DEFINITION of Appraised Equity Capital
The excess of the market value of an asset over its book value. Appraised equity capital was a form of regulatory capital allowed under the Federal Home Loan Bank Board, and was used specifically to take into account the value of property. Appraised equity capital allowed banks to count unrealized and unrecorded equity in owner-occupied buildings and land, and unamortized profits from leasing or selling buildings.
BREAKING DOWN Appraised Equity Capital
Appraised equity capital is closely associated with the savings and loans crisis of the 1980s and early 1990s. Beginning during the late 1970s, regulators noted that these financial institutions had a growing negative net worth. To increase the banks’ net worth the regulators lowered capital requirements and adjusted how these financial institutions could account for capital and earnings. These adjustments also allowed appraised equity capital to be considered part of a bank’s capital.
Prior to the change in accounting methods, banks, thrifts, and other financial institutions had historically been allowed to keep the purchase value of property that they owned on their books. The change to the regulatory account principles (RAP) in 1982 allowed banks that owned property to shift from using the book value of the property to using the market value of the property when calculating net worth, even if the bank didn’t sell the property.
While many financial institutions properly used this new value accounting method some groups of banks traded properties with each other, which allowed them to show higher and higher values. Another regulation issued around the same time allowed banks to report losses from selling property at a lower market value than book value over a ten year period rather than immediately (called a deferred loan loss). This allowed the bank to consider this loss an asset, despite it not being worth anything, as it amortized.
These two factors allowed banks to report higher asset values and thus higher net worth than they actually had.