Silicon Valley Bank losses embolden calls for US accounting rule reform

US accounting rulemakers are being urged to rethink how banks should value their assets in financial statements, in the wake of the run on Silicon Valley Bank and pressure across the regional banking sector.

Advocates of “fair value” accounting are urging the Financial Accounting Standards Board to force banks to recognise unrealised losses on securities such as those held by SVB, even when management insists they will never have to be sold.

A fair value approach would have made SVB’s losses on its bond portfolio obvious to more investors earlier, the advocates say, and could have forced the bank to take action to shore up its finances before it was too late.

Stephen Ryan, accounting professor at New York University, said: “Had Silicon Valley Bank or any of the other affected banks been using fair value for their long-term market securities, they would have had to cope with the rises in interest rates as they occurred rather than putting it off until a stress point.”

SVB had parked $91bn in a portfolio of bonds whose market value had fallen to $76bn because of rising interest rates, but it was still holding them at cost on its balance sheet because executives had certified they intended to hold them to maturity. The bank was seized by regulators on March 10 as depositors took fright over its bond exposure.

Only assets designated “available for sale” need to be marked to market, meaning changes in their value affect the bank’s balance sheet. The market value of assets designated “hold to maturity” is disclosed in financial reports but does not affect the balance sheet or income statement.

Selling hold-to-maturity assets, however, as investors feared SVB would need to do to cover depositor withdrawals, can trigger a requirement to recognise any losses all at once, eroding a bank’s capital cushion.

The FASB last proposed expanding the use of fair value on corporate balance sheets in 2010, but the proposal was roundly rejected. After the trauma of the global credit crisis, when markets seized up and many assets became unsellable at almost any price, banks said being forced to use fire sale prices would make their results more volatile and risked causing confusion or even panic. Then-Federal Reserve chair Ben Bernanke was among regulators who also spoke out against the proposals.

The CFA Institute, a professional body for investors, which campaigned vigorously for fair value rules in 2010, sent a new white paper to FASB last week urging it to “eliminate ‘hide-’til-maturity’ accounting”, saying “the hold-to-maturity classification only makes it harder for investors and depositors to see what’s really going on”.

“You have to go to the fair value footnote and you have to put the pieces of the puzzle together,” said Sandy Peters, the CFA Institute’s head of global advocacy. “Depositors don’t do that. Silicon Valley Bank’s unrealised losses were bigger in September. The problem was that it wasn’t obvious. On March 8, it became obvious.”

The FASB said it was “always open to engage with stakeholders on any issues”.

The discussion is not just an academic debate about which approach would paint the “correct” picture of what an asset is worth, because the accounting rules affect banks’ behaviour, according to many in the sector.

NYU’s Ryan said SVB executives would have known interest rate rises were likely to dent the value of its bonds. “They would have been much less likely to acquire long-duration securities in the first place and not to hedge them” if the bank was going to have to recognise mark-to-market losses, he said.

Peter Marshall, leader of EY’s financial services liquidity advisory group, said on a recent webinar that banks needed to be mindful of the risks. “Best-in-class institutions have rigorous frameworks that set the policy in a conservative way around how much held-to-maturity is used,” he said. “They get an accounting impact that is favourable but the ability to monetise those securities is limited.”

Opponents of changing the rules in 2010 said the current system reflects the reality of how banks do business, because unrealised gains and losses are irrelevant on loans and securities that are held for the full length of their life. Other arguments included that fair value requirements would make US results harder to compare with those prepared using international standards, and that there was no perfect valuation metric.

“This has been a very controversial issue in the past and I think would be so again,” said Bob Herz, who chaired FASB in 2010. “I lean towards fair value. I proposed to my fellow board members at the time that you should use a discounted cash flow valuation [rather than a market price] but I didn’t sell a lot of tickets.”

Brent Beardall, chief executive of Washington Federal, a $22bn-in-assets bank based in Seattle, described the current rules as “a camel, a horse built by committee”, because some assets are measured at fair value and some are not, and there is no attempt to use fair value on the liabilities side of the balance sheet.

“We’re straddling the fence and it’s ugly. What is the purpose of accounting information? You want it to provide useful information to stakeholders and it’s not useful information,” Beardall said.