Fair valuation of bank loans will increase volatility of shareholder interest, Fitch

June 21, 2010 By Omoh Gabriel Business Editor

The new requirement by financial regulators across the globe as a result of the impact of the global financial crisis on economies is generating heated debate and controversies. Specifically the requirement that bank loans be measured on the balance sheet at fair value is said to be a profound change that will affect the balance sheet of banks and financial institution if adopted.

According to Fitch Rating Agency two major changes to the financial reporting of loans are moving through the standard-setting pipeline. The first change will significantly expand and improve disclosures about the allowance for credit losses, the credit quality of loans, and the fair value of loans. The second change, which would likely be subject to intense debate, would require all financial instruments, including loans, to be measured on the balance sheet at fair value. The fair value proposal will affect the balance sheets of most banks in a very significant way, with possible repercussions on bank analysis and bank capital, depending on the regulatory response to any accounting change.

According to Fitch the United States FASB recently unveiled its much anticipated proposal on financial instruments and it requires most financial instruments, including loans, to be measured on the balance sheet at fair value. Over the years, the disclosure of the fair value of financial instruments, including loans, has garnered little attention. This was primarily due to the fact that the fair value of loans was generally higher than the carrying amount. However, the significant market deterioration over the past two years has led to a significant downswing in the fair value of many banks loan portfolios relative to their book value, net of allowance for loan losses.

The most notable change in the proposal the report said , if adopted in the current form, will be the requirement to account for all loans at fair value.“This is a profound accounting change that will affect the reported balance sheets of most banks in a very significant way, with possible repercussions on bank analysis and reported bank capital” said Olu Sonola, Director, Fitch Ratings.

From a regulatory standpoint, it remains to be decided what the capital impact will be; however, the total equity of most banks is set for more volatility. The presentation of financial instruments on the face of the balance sheet and income statement also changes, two notable changes are expected. The balance sheet would present separate line items for amortized cost and fair value. With this dual presentation, an analyst could easily choose the number that is most relevant for their analysis.Since Nigeria banks and other financial institution are to adopt the International Accounting Standard, and with the Central Bank of Nigeria reforms centred on risk based supervision, good corporate governance and adequate disclosure this proposal will affect the country banking sector financial reporting in which case loans will be accounted for in their fair value position

Fitch in its review of the proposal said ”In a December 2009 Fitch study of 20 large commercial banks in the U.S., loans made up 55 per cent of total assets, although this figure would be higher for smaller and regional banks. 98 per cent of loans held by the banks were classified as held for investment and therefore measured at amortized cost.” Based on Fitch’s review, if the proposal for loans was adopted in the third quarter of 2009, it would have resulted in a decrease in shareholder;s equity of $130 billion (approximately 14% of the combined total equity of all the 20 banks reviewed). This reduction excludes the tax effect and the offsets from applying FV to the liabilities that fund the loans.

From the data gathered, it is difficult to establish a set long-term trend between the deterioration in the fair value of net loans disclosed by the banks reviewed and loan loss/net charge-off metrics. Therefore, interpreting differences between the fair value and the carrying amount of loans is ambiguous at best. Significant disparities were noted in how banks currently measure the fair value of their loan portfolios. In addition, the lack of dis-aggregation in current disclosure on the fair value of loans hinders comparability and analysis. While the proposal is silent on disclosure, Fitch believes that current disclosure on the fair value of loans is largely not additive to analysis. An overhaul of disclosures on the fair value of loans is necessary to aid transparency and new disclosures would be expected to require more dis-aggregation.

Furthermore, given the potential for a lack of an active and liquid market for loans, disclosures of meaningful sensitivity analysis coupled with the methods and significant assumptions used in the valuation process would be needed to provide a robust and transparent presentation to be insightful to analysts and investors. Fitch will further study the analytical implications of applying fair value of loans as this will likely add increased volatility to core capital measures, irrespective of the regulatory capital treatment, which is yet unknown.

SON set to tackle challenges of exports of agricultural produce to UK, U.S. The Standards Organisation of Nigeria (SON) has initiated steps to address current challenges facing the export of Nigerian agricultural produce to the U.S., UK and other European Union countries. The plan is contained in a statement signed by the Head, Public Relations, Mr Bola Fashina.

The statement quoted the Director-General of SON, Dr John Akanya, as saying that the agency had gone into partnership with a UK- based organisation, Best Produce International to promote exports of agricultural produce. He said the partnership, which would include training of exporters, was aimed at providing needed tools towards building capacity for relevant stakeholders in agro-business and agro-industries.The stakeholders include farmers groups, processors, produce inspectors and exporters, as well as agencies involved in agro-allied business regulation.

In view of this, he said that a two-day workshop would be organised on establishing Global Agricultural Produce Standards for certification of Nigerian Agricultural produce for export. He said the workshop would be facilitated by experts from the UK and Nigeria, adding that this would be part of SON’s efforts to promote the diversification of the Nigerian economy. The director-general added that the measures were in line with the Federal Government’s 7-point agenda.

”It will also ensure the acceptance of Nigerian agricultural exports with a view to improving the inflow of foreign exchange earnings,” he said. Akanya said that the programme would be the second of its type in Africa following a similar one held in Kenya recently. He urged all stakeholders in the agro-allied business and regulatory agencies involved in the sector to take maximum advantage of the programme scheduled to hold on June 21 in Abuja.





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