Is the corporate credit crunch about to get worse? In late December, the Financial Accounting Standards Board decided that banks must mark to market certain types of commercial-loan commitments–such as revolvers–as well as financial guarantees.
The ruling applies to only a small percentage of loan commitments–essentially those that meet the definition of a derivative under FAS 133, because they can be easily resold. And that’s a determination that “needs to be assessed on virtually a case-by-case basis,” says consultant Ira Kawaller, who is a member of the FASB Derivatives Implementation Group (DIG).
Behind the ruling, however, is a quiet but fierce debate among banks about whether they should be required to apply fair value accounting to more of their offerings. For CFOs, the concern is that such a change might raise prices of backup credit.
Some banks, particularly those with a mix of commercial- and investment-bank offerings, such as J.P. Morgan Chase and Citigroup, do not want to mark lines of credit to market, in part because providing backup credit lines is a way of encouraging customers to purchase other financial services. This is a very sensitive issue because outright bundling raises antitrust concerns.
Other, more-traditional investment banks–such as Goldman Sachs, which marks all of its products to market–consider credit lines that can be drawn down at a predetermined interest rate to be the equivalent of an option.
Ernst & Young partner Michael S. Joseph, also a sitting member of the DIG, says he doubts the current decision will change the cost or availability of credit. In fact, he says, “the loans affected are, for the most part, originated by larger banks that plan to sell them, and they tend to manage them on a mark-to-market basis anyway.”
But, warns an insider at a bank that opposes mark-to-market accounting, that could change if the FAS 133 ruling is extended. “We’re already starting to see upward pressure on pricing because of fears of having to mark-to-market commercial-paper backup facilities.”
Sidebar: By Any Other Name
Despite a host of exceptions, FAS 133 uses the following properties to define derivatives:
Source: A. Chua, Society of Actuaries Spring Conference, 2001