear that something needs to be done to improve the area of financial reporting. A recent survey by Price Waterhouse indicated that 47% of the participating financial professionals said that both primary financial statements and disclosures were not "sufficiently useful."

The Bottom Line
The FASB is proposing changes to accounting methods that would depending on your point of view, either make financial statements more transparent and analyzable by the investment community, or create even more volatility in the price movement of bank stocks and the underlying credit cycle. Investors should keep watching this issue as it evolves over the next year. (For more stock analysis, take a look at Finding Growth In Asia.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Economics

    Understanding Cost-Volume Profit Analysis

    Business managers use cost-volume profit analysis to gauge the profitability of their company’s products or services.
  2. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  3. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  4. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  5. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  6. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  7. Stock Analysis

    The Top 5 Micro Cap Alternative Energy Stocks for 2016 (AMSC, SLTD)

    Follow a cautious approach when purchasing micro-cap stocks in the alternative energy sector. Learn about five alternative energy micro-caps worth considering.
  8. Stock Analysis

    Analyzing Porter's Five Forces on Under Armour (UA)

    Learn about Under Armour and how it differentiates itself in the competitive athletic apparel industry in light of the Porter's Five Forces Model.
  9. Stock Analysis

    The Biggest Risks of Investing in Qualcomm Stock (QCOM, BRCM)

    Understand the long-term fundamental risks related to investing in Qualcomm stock, and how financial ratios also play into the investment consideration.
  10. Stock Analysis

    The Biggest Risks of Investing in Johnson & Johnson Stock (JNJ)

    Learn the largest risks to investing in Johnson & Johnson through fundamental analysis and other potential risks. Also discover how JNJ compares to its peers.
RELATED FAQS
  1. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  2. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  3. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  4. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  5. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
  6. What is the formula for calculating earnings per share (EPS)?

    Earnings per share (EPS) is the portion of a company’s profit that is allocated to each outstanding share of common stock, ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center