Guidance Regarding FASB's Mark to Market Proposal The Financial Accounting Standards Board (FASB) has issued an exposure draft (proposal) that will significantly revise accounting for banking institutions. The proposal requires that all financial instruments be marked to market ("fair value") on the balance sheet – including loans. The revisions could radically change how investors and customers view banking institutions and could also change banking products. FASB often says that investors want mark to market accounting; however bank analysts and investors have indicated this is not the case. Similarly, the International Accounting Standards Board (IASB) has found that investors do not want mark to market for assets held long-term, and the IASB rejected it in its final rule addressing which assets must use mark to market accounting, "IFRS 9".

How to write to FASB

Due date: September 30, 2010.

Where to send letter: By email to director@fasb.org, File Reference No. 1810-100. Those without e-mail should send their comments to:

Technical Director Financial Accounting Standards Board 401 Merritt 7, PO Box 5116 Norwalk, CT 06856-5116 File Reference No. 1810-100

Writing Tips

All comment letters will be made public on FASB's website. No "form" letters. Please write your own letter, explaining your individual situation. You may choose to write to the FASB on all the aspects of their proposals; however, it would be

most useful to write on the "mark to market" portion, at a minimum.

Industry Issues: Summary of the FASB Proposal

http://www.aba.com/Industry+Issues/FASB_advocacyIII.htm[9/16/2010 11:22:06 AM]

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Accounting Changes Proposed by the FASB

The Financial Accounting Standards Board (FASB) has issued an exposure draft (ED) that will

significantly revise accounting for banking institutions. The revisions could radically change how

investors and customers view banking institutions. In summary, the ED includes:

The accounting will be similar for loans and debt securities.

The balance sheet classification for both loans and debt securities will be similar to today's

"trading" and "available for sale" buckets.

All loans and debt securities will be recorded at fair value (FV) on the balancesheet.

Changes in FV for assets held for trading purposes will continue to be recorded through

earnings.

For assets held for long-term investment, an allowance for credit losses will be maintained,

with changes affecting earnings. Changes in FV will be recorded to Other Comprehensive

Income (OCI).

Currently, the FVs for loans held for investment and held-to-maturity debt securities

are recorded at amortized cost, with FVs disclosed only in the footnotes to the

financial statements.

For those assets held for long-term investment, the balance sheet will detail the

amortized cost, the allowance for credit losses, and a FV adjustment to reach an

ending balance at FV.

Unfunded loan commitments for most loans will be reported at FV on the balance

sheet, with any changes in FV reported in OCI. Currently, most unfunded loan

commitments are not reported on the face of the balance sheet, but are disclosed in

the footnotes.

Borrowers are exempt from this requirement.

Credit card loan commitments are exempt from this requirement.

Allowances for credit losses will apply to both loans and debt securities held forlong-term investment and will now be estimated based on "expected losses", asopposed to "incurred losses".

The "triggers" for recognizing losses that have been subject to much controversy and audit

scrutiny will be eliminated.

Interest income will be based on an effective yield calculated after (not prior to) expected

losses.

Based on the expected losses at the time of acquisition, for practical purposes there may be

"Day 1 losses" recorded.

Equity Securities will be marked to market, with changes in FV recorded directlyto earnings.

Equity method accounting will apply for unconsolidated equity investments if the entity has

significant influence over the investee and the investment is related to the entity's

consolidated business.

One Statement of Comprehensive Income will be required to be presented.*

Industry Issues: Summary of the FASB Proposal

http://www.aba.com/Industry+Issues/FASB_advocacyIII.htm[9/16/2010 11:22:06 AM]

A "continuous statement of comprehensive income that would enhance the prominence of the

items reported as other comprehensive income" will be required. Both net income and other

comprehensive income will be reported, summing to total comprehensive income (TCI).

Thus, the FV adjustments that go through OCI will be included in the new bottom line as

part of TCI.

It is expected that TCI will be available at the time of earnings releases along with Net

Income, though a TCI per share will not be required to be provided on the Statement of

Comprehensive Income.

Financial liabilities will generally be recorded at FV.

Core deposit liabilities are recorded at their present value, which may reflect a core deposit

intangible that approximates the interest rate borrowing advantage inherent to banks from

deposits. The amount of this intangible is much more limited than the deposit intangibles now

recorded in business combinations.

Other than for derivative liabilities, changes in FV will generally be reported in OCI.

Companies have the option to record their own debt at amortized cost if FVs would create or

exacerbate a mismatch with the asset it is funding.

Hedge accounting will be streamlined to allow hedging of specific risks, asopposed to whole instruments.

Hedging instrument must be "reasonably effective" to offset changes in value or cash flows

of the hedged item.

Qualitative analysis of effectiveness is required at inception.

Effectiveness is reassessed only if circumstances indicate the relationship is no longer

reasonably effective.

"Shortcut" and "critical terms match" methods are eliminated.

Hedge accounting may be discontinued only if criteria for hedge accounting are no longer

met. No arbitrary de-designation.

The effective date for non-public banks with assets under $1 billion is deferred forfour years.

These smaller banks will still be required to disclose fair values of all financial instruments

with a FAS 157-based "exit price".

*Note: The statement of comprehensive income is addressed in a separate ED, issued

concurrently with the Accounting for Financial Instruments ED. The proposal is issued at this time

because of FASB's desire to reflect all fair value changes as a prominent part of a financial

institution's performance.

For more information contact: Michael Gullette (202) 663-4986

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FASB's Mark-to-Market Accounting Plan Misses the Mark

By Ann Grochala, ICBA Vice President of Lending and Accounting Policy

Despite warnings by ICBA about the dangers of mark-to-market accounting on the nation's community banks, the Financial Accounting Standards Board has released a proposal to mark nearly all financial instruments on financial firms' balance sheets to fair value, including deposits and loans. The Exposure Draft, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedge Activities, is out for public comment until Sept. 30, 2010.

ICBA has repeatedly urged FASB and other policymakers to recognize that community banks fund their operations by taking deposits and holding loans for the long term, which are not readily marketable, not by creating or purchasing assets or liabilities for quick resale. The accounting changes in the Exposure Draft will cause all financial institutions, particularly community banks, to significantly change their accounting policies and practices. Unfortunately, all financial institutions may well need even more capital to offset the resulting increased volatility in financial instrument values.

In a recent letter to Congress, ICBA urged FASB not to move forward with its mark-to-market plan for community banks. ICBA questioned how fair-value measurements would provide a better understanding of, for instance, illiquid agricultural loans held by small banks in rural areas. As ICBA noted in the letter, mark-to-market accounting completely misses the mark. We reiterated our concerns in a recent meeting with representatives of the Financial Accounting Foundation and FASB.

What Will It Do? The proposal's objective is to provide financial statement users with a more timely and representative depiction of an entity's involvement in financial instruments while reducing the complexity in accounting for them. FASB states that its proposal simplifies and improves financial reporting for financial instruments by developing a consistent, comprehensive framework for classifying financial instruments, removes the threshold for recognizing credit impairments and makes changes to the requirements to qualify for hedge accounting.

Specifically, the proposal would require: presentation of both amortized cost and fair value on an entity's statement of financial position for most financial instruments held for collection or payment of contractual cash flows, and the inclusion of both amortized cost and fair value information for these instruments in determining net income and comprehensive income. Additionally, it would require that financial instruments held for sale or settlement (primarily derivatives and trading financial instruments) be recognized and measured at fair value and with all changes in fair value recognized in net income.

Nonpublic entities with less than $1 billion in total assets would be given an additional four years to implement the new requirements relating to loans, loan commitments and core deposit liabilities that meet certain criteria. Some specific types of financial instruments, such as pension obligations and leases would be exempt from the guidance. Short-term receivables and payables would continue to be measured at amortized cost (plus or minus fair value hedging adjustments).

Why Now? For several decades, FASB has been working toward full mark-to-market accounting and has implemented guidance impacting parts of the balance sheet such as investments. It has been criticized for requiring mark-to-market accounting for only parts of the balance sheet, which has caused some confusion for financial statement users. More recently, in an effort for more uniformity of accounting standards on a global basis, FASB has been working with the International Accounting Standards Board on a joint project to revise and improve accounting for financial instruments.

The global economic crisis put this project on a fast track. FASB says that to support well-functioning global capital markets, many investors, preparers and even high-level governing bodies urged as a top priority the development of a single, converged financial reporting model for financial instruments that provides investors with the most useful, transparent and relevant information about an entity's exposure to financial instruments. Interestingly, while IASB and FASB have an agreement to work together on financial instrument accounting, FASB is moving ahead separately and plans to later continue its work to resolve differences between U.S. and international standards that address accounting for financial instruments.

What Can Community Bankers Do? Below are listed sources of information about FASB's proposal. It is important for community banks to understand its impact on their operations and to tell FASB about it. The proposal contains a series of questions for users, preparers and auditors. FASB is hosting a free Webcast to discuss the proposal at 2 p.m. (Eastern time) Wednesday, June 30. We encourage community banks to listen in and submit questions.

ICBA will be developing tools to help community banks send comment letters in the coming weeks. If you do send a letter, please send a copy to ICBA at info@icba.org. Read ICBA NewsWatch Today about these and other initiatives.

Donna J. Fisher Senior Vice President – Tax, Accounting and Financial Management

202-663-5318 dfisher@aba.com

August 31, 2010

Mr. Russell Golden

Technical Director

Financial Accounting Standards Board

401 Merritt 7

P.O. Box 5116

Norwalk, CT 06856-5116

Via email: director@fasb.org

File Reference: No. 1810-100 Accounting for Financial Instruments and Revisions to the Accounting

for Derivative Instruments and Hedging Activities

Re: Classification and Measurement of Financial Assets and Liabilities

(ABA Comment Letter 1 of 3 for File Reference 1810-100)

Dear Mr. Golden:

The American Bankers Association (ABA) appreciates the opportunity to comment on the Exposure

Draft: Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments

and Hedging Activities (ED). ABA represents banks of all sizes and charters and is the voice for our

nation’s $13 trillion banking industry and its two million employees. The majority of ABA’s members

are banks with less than $165 million in assets. ABA’s extensive resources enhance the success of the

nation’s banks and strengthen America’s economy and communities.

The ED represents major changes to bank financial reporting. Because of the importance of the issues

addressed in the ED, as well as the wide range of issues within, ABA is dividing our response to the ED

in three parts: 1) classification and measurement of financial assets and liabilities, 2) credit impairment

of financial assets, and 3) derivative instruments and hedging activities. This is the first of our three

comment letters and will focus on the classification and measurement of financial assets and liabilities,

as well as other general topics.

The ABA strongly believes that the mixed measurement approach is the most relevant and reliable

model, and we disagree with the proposal to expand “fair value accounting” 1

to all financial

instruments. 23

This view is shared globally by the banking industry4 and many others. Much attention

1 “Fair value” is the technical term used in the ED and in other accounting standards, though we believe “mark to market” is more

descriptive and we have used “market value” and “mark to market” in place of “fair value” in other comment letters.

2 ABA has written numerous letters, during the period of 1990 through today, to the FASB, the IASB, SEC, and others. A few

examples are:

ABA’s letter (May 31, 2000, File Reference 204-B) in response to the Preliminary Views, Reporting Financial Instruments

and Certain Related Assets and Liabilities at Fair Value, dated December 14, 1999.

2

has been given to fair value accounting over the past three years by world-wide accounting standards

setters, regulators, former regulators, bankers, and financiers of all types. Bankers have warned against

the various unintended consequences for years, but their qualitative arguments about the lack of

reliability combined with the devastating procyclical effects of fair value accounting became virtually

self-evident during the financial crisis of 2007-2008. Organizations such as the Financial Stability

Board, while advocating more forward-looking impairment provisions, have expressed serious concerns

regarding fair value accounting.5 Accounting standards that are procyclical have also had a prominent

place on the agendas of the G20.6 Further, the significant and substantive world-wide investor outreach

– which included the U.S. – performed by the International Accounting Standards Board (IASB) 7

convinced them that users of bank financial statements do not generally want fair value accounting for

ABA’s letter (November 13, 2008, file number 4-573) to SEC during its study of fair value accounting. ABA has also

participated in international papers, written by the International Banking Federation Accounting Working Group (for

example, see Accounting for Financial Instruments Conceptual Paper, April 2008) and its predecessor, the Joint Working

Group of Banking Associations (for example, see Accounting for Financial Instruments for Banks, October 1999).

3 ABA agrees with the use of fair value accounting for assets that are traded; however, the traditional banking model is to hold loans

and many debt instruments for their contractual cash flows. Therefore, the increase in the use of fair value accounting that is being

proposed in the ED would provide less relevant and less transparent information.

4 See International Banking Federation papers.

5 The Financial Stability Board, Improving Financial Regulation - Report of the Financial Stability Board to G20 Leaders, September

25, 2009: “We strongly encourage the IASB and FASB to agree on improved converged standards that will…simplify and improve

the accounting principles for financial instruments and their valuation. We are particularly supportive of continued work in a manner

that does not expand the use of fair value in relation to the lending activities (involving loans and investments in debt instruments) of

financial intermediaries.

6 For example, see G20 Working Group 1: “Enhancing Sound Regulation and Strengthening Transparency Final Report”, March 25,

2009. Also, see G20 “Declaration on Strengthening the Financial System”, London, 2 April 2009:

“[T]he FSB, BCBS, and CGFS, working with accounting standard setters, should take forward, with a deadline of end 2009,

implementation of the recommendations published today to mitigate procyclicality, including a requirement for banks to

build buffers of resources in good times that they can draw down when conditions deteriorate….”

“We also welcome the FSF recommendations on procyclicality that address accounting issues.”

7 The IASB discussed classification and measurement globally with investors and found that investors do not prefer fair value.

Additionally, the IASB’s international advisors, the Standards Advisory Council, discussed fair value accounting at several of its

meetings. (The purpose of the SAC is to advise the IASB on a range of issues – including the IASB’s agenda – and its membership

consists of a wide range of representatives from users of financial statements, preparers, financial analysts, academics, auditors,

regulators, professional accounting bodies and investor groups.) At its February 24, 2009 meeting, the SAC was asked to vote among

three accounting models to account for financial instruments that the FASB and IASB were beginning to consider at that time. The

proposals and votes were as follows:

1. Fair value for all financial instruments – 2 votes

2. Mixed model, using amortized cost if there are contractual payments for the financial instruments, otherwise fair value – 8

votes

3. Mixed accounting model, with all trading instruments at fair value and the remaining at amortized cost, with one impairment

rule – 26 votes

The vote count demonstrates a significant lack of support among SAC members for fair value accounting for all financial instruments.

3

financial instruments. Indeed, the logical result of fair value accounting, with companies recording

significant gains as the credit rating of their debt drops, has been broadly derided.

With all this experience, it is difficult to understand why the centerpiece of the ED is to expand fair

value accounting to all financial assets and liabilities. This appears to fly directly in the face of the

desires of virtually all constituents of financial statements: knowledgeable users of bank financial

statements – including investors – who do not want it, banking managers who do not use it to manage

their businesses, and regulators8 who believe it is dangerous.

We also continue to be concerned about the impact of changing the accounting model for the banking

industry versus other industries as well as the costs versus benefits. In previous communication9 with

the FASB, the ABA has requested that the FASB focus on the following:

What is the logic of accounting for financial instruments at market value, but not using fair value as

the model for all assets and liabilities for all industries?10

What will the impact be in the markets and on the cost of capital for financial institutions versus

other types of industries that are not subject to fair value accounting? 11

8 For example:

FDIC Chairman Sheila Bair, interviewed by Steve Forbes on www.forbes.com (August 2, 2010):

o For “deposits and loans held to maturity, there's no liquid market for them.” She further stated: “There is no way to

mark them really that would be realistic and I think helpful to investors. So requiring these loans to be mark-to-

market as opposed to held at amortized cost I think will be less transparent, not more transparent. This Level III

modeling that is contemplated under FASB rules for mark-to-market assets where you don't have a market to look to

for pricing did not work well during the crisis. My preference would be for FASB to stop. Don't expand fair value

accounting.”

o “I think all the bank regulators are very much concerned and do not support this proposal.”

Former Federal Reserve Chairman Paul Volcker, interviewed on CNBC with Larry Kudlow, June 14, 2010 on mark to

market:

o “…it’s appropriate for trading operation, it’s appropriate for instance if you are going to trade. It’s not appropriate

for the basic portfolio of instruments that you have created with a customer and intend to hold--the loan portfolio.”

o “…I hope they will get enough comments to say that this is both not suitable on its own merits and certainly not

suitable to lead to an unnecessary clash with the international [accounting standards], where I think the weight of the

evidence is certainly on the international side. And we end up with, hopefully an international accounting system

that makes sense.”

9 See ABA letter to FASB and IASB (August 4, 2009).

10

The ABA is not proposing that fair value accounting be used for the entire balance sheet. However, the use of fair value accounting

solely for financial instruments, particularly those that are not traded or intended to be sold, should be evaluated against the use of fair

value more broadly. This includes determining whether the accounting standards would be placing one industry at a disadvantage

versus other industries by making a “practical cut” with financial instruments at fair value. The ED does not provide sufficient

information for us to evaluate how or why the decision was made to limit fair value to financial instruments.

11

One of the guiding principles that is part of the mission statement of the FASB is: “To issue standards only when the expected

benefits exceed the perceived costs. While reliable quantitative cost-benefit calculations are seldom possible, the FASB strives to

determine that a proposed standard will fill a significant need and that the perceived costs it imposes, compared with possible

alternatives, are justified in relation to the overall expected benefits.” [emphasis added]

4

What will the impact be on products provided by financial institutions?

Given that the majority of banking institutions in the U.S. have under $500 million in assets, are

community-based, and operate a traditional banking business model, will such accounting changes

induce burdens that will cause these entities to reconsider participation in certain types of

instruments or markets?

These are critical issues that must be considered when examining the costs versus the benefits of the ED.

We appreciate the FASB’s efforts to better understand the costs versus benefits in its field visits with

banks, and we urge you to examine the above issues during the deliberation process.

Accounting for Financial Instruments Should be Based on the Business Model

ABA supports accounting that is based on the business model: instruments managed for fair value and

trading purposes should be accounted for at fair value, while those managed for long-term investment in

order to collect the contractual cash flows should be accounted for at amortized cost, with a vigorous

impairment model. Such an accounting model reflects how the entity will generate its future cash flows.

Most importantly, it reflects how the company manages its business, which is key information for

investors.

With this in mind, ABA strongly urges the FASB to reject the proposal to record all financial assets

(including loans) and liabilities at fair value on the balance sheet. Both the G20 and the Basel

Committee on Banking Supervision have recognized this, recommending to the IASB that its accounting

for financial instruments be based on the business model. It is our understanding that some at the FASB

believe the ED is based on the business model because certain changes in market values are reported in

earnings while others are reported in other comprehensive income. We disagree with this notion, and

we believe this is not what the G20 and the Basel Committee are recommending. The G20 Banking

Statement (September 5, 2009, London), recommends the following:

“Within the framework of the independent accounting standard setting process, the IASB is

encouraged to take account of the Basel Committee guiding principles on IAS 39…”

The Basel Committee on Banking Supervision’s, Guiding principles for the replacement of IAS 39,

contains the following:

“There should be a strong overlay reflecting the entity's underlying business model as adopted by

the Board of Directors and senior management, consistent with the entity’s documented risk

management strategy and its practices, while considering the characteristics of the instruments.”

“Fair value should not be required for items which are managed on an amortised cost basis in

accordance with the firm’s business model…”

5

Contrary to what is stated in the ED, across-the-board fair value accounting for all financial instruments

does not reflect a bank’s business model. In fact, in light of the emphasis by both banking regulators

and investors on different aspects of bank capital, the proposal will significantly distort bank

performance and financial position.

ABA supports transparency of financial information. However, ABA notes that the fair values of loans

held for long-term investment are already disclosed in the footnotes. Because it is not relevant to

traditional commercial bank operations (in other words, it is not relevant to how the bank will generate

its cash flows), this information is appropriate only for footnote disclosure. Combined with the separate,

but related proposal to provide one statement of comprehensive income, FASB is changing the

performance measure for banks to that unrelated to the management of credit. As a result, FASB is

attempting to change how commercial banks are managed and how they are evaluated by analysts, and

implementation of this aspect of the ED will have significant deleterious effects. Our opposition to full

fair value accounting for core banking activities, which has been consistent and unwavering for over

twenty years, is based on the following:

Fair value accounting is not relevant to the commercial banking business model.

Fair value accounting will undermine the reliability in bank capital levels and decrease

comparability between banks.

Fair value accounting introduces complexity where complexity is neither needed nor desired.

Fair value accounting will require significant costs to banks with little benefit to users.

Fair value accounting changes the concept of “comprehensive income” within FASB’s Conceptual

Framework.

Fair value accounting complicates efforts to converge GAAP with IFRS and creates a competitive

disadvantage to U.S. banks.

Fair value accounting will add unnecessary procyclicality to the financial system.

Fair value accounting is not relevant to the commercial banking business model.

Considering loans are normally held by commercial banks for the long-term, bank financial statements

will be clouded with data that is irrelevant in determining the key metrics of the commercial banking

model: bank capital and “bottom-line” return. Recording fair values of loans masks the most important

aspect of the banking business model: managing the credit risk of customers. Performance will be

distorted with unrelated market reactions to interest rate, credit spread, and liquidity movements.

To show why those market reactions are irrelevant to a typical commercial bank’s operations, one need

go no further than their local banker. If a borrower demonstrates financial difficulty, the typical banker

does not sell the loan, the banker works out the loan with the customer. This work out process may

involve modified payment terms, additional collateral provided by the customer, or even significant

changes to the customer’s operations in order to meet the payment schedule. The value of the loan is

rarely realized through an immediate sale.

6

With this in mind, bankers are not “hiding behind” the business model argument for their own sake.

Bankers are reliant on their investors for funding and are appropriately responding to their needs. For

example, in a recent survey, consisting of hour-long interviews, PricewaterhouseCoopers12

found that

72% of investment professionals who analyze banks believe the business model is a primary

consideration in determining an instrument’s measurement basis. In the survey, only 17% believe that

the fair value of loans should be recorded on the balance sheet – 21% feel the same regarding core

deposits. ABA has found overwhelming opposition to fair value for all financial instruments in its

informal discussions with bank investors and with both sell-side and buy-side analysts, and in a recent

newsletter from Stifel Nicolaus, it was reported that during the banking regulators’ July 29 roundtable-

conference call, which was held in order to receive investor input on the ED, none of the 100 or more

investors spoke up in favor of the ED; instead, all those who spoke were opposed. These professionals –

those who actually follow banking institutions on a daily basis – want to be able to continue to

understand how banks are managed from the bottom up.

We encourage the FASB to focus on banking institution investors and depositors – from the most

sophisticated to the least sophisticated. Because the FASB has made a practical cut at fair value

accounting for financial instruments as opposed to all assets and liabilities, and because financial

instruments are the primary products and services of banking institutions, the ED effectively changes the

entire accounting model for banks. If the ED becomes final, then we believe it is inevitable that banks

will react to the new accounting model by changing their product mix and approach to banking. In other

words, this ED is proposing to change how commercial banks are run.

Fair value accounting will undermine the reliability in bank capital levels and decrease comparability

between banks.

Capital is a critical measure for various stakeholders in a bank. Whether referring to Tier 1 regulatory

capital, tangible common equity, or total capital, regulators and depositors who are interested in safety

as well as investors who analyze return on equity and forecast future capital needs focus closely on these

balances. With this in mind, the reliability of reported bank capital will decline by marking to market

financial instruments. Basically, information in bank financial statements will not satisfy the adequate

thresholds of reliability and comparability, as there is no active market (and, in many cases, never has

been) for the vast majority of commercial loans held by most banks. In essence, such values must be

derived by “making up” an imaginary market in which to sell these loans. This obviously invites

enormous variability in assumptions and in any recorded amounts. For example, during a recent process

to acquire a portfolio of impaired loans, one bank hired two different independent consulting firms to

value the portfolio. The range of the two estimates exceeded $500 million – over half the $1 billion par

value of the total portfolio. Therefore, we believe that determining fair values for assets and liabilities

will often be, for all intents and purposes, an exercise in imagination for many entities. While such

speculation may be acceptable for disclosure purposes, it is clearly inappropriate in determining capital

or measuring financial performance. In fact, as small modifications to certain fair value assumptions

can have large impact to the recorded value of loans, a company’s financial performance may become

highly subjective.

12

See PricewaterhouseCoopers, What investment professionals say about financial instrument reporting, June 2010.

7

These values also will not reflect a loan’s true value to the enterprise, since it must exclude the value of

other products and services that are critical to the total customer relationship. Because of this, as well as

the greater knowledge the bank has about the borrower’s credit,13

the value of a loan is greater to the

bank than it is to an outside party. Additionally, due to the fact that most commercial loan markets are

typically inactive, estimating their “fair value” often necessitates a significant liquidity discount. Under

the ED, this would often result in a loss to be recorded at inception in comprehensive income. Further,

due to the unique terms involved in most commercial loans, distinctive underwriting standards in

individual banks, as well as differing perceptions of the liquidity discounts required for the wide range

of products and lending sectors, comparability between banking organizations will be tarnished. In fact,

the lack of comparability is one of the common themes ABA hears from banking analysts as to why fair

values are not currently relied upon in their analyses.

Further undercutting reliability in capital levels is an inevitable result of full fair value accounting for

financial liabilities: troubled banks may report improvements in capital when their credit ratings

decline. This incredulous outcome may occur when the fair value of their debt declines. Although this

may be the appropriate accounting in a fair value model, it is also beyond belief that financial statement

users will find this result – or fair value for assets – useful. While the Board has proposed separately

highlighting such an amount within the body of the financial statements, the bottom line will remain

clouded with this result.

Fair value accounting introduces complexity where complexity is neither needed nor desired.

The majority of loans held by most commercial banking institutions have no active secondary market.

As a result, the vast majority of the balance sheet will require modeling to estimate fair values with

“level 3” inputs14

– as opposed to using quoted prices. Investors would then be required to digest the

numerous assumptions, which would vary from entity to entity. They will need to understand how

banking models determine interest rate, credit, and liquidity discounts across wide ranges of products

and geographic areas. With this in mind, in order to evaluate corporate performance, investors and other

stakeholders will be required to decipher why differences exist between the amortized cost (after

reserves) and fair values and, effectively, will not be able to compare entities. Over long periods of

time, these differences may possibly provide a picture of relative interest rate and credit risk assumed

between entities. However, such snapshots are not indicative of how effectively a bank executes its

business model.

Compounding this complexity, requiring fair value accounting on loans necessitates a reciprocal fair

value measurement of deposits, including a core deposit intangible asset (CDI). The ED, however, does

not use a fair value measurement; instead, it proposes a present value method to estimate the CDI that

will exclude certain major factors (for example, customer relationships) normally used in estimating the

13

Banks typically have more information about a borrower’s credit than does the market, resulting in asymmetrical information.

FASB Statement No. 157 assumes that a market participant would perform due diligence that is “usual and customary”. This risk

presented by asymmetrical information results in further discounts that do not reflect the loan’s actual credit risk.

14

Under SFAS 157, level 3 inputs are generally considered to be the least reliable estimates of fair value.

8

fair value of the CDI. Since this calculation will conflict with the current methods to recognize and

measure CDIs within a business combination, financial statement users will be required to either

differentiate between the two, or completely relearn what the CDI represents in the financial statements.

Although the concept of the CDI initially appears acceptable when also valuing assets at fair value, it

introduces complexity related to alternative funding and maturity assumptions that investors have not

desired. With the infrequent exception for business combinations, investors almost never ask about the

inherent value of deposits – fair value or present value – and it is likely that customers would be aghast

to learn that their accounts will be recorded on a bank’s books and records for amounts less than the

deposit’s principal balance. Training depositors to understand the notion that the “market value” of their

deposits is less than what is owed is a tall order.

Fair value accounting will require significant costs to banks with little benefit to users.

Combined with the current fair value measurement exposure draft, which proposes to require sensitivity

disclosures for those financial statement items using level 3 fair value inputs, banking costs will

significantly increase, with little incremental benefit for those long-term equity and debt investors in

banking institutions. In other words, the vast majority of long-term investors in banks has not

historically been, and is not currently, asking for this information and is unlikely to use it significantly in

their financial analysis. In a survey of banking chief financial officers we performed, a tiny minority of

both publicly-held and privately-held banking institutions report having moderate or significant

discussions about the fair values of their loan portfolios from 2007 to 2010. This is during a time period

during which one might expect such discussions, as the financial crisis grew. Our own outreach to

dozens of both sell-side and buy-side banking analysts indicated no need for expansion of fair value

accounting. In fact, virtually all analysts we talked to who specialize in the banking industry did not rely

on fair values and oppose this measure.

These results should not be surprising. Fair values are not a significant part of commercial bank

financial analysis. Indeed, education courses related to commercial bank analysis and offered by the

New York Society of Security Analysts (NYSSA)15

, while in-depth regarding many individual issues

relating to bank analyses, are silent on the fair value of loans – fair values are not considered when

analyzing bank financial statements. With this in mind, for the extra anticipated preparation time,

personnel, and audit work, virtually every company will experience higher costs due to this new

requirement. For those banks that present a balance sheet completed in accordance with GAAP during

their earnings announcements, this will also impact the timing of those announcements – likely delaying

them. Clearly, the proposal will require higher costs for no additional benefit. In fact, the costs incurred

are expected to result in inferior rather than improved quality of financial information for investors.

15

With over 11,000 members, NYSSA is the largest of the societies comprising the CFA Institute. In 2010, NYSSA has offered a

wide range of education courses, including “Analyzing and Interpreting Bank Financial Statements Primer” and “Bank Financial

Modeling.”

9

Fair value accounting changes the concept of “comprehensive income” within FASB’s Conceptual

Framework.

Within the Accounting Standards Codification, “comprehensive income” and “other comprehensive

income” have historically been understood in relation to an entity’s ability to generate favorable cash

flows. That is why the fair values of loans held for investment and held-to-maturity securities (not

subject to other than temporary impairment) are excluded from comprehensive income. Such fair values

are not relevant to the generation of future cash flows. To now include changes in these fair values

within a statement of comprehensive income is to change one of the main objectives of financial

reporting: relevance. Relevance is further corrupted by the related FASB exposure draft that would

require one statement of comprehensive income that presents net income as a subtotal and practically

redefines “the bottom line”, which will reflect all fair value changes. Bankers believe that the objective

of the performance statement is to reflect how effectively management executes its business model. The

current proposals complicate that objective. While we acknowledge that fair values may provide

information useful to some, we disagree that such information is relevant to an institution’s performance

when the institution manages such assets and liabilities for the collection of specific cash flows

unrelated to their market values.

Such a change to the concept of relevance requires extensive and comprehensive deliberation on the

Conceptual Framework, not only as it affects banks, but entities in all industries. With this in mind, we

urge FASB to reject any change to the options provided for presentation of the current performance

statement and, prior to issuance, complete its review of the Conceptual Framework.

Fair value accounting complicates efforts to converge GAAP with IFRS and creates a competitive

disadvantage to U.S. banks.

The proposal to expand fair value accounting is in direct conflict with the recently issued IFRS 9

Financial Instruments, issued by the IASB in November 2009. Instead of progressing to one set of high

quality accounting standards, the ED proposes to dramatically increase the differences between the two

sets of standards. While we understand that the original goal of convergence by 2011 may be justifiably

postponed, the ideological difference between FASB requiring fair value accounting for all financial

instruments and the IASB basing the accounting upon an entity’s business model is likely to slow the

convergence process to a halt. In fact, some believe that if the FASB were to proceed with the ED, then

the banking industry should encourage the SEC to accept IFRS for U.S. registrants within an earlier time

frame than is currently being considered, since future adoption of IFRS may be inevitable and IFRS

would more clearly reflect the business model of banking.

Further, if U.S. companies are required to expand fair value accounting, the costs of implementation and

administration, along with the increase in financial statement volatility, will put U.S. companies at a

competitive disadvantage with their IFRS-based competitors in pursuing capital world-wide. There is

no question that both higher costs and additional volatility will increase the cost of capital for U.S.

companies.

10

Fair value accounting will add unnecessary procyclicality to the financial system.

By implementing fair value accounting, systemic risk is added to the financial system by unnecessarily

adding to volatility of bank capital, and, thus, procyclicality. Whether linked to regulatory accounting or

not, procyclicality both adds to the cost of capital of banks and exacerbates financial cycles. When a

bank’s performance is based on factors that are unrelated to credit risk – such as for the significant

liquidity discounts that have been prevalent since the beginning of the financial crisis or the routine

movements in interest rates – its performance becomes a result of factors unrelated to its business and

irrelevant to the investor who is seeking long-term capital growth. Further, while marking deposit

liabilities to market may mitigate a portion of the volatility caused by interest rate movement, this

practice can actually exacerbate the problem in times of economic contraction.

Those who believe that fair values of financial assets and liabilities are effective predictors of credit

losses need look no further than the power of procyclicality as it ravaged its way through the economy in

2007 and 2008. Subjecting bank financials to the wild volatility experienced in the last few years also

ignores that banks are unique in their responsibility to serve illiquid markets while having deposits

available for immediate withdrawal. Those who advocate the market’s long-term efficiency, thus, must

understand that short-term inefficiencies can irreparably harm specific institutions.

With that in mind, while we recognize that sophisticated investors may understand the differences

between fair value-based results and non-fair value results, other stakeholders should not be expected to

effectively assess the fine details. Performance statements based on temporary fair values can subject

banks to significant risk when the results are not thoroughly understood. ABA agrees with world

banking regulators16

, as well as leading figures, such as FDIC Chairman Sheila Bair, former Federal

Reserve Chairman Paul Volcker, and former FDIC Chairman William Isaac – all of whom believe fair

value accounting should not be expanded. In addressing the problems that led to the recent financial

crisis, while there was discussion by expert groups regarding improving loss reserving techniques and

recognition of certain off-balance sheet vehicles, there was no mention of expanding fair value

accounting. In fact, it was widely accepted that fair value accounting played a role in exacerbating the

crisis.

We appreciate FASB’s concern for the ED’s potential impact on smaller institutions (as evidenced by

the proposed four year deferral of the requirements for loan fair values and core deposit intangibles) and

support the deferral, but we also believe the impact of such a deferral sounds more appealing than it is.

Our primary concern is that the FASB has made it clear that “exit prices” will be required in the SFAS

107 footnote disclosures during the deferral period, rather than the practical estimates of fair value

provided for in SFAS 10717

that are currently being used by many small banks. If the smaller

institutions are required to provide exit prices at the effective date of the ED, then the community banks

must develop systems and processes for estimating exit prices in an environment where efficient

information systems do not yet exist. Presumably, after the large banks implement the ED, such systems

will have been developed and the smaller banks would be able to use the improved systems and

16

Basel Committee on Banking Supervision, “Guiding Principles to Replace IAS 39”, August 2009. 17

See paragraphs 14 and 15 of SFAS 107.

11

processes. If the smaller banks are required to provide exit prices during the deferral period, they must,

effectively, go through two different implementation processes. We agree with the delay for smaller

institutions and believe that the deferral period will need to be extended based upon our

recommendation that the implementation by larger companies be four years from the release date. That

said, even though the costs of compliance are relatively much higher for smaller institutions, expansion

of fair value accounting is not appropriate for any traditional bank, whether small and privately-held or

large and publicly-held, for the same reasons of relevance, reliability, and cost-benefit. Further,

implementation of such a standard could have devastating effects on the overall economy.

Other Significant Matters Relating to the ED

In addition to addressing the implementation of fair value accounting for all financial assets and

liabilities, ABA has the following comments on other significant areas within the recognition and

measurement portion of the ED:

Fair value accounting of a company’s own debt distorts performance: gains are realized when

company performance declines.

Reclassification of assets and liabilities should be permitted to reflect changes in strategy.

Cost method accounting should be continued for certain equity investments.

Current rules for equity method of accounting for equity securities should be maintained.

Commitments related to credit card arrangements should be excluded from the scope of the ED.

There should be consistency in initial measurement.

Implementation will be lengthy and costly.

Other transition issues need to be addressed.

Fair value accounting of a company’s own debt distorts performance: gains are realized when

company performance declines.

ABA agrees with the many investors who believe that recognizing gains due to declines in an entity’s

own credit rating not only blurs transparency, but directly masks it. Both good and poor financial

performance will be distorted – even contradicted – by these marks. The recognition of gains in such a

situation also appears to contradict the “going concern” principle – entities should not recognize

improved financial performance because of a grave financial condition. However, this is a necessary

evil of fair value accounting.

Thus, ABA supports efforts to separately identify any fair value change related to changes in an entity’s

own credit rating. While we disagree with recognizing such unrealized gains through net income or

other comprehensive income (OCI) in any situation, we believe recognizing these gains in other

comprehensive income is preferable to net income recognition. ABA also cautions that the impact of

recognizing these gains through OCI is negated by the proposal to require one continuous statement of

comprehensive income, which implies that total comprehensive income is the new “bottom line.” Such

gains, if the proposals are adopted, will still be reflected in a bottom line number that will likely be the

focus of many users of financial statements.

12

Reclassification of assets and liabilities should be permitted to reflect changes in strategy.

ABA believes that reclassifications of financial assets and liabilities between those held for trading

purposes and for long-term purposes should be allowed under specific circumstances. This view was

also expressed by the Basel Committee on Banking Supervision to the IASB, as follows:

“The new standard should…permit reclassifications from the fair value to the amortised cost

category; this should be allowed in rare circumstances following the occurrence of events having

clearly led to a change in the business model…”18

The first circumstance for permitting reclassifications should be, consistent with the “business strategy”

basis of classification used in the ED, when the business strategy or business model changes.

Thoughtful and deliberate changes, for example, during a business combination, realignment of

operations, or for significant changes in corporate liquidity, would be reflective of the natural course of

business.

Another common circumstance is when assets are originated or acquired with the understanding that

they will be sold under a pre-existing agreement (for example, forward purchase and sale agreements

with government-sponsored enterprises) and that forward agreement is terminated. Such terminations

may occur because of insufficient volume to be sold under the agreement or through a pay-off process.

In these situations, the business strategy regarding these assets may logically change.

Cost method accounting should be continued for certain equity investments.

ABA opposes the requirement for fair value accounting for all equity investments not subject to

consolidation or the equity method of accounting. For practical reasons, reliable fair values of many

privately-held entities are virtually impossible to determine, due to the lack of timely financial

statements produced by many small companies. Such a requirement will further introduce concerns

about reliability and unnecessarily introduces a complexity to the financial statements where such

complexity is neither desired nor necessary.

Current rules for equity method of accounting for equity securities should be maintained.

ABA opposes the requirement that an investee’s operations be related to the entity’s consolidated

business in order to qualify for the equity method of accounting for equity investments. Questions on

the relation of one business to another will inevitably arise without more guidance. For example,

holdings in tax-related investments, such as low-income housing entities, may be considered related to

certain banks, but not others. In many cases, the non-administrator/investor is not solely interested in

the housing aspect of the entity, but also of the cash flows related to income tax credits. Because the

18

See Basel Committee on Banking Supervision, Guiding principles for the replacement of IAS 39. The G20 recommended that the

IASB take into account those principles when developing its new accounting standard for financial instruments.

13

value of these credits depends solely on the tax benefits to a specific organization, and not on the value

of the organization’s shares, fair values of equity shares are not helpful to the financial statement user.

Commitments related to credit card arrangements should be excluded from the scope of the ED.

ABA believes that unfunded loan commitments related to credit card arrangements should be excluded,

as proposed, from the requirement to be recorded on the balance sheet at fair value. Like many other

loan facilities, the value of such a commitment is often undistinguishable from the value of the account

itself, which includes significant value from transaction-based fees, marketing opportunities, and other

promotional value. In addition to this, commitments on credit card arrangements often are unilaterally

cancelable by the issuer at any time.

With this in mind, for the purposes of investor information, ABA believes that determining a fair value

for standby letters of credit (SLOC) or for unfunded loan commitments is, in general, fraught with the

same pitfalls as the fair value of the loan itself. For most SLOCs or unfunded commitments on loans

that are not held-for-sale (for example, for revolving corporate credit lines), there is normally no active

market. Bid and ask spreads are significant in instances when they are traded, so the reliability of such

estimates is often significantly reduced. Further, the relevance of such information is negligible, since

any fair value changes will not be recognized as cash flows to the bank. With such questionable

reliability and relevance, bank capital, one of the most critical elements in analyzing bank performance

and risk, should not be subject to changes in the fair value of any unfunded loan commitments.

There should be consistency in initial measurement.

The ED proposes initially measuring trading assets at fair value (with transaction costs immediately

expensed) and initially measuring assets held for long-term investment at transaction price, unless there

is a significant difference between the transaction price and fair value. Although the immediate

expensing of transaction costs for trading assets is consistent with the current accounting used with the

fair value option, we understand that the Board’s proposal to separate such transaction costs relates

primarily to the investment company industry, since important expense metrics may be based on such

numbers. ABA believes that such a desire should be reflected in industry-specific guidance, since

investors in investment companies have very different needs from those in financial institutions. The

accounting should not be determined on a general financial instrument basis, but should be based on the

business model.

From a practical perspective, the notion of comparing transaction price with fair value in a loan issuance

can be a day-by-day exercise that is fraught with complexities. We also note that transaction costs for a

fixed income security trade are normally embedded in the bid/ask spread, but separately valued in the

commission charge in an equity security transaction. Therefore, separating out transaction costs and

determining the actual fair values in these circumstances are often cumbersome processes. Additionally,

for two of the important metrics in banking – net interest margin, and investment gains and losses –

related direct costs should be recorded in a consistent manner. With all this in mind, ABA believes that

there must be more guidance to efficiently establish daily fair values within the transaction process.

14

First and foremost, however, there should be consistency in measurement, whether for a trading asset or

long-term investment.

Implementation will be lengthy and costly.

Implementation of the rules as proposed will be complicated and likely take a minimum of four years

after the final standard is released for those banks that do not qualify for the four-year deferral. The

individual phases of fair value accounting and of impairment (including the change to the recognition of

interest income) will take significant time. The four year period is a high-level estimate that is

influenced by a number of factors and the timing of their resolution:

Prior to incurring costs for information systems changes, banks will need to know whether there will

be any regulatory changes related to the final standard that could also result in systems changes.

Regulators must determine how these accounting changes will factor into capital requirements and

periodic reporting.

Software vendors must evaluate requirements and develop software frameworks. Since the

processes proposed in the ED are processes never before performed19

, it is likely to take several

years before a generally accepted software solution framework will emerge.

Data that has never been tracked for accounting purposes must be gathered. This includes factors

related to fair values, certain customer deposit trends, as well as life-of-loan losses.

Education of loan officers as managers of fair value processes must be performed.

Projects must be undertaken to change loan processing systems in order to account for fair values

and impairment on a loan or pool level.

Efforts are required to determine and analyze specific markets on industry, geographic, and

programmatic levels on a timely basis. These include the determination of appropriate credit,

interest rate, and liquidity adjustments. Efforts must also address procedures to determine when

overall market liquidity has significantly changed and how those changes impact specific valuation

models.

Integration of fair value modeling into general ledger systems within mandated closing periods will

be necessary.

Reengineering of closing processes related to interest income recognition will be required to comply

with regulatory deadlines.

Education is necessary of users as to understanding fair value results. Despite the proposed

cumulative effect adjustment, this will likely require a minimum of three years of prior period data

for comparative results.

Internal controls must be developed and tested for internal purposes and to comply with Sarbanes-

Oxley requirements.

19

SFAS 107 requires fair value footnote disclosures for financial assets and liabilities. However, the requirements of the ED differ

from SFAS 107 (for example, paragraphs 14 and 15 of SFAS 107), which will result in significant process changes for many, if not

most, banks. Additionally, the processes required for recording unfunded loan commitments at fair value, for interest income, and the

customer deposit intangible in the ED are not currently available on banks’ systems.

15

Other transition issues need to be addressed.

ABA believes more transition guidance is required regarding a number of different areas:

Guidance must address any restatement of the core deposit intangible that may be needed due to the

different valuations used on an ongoing basis under this ED versus the valuations currently used for

business combinations and similar acquisitions.

Additional disclosures will be needed in the likely circumstance of a business combination where

fair values of assets and liabilities are significantly different than those recorded prior to the

transaction.

Since financial assets are being added to the balance sheet and measured on a different basis (for

example, many loan commitments are being added and a significant percentage of assets will be at

fair value), the $1 billion total assets amount (to qualify for deferral) will be variable. More

guidance is required to determine whether a bank will qualify for the deferral. Further, future

changes in accounting standards that will result in changes to the level of recorded assets (for

example, in lease accounting) will also need to be explained as to their impact on the deferral scope.

Smaller, non-public entities and their auditors will need additional education and guidance in order

to adequately comply with the proposed standards.

On the attached pages, ABA provides responses to some of the various questions posed in the ED that

relate to the classification and measurement of financial assets and liabilities. This letter also confirms

our earlier discussions with your staff that ABA has registered to participate in the roundtable meetings

scheduled for October 2010.

Thank you for your attention to these matters and for considering our views. Again, ABA will also be

submitting separate comment letters on credit impairment of financial assets and on derivative

instruments and hedging activities. Please feel free to contact Mike Gullette (mgullette@aba.com; 202-

663-4986) or me (dfisher@aba.com; 202-663-5318) if you would like to discuss our views.

Sincerely,

Donna J. Fisher

16

Questions Raised in Exposure Draft on Accounting for Financial Instruments and Revisions to the

Accounting for Derivative Instruments and Hedging Activities20

Scope: For All Respondents

Question 1: Do you agree with the scope of financial instruments included in this proposed update? If

not, which other financial instruments do you believe should be excluded or which financial instruments

should be included that are proposed to be excluded? Why?

Response: ABA does not agree with the scope. Financial instruments that are traded should be

marked to market; other financial instruments should not be included in the scope. The reasons

for this are covered in depth in the cover letter.

Question 2: The proposed guidance would require loan commitments, other than loan commitments

related to a revolving line of credit issued under a credit card arrangement, to be measured at fair value.

Do you agree that loan commitments related to a revolving line of credit issued under a credit card

arrangement should be excluded from the scope of this proposed Update? If not, why?

Response: ABA believes that unfunded loan commitments related to credit card arrangements

should be excluded from the requirement to be recorded on the balance sheet at fair value. Like

many other loan facilities, the value of such a commitment is often undistinguishable from the

value of the account itself, which includes significant value from transaction-based fees,

marketing opportunities, and other promotional value. In addition to this, commitments on

credit card arrangements often are unilaterally cancelable by the issuer at any time. With this in

mind, for the purposes of investor information, ABA believes that determining a fair value for

standby letters of credit (SLOC) or for unfunded loan commitments is, in general, fraught with

the same pitfalls as the fair value of the loan itself.

For most SLOCs or unfunded commitments on loans or that are not held-for-sale (for example,

for revolving corporate credit lines), there is normally no active market – bid and ask spreads are

significant when they are traded, so the reliability of such estimates is often significantly

reduced. Further, the relevance of such information is negligible, since any fair value changes

will not be recognized as cash flows to the bank. With such questionable reliability and

relevance, bank capital, one of the most critical elements in analyzing bank performance and

risk, should not be subject to changes in the fair value of any unfunded loan commitments.

20

As noted in the cover letter, the answers to these questions refer to the classification and measurement of financial assets and

liabilities. The remaining issues in the ED and the answers to the questions relating to those issues will be covered in a separate

comment letter.

17

Question 4: The proposed guidance would require an entity to not only determine if they have

significant influence over the investee as described currently in Topic 323 on accounting for equity

method investments and joint ventures but also to determine if the operations of the investee are related

to the entity’s consolidated business to qualify for the equity method of accounting. Do you agree with

this proposed change to the criteria for equity method of accounting? If not, why?

Response: ABA disagrees that an investee’s operations must be related to that of the reported

entity in order to obtain equity method accounting for equity securities. Securities related to

many private companies have no active market and, in fact, entities that financial institutions

often invest in have no profit motive. Examples of these entities are housing cooperatives and

low income housing entities. In fact, most low income housing entities are formed specifically

for tax benefits provided to investors. In these cases, the investee operations are not likely to be

sufficiently related to the investor. Fair values of such securities do not faithfully represent the

value to the investor, who must often hold these restricted securities for many years to avoid a

recapture of tax benefits.

ABA also disagrees that all equity securities not accounted for through consolidation or through

the equity method (and currently accounted for using the cost method) should be accounted for at

fair value. Estimating fair values for most non-marketable securities is a process that will be

bereft of timeliness and precision. Often, reliable financial information in which to base fair

value estimates is not available for several months after a period-end. Further discounts for

liquidity of these investments will provide bid/ask spreads that put reliability of such values into

further doubt.

Initial Measurement: For All Respondents

Question 8: Do you agree with the initial measurement principles for financial instruments? If not,

why?

Response: See responses to questions 9 through 11.

Question 9: For financial instruments for which qualifying changes in fair value are recognized in other

comprehensive income, do you agree that a significant difference between the transaction price and the

fair value on the transaction date should be recognized in net income if the significant difference relates

to something other than fees or costs or because the market in which the transaction occurs is different

from the market in which the reporting entity would transact? If not, why?

Response: ABA believes that the transaction price should be the measurement principle for all

such transactions and cautions that, due to the cumbersome requirement to determine whether

there is reliable evidence of a significant difference between the transaction price and fair value,

significant implementation issues will drive up operational and audit costs. Volatility in interest

rates and credit and liquidity discounts will require an analysis of loan fair values on a virtually

continuous basis. Maintaining documentation to support the difference between the current fair

value and the transaction will be overly burdensome. In the end, we believe this requirement

may provide little, if any, value to the user of the financial statements.

18

Further, in addition to the fact that most commercial loans held for long-term investment are, in

fact, transacted in a different market from the one the bank could sell the asset (per paragraph 16

b. of the ED), determining the fair value itself will be problematic. The majority of loans in the

non-residential mortgage market have no active secondary market, and pricing for many loans is

also based on factors that are not recognizable within the current definition of “fair value” of a

loan. Namely:

Loans terms are often based on a bank/borrower relationship that transcends financial terms

of the specific instrument. Banks can have a holistic view of their customer. Therefore, they

may price a loan in relation to other services provided to the borrower, such as transactional

account, trust, and other investment management services. The value of these services is not

reflected in the financial statements, though they would factor into any valuation for business

combination purposes. While the financial instrument (the loan) itself may be issued at a

discount to the customer, the financial statements will mislead users if bank performance

reflected a decline in operating performance, when, in fact, total future revenues will increase

because of the other services.

Banks that have more underwriting experience with certain industry sectors may enjoy a

competitive pricing (interest rate) advantage. However, the fair value of that loan, even if

estimated accurately, will not reflect such an advantage.

Banks that have more efficient servicing processes may enjoy a competitive pricing (interest

rate) advantage. However, the fair value of that loan, even if estimated accurately, will not

reflect such an advantage.

Banks may price a loan in relation to other facilities already granted to the borrower. The

unit of account may not take that factor into account in determining the fair value.

With all this in mind, the process to determine and support the fair value of the loan at the time

of origination is too costly in light of the benefits users are expected to receive. ABA

recommends that the transaction price be maintained as the measurement for all transactions of

loans and debt securities that are held for long-term investment. If it is the Board’s intention (as

in Example 1 of the implementation guidance) to segregate marketing subsidies from non-

financial subsidiaries, then the final standard should specify this. However, generally

maintaining this requirement puts an unrealistic burden on institutions to maintain such

supporting documentation.

19

Question 10: Do you believe that there should be a single initial measurement principle regardless of

whether changes in fair value of a financial instrument are recognized in net income or other

comprehensive income?

If yes, should that principle require initial measurement at the transaction price or fair value? Why?

Response:

ABA supports a single initial measurement principle, regardless of whether the investment will

be held for trading purposes or for long-term investment. This will help simplify operational

compliance, as well as user understanding, as explained in our response to question 11.

Question 11: Do you agree that transaction fees and costs should be (1) expensed immediately for

financial instruments measured at fair value with all changes in fair value recognized in net income and

(2) deferred and amortized as an adjustment of the yield for financial instruments measured at fair value

with qualifying changes in fair value recognized in other comprehensive income? If not, why?

Response: ABA supports consistency in recording such costs. Deferring such costs would

reflect similar treatment in current GAAP for loans held for sale and loans held for investment,

while expensing them reflects how such transactions are treated under the fair value option.

From a user perspective, ABA is concerned that immediate expensing of costs will not reflect the

true performance of the trading operation, as gains and losses will not reflect the direct costs of

those transactions. These costs are normally presented as administrative expenses. Further

confusing this issue is the diversity in practice of securities dealers to charge a separate

commission for certain transactions (such as equity trades), yet embed such a charge within the

bid/ask spread for others (such as fixed-income trades).

This is in contrast to the yields that are presented net of the direct fees and costs that were

deferred. In other words, the costs are included in one business strategy and excluded in the

other. We believe this will provide less meaningful information to the financial statement users

if they are comparing performance by business strategy.

Operationally, we believe it is much simpler for a bank to treat all originated and purchased

assets the same at the time of origination or acquisition. Often, because of changing data

supplied by the borrower through the underwriting pipeline, banks may need to change how they

expect to manage the asset. Therefore, accounting for such costs consistently will help avoid the

confusion that often accompanies the pipeline process. Our operational concerns are also geared

toward whether GAAP versus tax accounting differences are necessary. If there is no

compelling reason in financial reporting to create a GAAP/tax difference, then we believe that

such a difference should be avoided.

20

Initial Measurement: For Preparers and Auditors

Question 12: For financial instruments initially measured at the transaction price, do you believe that

the proposed guidance is operational to determine whether there is a significant difference between the

transaction price and fair value? If not, why?

Response: ABA believes more examples of why the transaction prices may be significantly

different from the fair value should be included. Further analysis may also be required within

the examples noted. For example:

In the commercial loan market, it is likely that the fair value of a loan, which is based on the

exit price within an illiquid secondary market, is significantly different from the issued loan

pricing. More guidance is required to evaluate and audit such differences expected within

paragraph 16b.

In a competitive bid environment, more examples are needed to determine how other

differences should be evaluated, as well as how the related pricing should be evaluated. For

example, if two companies bid significantly lower rates in a bid process that includes five

lenders, do the lower rates constitute fair value?

In Example #1, competition in the auto industry results in wide variations in loan rates on a

period by period basis. Therefore, more practical guidance is needed. For example, could

the fair value of a loan change on a day-to-day basis merely because the competition has

responded to initial incentives offered by the company?

Subsequent Measurement: For All Respondents

Question 13: The Board believes that both fair value information and amortized cost information should

be provided for financial instruments an entity intends to hold for collection or payment(s) of contractual

cash flows. Most Board members believe that this information should be provided in the totals on the

face of the financial statements with changes in fair value recognized in reported stockholders’ equity as

a net increase (decrease) in net assets. Some Board members believe fair value should be presented

parenthetically in the statement of financial position. The basis for conclusions and the alternative views

describe the reasons for those views.

Do you believe the default measurement attribute for financial instruments should be fair value? If not,

why? Do you believe that certain financial instruments should be measured using a different

measurement attribute? If so, why?

Response: The default measurement for financial instruments should not be fair value, and

unreliable fair values should not be provided on the face of the balance sheet. The entity’s

business model dictates how performance is measured and how it manages its capital.

There are some that believe that all financial decisions are based on fair values. . However,

banks in the U.S. do not operate in that realm. Therefore, such an assumption is based on three

faulty hypotheses:

21

1. Fair values for financial instruments are reliable: Daily volatility of debt security prices

during the recent financial crisis has demonstrated that fair values can often be unreliable

as a measure of corporate performance. Uncertainty and illiquid markets rather than

financial instrument performance contribute to this. While volatility in the financial

statements is not to be avoided when applicable, unnecessary volatility is, since

significant portions of such volatility were not due to credit, but due to a liquidity

concerns as the once-liquid markets dried up. In other words, the volatility was not

related to the underlying credit quality. If banks are in the business of managing

underlying credit quality, bank performance and bank capital should not be measured by

the unrelated market forces.

2. There is an active market for all financial instruments: The plain truth is that, for the

majority of all non-residential mortgage loans, there is no active market. As a result, not

only are estimates subject to questionable quality (see hypothesis 1 above) but, as a

result, there is normally no effort whatsoever by a banking institution to realize a loan’s

estimated fair value. Those who believe that banks react to fair value changes by selling

individual loans are sorely mistaken. Banks make financial decisions on these loans not

based on a fair value, but by the cash flows they believe they will collect. For a loan’s

principal balance, this value is the amortized cost, less a loan loss reserve. However, if

the ED becomes final, then we believe it is inevitable that banks will react to the new

accounting model by changing their product mix and approach to banking.

3. There is an infrastructure where fair value can be reliably estimated if required: Outside

of the residential mortgage securities market, most loan terms and collateral arrangements

are unique – there is no standardization in these markets and, thus, no basis to believe a

“market” rate for those terms is credible. Further, independent appraisals of collateral are

normally updated on less than a quarterly basis. With this in mind, it is apparent that any

fair values that are estimated are based on unreliable data assumptions.

With this in mind, the default measurement attribute should be based on the business model and

strategy used in managing its different books of business.

Question 14: The proposed guidance would require that interest income or expense, credit impairments

and reversals (for financial assets), and realized gains and losses be recognized in net income for

financial instruments that meet the criteria for qualifying changes in fair value to be recognized in other

comprehensive income. Do you believe that any other fair value changes should be recognized in net

income for these financial instruments? If yes, which changes in fair value should be separately

recognized in net income? Why?

Response: For those financial assets that, because of a bank’s business model, are not held for

trading purposes, but are held primarily for long-term investment, fair value changes should be

recognized in neither net income nor in other comprehensive income. These changes are not

relevant to the operation or management of the traditional commercial bank and, thus,

22

should not be included on the face of a financial statement. Such information is appropriate only

for footnote disclosure.

ABA also notes that, for the purposes of general clarification, those items that are recognized in

net income under the proposed accounting model (interest income and expense, credit

impairments and reversals, and realized gains and losses) do not represent fair values, but

represent actual past and estimated future transactions affecting cash flows.

Question 16: The proposed guidance would require an entity to decide whether to measure a financial

instrument at fair value with all changes in fair value recognized in net income, at fair value with

qualifying changes in fair value recognized in other comprehensive income, or at amortized cost (for

certain financial liabilities) at initial recognition. The proposed guidance would prohibit an entity from

subsequently changing that decision. Do you agree that reclassifications should be prohibited? If not, in

which circumstances do you believe that reclassifications should be permitted or required? Why?

Response: Reclassifications should be allowed in certain circumstances. Business strategy

changes occur in the natural course of business through a deliberate and thoughtful process, and

the accounting should reflect this change. Of course, an example of this is in the event of a

business combination, but may also include strategic changes in the markets an institution serves.

Further, companies that originate loans may often execute master commitments sales agreements

to sell loans to government-sponsored enterprises at prices based on volume during a specified

period. In certain situations, the sales agreements are cancelled and the loans may then be held

for long-term investment. This normally occurs within the first three months after origination.

In these situations, where management’s strategy to hold the instrument has changed within the

first few months subsequent to origination/acquisition and because of unusual circumstances,

reclassification should be permitted.

Question 17: The proposed guidance would require an entity to measure its core deposit liabilities at the

present value of the average core deposit amount discounted at the difference between the alternative

funds rate and the all-in cost-to-service rate over the implied maturity of the deposits.

Do you believe that this remeasurement approach is appropriate? If not, why? Do you believe that the

remeasurement amount should be disclosed in the notes to the financial statements rather than presented

on the face of the financial statements? Why or why not?

Response: ABA believes the proposed measurement approach for core deposits is theoretically

appealing by helping to repair a flawed fair value model; however, there is significant concern

among our members about this model. First, the overall accounting model (whereby all financial

assets and liabilities are recorded at fair value on the balance sheet) does not comply with our

recommendation to account for loans and debt securities held for long-term investment, as well

as the related liabilities, at amortized cost. We have provided reasons for our position elsewhere

in this document.

Second, the measurement approach is not consistent with the overall accounting model that has

been proposed in the ED nor is it consistent with the model that is currently used in business

23

combinations – fair value. While the Board has acknowledged there is value in core deposits

that may be separately measured, one of the most significant aspects of this value – the

marketing value of the customer accounts – is specifically excluded from consideration. As a

result, core deposits will be subject to two different accounting models: one for business

combinations and another for “remeasurement value” of financial instruments.

Third, ABA believes that the present value measurement approach will further decrease

comparability of capital among financial institutions. The key assumptions of implied maturity,

all-in-cost-to-service rate, and alternative funds rates will be subject to wide ranges and

interpretations. These assumptions have, for most banks, not truly been subject to audit and,

from an accounting perspective, are not evaluated on a regular basis. Further, these assumptions

have never been derived by most individual banking institutions on any kind of regular basis.

So, the operational costs to begin this process may be significant.

Fourth, if the Board is concerned with reflecting asset-liability duration mismatching, we believe

that any one specific present value approach is inappropriate. Interest rate risk management is

performed using a variety of methods and includes various stress testing over a range of future

interest rate and curve assumptions. If there is concern regarding the asset-liability mismatching,

we recommend that such qualitative information be required only in Management Discussion

and Analysis sections, as liquidity management is a separate issue from financial statement

performance.

Most important, however, we question whether the benefits will exceed the significant costs to

prepare and audit this information. We are aware of no investor (or any other user) interest in

such core deposit information as defined in the ED. In fact, what they do understand about core

deposit intangibles may need to change under the ED. While we believe the desires within the

investment and banking communities were to reduce complexity within accounting for financial

instruments, this significantly adds further complexity, both operationally and conceptually.

While ABA has historically supported the idea of using the same measurement basis for assets as

the liabilities that fund them, we recommend that significantly more research be performed to

analyze possible procyclical effects of requiring the value (whether fair value or present value) of

core deposit intangibles in the event of systemic economic stress.

Specifically, the countercyclical effect of the core deposit intangible (CDI21

) is assumed to occur

in relation to a portion of interest rate volatility. However, procyclical moves in CDI may result

in recessionary times and general economic stress. Since the new CDI estimates have never been

subject to audit, we foresee practical questions arising, including:

Should bankers assume that depositors are sensitive to the bank’s financial position so that

declines in asset quality will result in decreasing (or completely eliminating) the implied

21

While the ED refers only to “core deposit liabilities”, the alternative model views presented in the ED refer to this as a “core deposit

intangible”, which conforms to general industry practice.

24

maturity time period? If so, then the procyclical nature of recording assets at fair value will

be exacerbated by the recording of the CDI.

Should bankers assume that regulatory agencies, such as the FDIC, will provide backstops as

they did recently to prevent depositor panic? If not, then the procyclical nature of recording

assets at fair value will be exacerbated by the recording of the CDI.

Will declines in asset values at a bank result in a tightening in the spread between the

alternative funds rate and the all-in-cost-to-service rate? If so, then the procyclical nature of

recording assets at fair value will be exacerbated by the recording of the CDI.

In an environment of general economic stress, is it reasonable to assume that all alternative

funding sources will actually be available? If not, then the procyclical nature of recording

assets at fair value will be exacerbated by the recording of the CDI.

ABA also believes that the Board should reevaluate the requirement of recording the CDI in light

of the project as a whole, which was undertaken to address financial instruments, and not

intangibles. By creating a new accounting model for intangibles (present value for internally

generated core deposit intangibles), the Board may be opening the door to revise accounting

principles for all internally generated intangibles. With this in mind, we recommend that a more

comprehensive project on intangibles be conducted before CDIs are required to be recorded.

In any event, if this portion of the ED is adopted, more transition guidance will be required

regarding how to treat the currently recorded deposit intangibles (which are based on a

comprehensive fair value concept and amortized) in light of the new CDI (which is limited and

not amortized).

Question 18: Do you agree that a financial liability should be permitted to be measured at amortized

cost if it meets the criteria for recognizing qualifying changes in fair value in other comprehensive

income and if measuring the liability at fair value would create or exacerbate a measurement attribute

mismatch? If not, why?

Response: The Board should be aware that measurement attribute mismatches will naturally

occur based on the proposal to record all loans on the balance sheet at fair value. Such a

mismatch is further complicated because deposit liabilities are not normally managed based on

fair value. Indeed, depositors would be astonished to realize that financial statements would

measure their funds at amounts less than the amount of their deposits.22

Given all this, ABA recommends that both financial assets and liabilities be recorded on the

balance sheet based on their business model, and companies should be permitted to record

financial liabilities at amortized cost based on how the corresponding assets are managed. Based

on this, liabilities (including deposits) that fund assets managed at amortized cost should be

measured at amortized cost.

22

Depositors are extremely important “users” of bank financial statements. ABA is also concerned about the reactions of depositors

who may not understand the recording of present values of CDIs when the values reported are less than the amounts owed.

25

Question 19: Do you believe that the correct financial instruments are captured by the criteria in the

proposed guidance to qualify for measurement at the redemption amount for certain investments that can

be redeemed only for a specified amount (such as an investment in the stock of the Federal Home Loan

Bank or an investment in the Federal Reserve Bank)? If not, are there any financial instruments that

should qualify but do not meet the criteria? Why?

Response: Yes. An investment that has an agreed-upon redemption amount should be measured

at the redeemable price. Such investments have no real value other than par, since transfers may

occur only with approval of the issuing organization and for the stated price.

Question 20: Do you agree that an entity should evaluate the need for a valuation allowance on a

deferred tax asset related to a debt instrument measured at fair value with qualifying changes in fair

value recognized in other comprehensive income in combination with other deferred tax assets of the

entity (rather than segregated and analyzed separately)? If not, why?

Response: ABA does not support a requirement that the entity’s entire tax position should be

assessed when evaluating the valuation allowance. Such an approach adds complexity to an

already-complex issue – fair value changes to assets that are recorded but, since the assets are

being held for long-term purposes, are unlikely to be realized. To require that these deferred tax

assets be analyzed along with the rest of the entity is to imply that it is probable that the related

gains or losses will be realized, which is misleading.

Question 21: The Proposed Implementation Guidance section of this proposed Update provides an

example to illustrate the application of the subsequent measurement guidance to convertible debt

(Example 10). The Board currently has a project on its technical agenda on financial instruments with

characteristics of equity. That project will determine the classification for convertible debt from the

issuer’s perspective and whether convertible debt should continue to be classified as a liability in its

entirety or whether the Board should require bifurcation into a liability component and an equity

component.

However, based on existing U.S. GAAP, the Board believes that convertible debt would not meet the

criterion for a debt instrument under paragraph 21(a)(1) to qualify for changes in fair value to be

recognized in other comprehensive income because the principal will not be returned to the creditor

(investor) at maturity or other settlement.

Do you agree with the Board’s application of the proposed subsequent measurement guidance to

convertible debt? If not, why?

Response: ABA disagrees that convertible debt will automatically require fair value changes to

be recorded through income. While we believe that the criteria for classifying such an

instrument is not inappropriate, we believe that terms (for example, certain call/put features) in

many convertible debt issuances will cause the principal to, in fact, be returned to the

investor/creditor at maturity or other settlement. Therefore, we believe that such treatment

should be determined on a case-by-case basis, and based on the expected resolution.

Having said that, we recommend that, along with financial assets, financial liabilities, such as

26

convertible debt, be recorded at amortized cost and not at fair value. We warn the Board that in

cases in which convertible debt, under the ED’s criteria, is required to be accounted for at fair

value with changes recorded through net income, fair value issues related to a company’s own

credit will emerge. Although theoretically appealing in a fair value model, practically speaking,

situations in which net income increases because of a decline in corporate asset quality (and vice

versa) do not provide decision-useful information. As noted in our response to question 32, fair

value changes to changes in a company’s own credit costs should not be reflected in either net

income or in bank capital. Unfortunately, because of the proposal to present one statement of

comprehensive income, this cannot be avoided, since fair value changes will be reflected in the

bottom line performance statement amount.

Subsequent Measurement: For Preparers and Auditors

Question 28: Do you believe that the proposed criteria for recognizing qualifying changes in fair value

in other comprehensive income are operational? If not, why?

Response: If the Board proceeds with a fair value model, we agree that certain fair value

changes should be included in net income while others are included in other comprehensive

income. The proposed criteria for recognizing changes in fair value in other comprehensive

income is generally operational, with the exception of loans and debt securities that are

purchased at a substantial premium over the amount at which they can be prepaid. While this

criterion has developed in practice with some large institutions since EITF 99-20 was issued,

there is no clear practice as to what that “substantial premium” level is. Determining that

specific level will present challenges, as the likelihood of the individual loan prepaying (and,

thus, causing a loss) can vary on a borrower-by-borrower basis and often can depend on, among

other things, other loans that the borrower has outstanding. These assets can often be managed

for the collection of contractual cash flows, so not only does the criterion present operational

issues, but the criterion contradicts the general spirit of the business strategy criterion. With this

in mind, we recommend that this criterion be excluded from the final standard.

Question 29: Do you believe that measuring financial liabilities at fair value is operational? If not, why?

Response: From a cost/benefit perspective, we do not believe measuring financial liabilities at

fair value is operational, nor do we believe measuring financial assets at fair value is operational.

Given the concerns expressed with the core deposit intangible and the issues with fair value

changes in an entity’s own credit, we believe that the work required to measure financial

liabilities at fair value will not be at all cost effective and may, in the end, provide information

that hinders banking analyst efforts to predict the cash flows of a banking entity.

If the Board moves forward with this project, it is important to work further with industry to

determine whether financial liabilities should be reported at market. If one assumes that all

financial instruments should be accounted for at fair value, this treatment is consistent with that

notion, but many banks believe it will only add to the confusion that the ED will bring.

27

Question 30: Do you believe that the proposed criteria are operational to qualify for measuring a

financial liability at amortized cost? If not, why?

Response: Due to the way that many institutions manage their assets and liabilities, we believe

there will be limited situations in which a banking entity will qualify for such an option.

Question 31: The proposed guidance would require an entity to measure its core deposit liabilities at the

present value of the average core deposit amount discounted at the difference between the alternative

funds rate and the all-in cost-to-service rate over the implied maturity of the deposits.

Do you believe that this remeasurement approach is operational? Do you believe that the remeasurement

approach is clearly defined? If not, what, if any, additional guidance is needed?

Response: There are significant operational challenges related to measuring the core deposit

intangible. In addition to the fact that for most banks these amounts are not generally estimated

or subject to audit (nor to the required internal controls as per the Sarbanes-Oxley Act), it is

difficult to determine the actual cost to implement such a system. It is true that certain present

value information may be currently derived from interest rate risk management reports already

performed by banks for regulatory purposes. However, unique, entity-based maturity and

funding cost assumptions are not often used.

In addition to the issues noted on question 17, additional guidance that will be required includes:

How will banks account for core deposit intangibles (CDI) recognized upon business

combinations/acquisitions, as opposed to the ongoing CDI within this ED?

If there will be a change to the accounting for acquisition-related CDI, will there be a

transition period in which such a change may be implemented?

Should hedging costs be included in the interest rate spread assumptions?

Since alternative funding may come from a variety of sources, how much documentation

regarding the availability of such sources will be required when subject to audit?

How can future expectations regarding future alternative funding costs be used? Should

the use of forward interest rate curves be utilized when making assumptions regarding

alternative funding in the future?

28

Presentation: For All Respondents

Question 32: For financial liabilities measured at fair value with all changes in fair value recognized in

net income, do you agree that separate presentation of changes in an entity’s credit standing (excluding

changes in the price of credit) is appropriate, or do you believe that it is more appropriate to recognize

the changes in an entity’s credit standing (with or without changes in the price of credit) in other

comprehensive income, which would be consistent with the IASB’s tentative decisions on financial

liabilities measured at fair value under the fair value option? Why?

Response: ABA agrees with the many investors who believe that recognizing gains due to

declines in an entity’s own credit rating does not provide decision-useful information. The

recognition of gains in such a situation also appears to contradict the going concern principle.

Thus, ABA supports efforts to separately identify such amounts. While we support recognizing

such unrealized gains through other comprehensive income (OCI) in any situation, ABA also

cautions that the impact of recognizing these gains through OCI is muted, due to the proposal to

require one continuous statement of comprehensive income. Such gains, if the proposals are

adopted, will still be reflected in a bottom line number that will likely be the focus of many users

of financial statements.

As a result, we believe that such fair value information related to a company’s own debt

(whether applied to its own credit rating or the credit costs applied to its industry in general), not

only blurs transparency, but directly masks it. Both good and poor financial performance will be

distorted – even contradicted – by these marks. This is the inevitable result of full fair value

accounting.

Question 33: Appendix B describes two possible methods for determining the change in fair value of a

financial liability attributable to a change in the entity’s credit standing (excluding the changes in the

price of credit).

What are the strengths and weaknesses of each method?

Would it be appropriate to use either method as long as it was done consistently, or would it be better to

use Method 2 for all entities given that some entities are not rated?

Alternatively, are there better methods for determining the change in fair value attributable to a change

in the entity’s credit standing, excluding the price of credit? If so, please explain why those methods

would better measure that change.

Response: ABA supports providing an option to use any method, as long as it is performed

consistently, with appropriate disclosure as to the method. With this in mind, measuring credit

and debt value adjustments is an evolving process and we believe that neither option that is

presented reflects how banks or investors measure credit risk. In short, market participants do

not normally separate entity-specific credit risk valuation from credit spreads. In fact, doing so

would be extremely difficult. Therefore, issuing a final standard that advocates either method

will present both conceptual and operational challenges.

29

Question 34: The methods described in Appendix B for determining the change in fair value of a

financial liability attributable to a change in an entity’s credit standing (excluding the changes in the

price of credit) assume that the entity would look to the cost of debt of other entities in its industry to

estimate the change in credit standing, excluding the change in the price of credit. Is it appropriate to

look to other entities within an entity’s industry, or should some other index, such as all entities in the

market of a similar size or all entities in the industry of a similar size, be used?

If so, please explain why another index would better measure the change in the price of credit.

Response: Subject to our answer addressing question 33, ABA supports not limiting the

principle that is intended to merely estimate a cost differential from a peer group. Individual

banks have differing funding strategies and geographic reach. Therefore, their basis for one

index or another may appropriately differ.

Disclosures: For All Respondents

Question 65: Do you agree with the proposed disclosure requirements? If not, which disclosure

requirement do you believe should not be required and why?

Response: Due to our opposition on how interest income is calculated in the ED (which we

detail our opposition in our separate comment letter on loan impairment), ABA opposes the

disclosure requirements in paragraph 102 and 103, which are required only because of the

proposed method change.

Disclosures: For Preparers and Auditors

Question 68: Do you agree with the transition provision in this proposed Update? If not, why?

Response: ABA believes more transition guidance is required regarding a number of different

areas:

Guidance must address any restatement of the core deposit intangible that may be needed

due to the different valuations used on an ongoing basis under this ED versus the

valuations currently used for business combinations and similar acquisitions.

There will be needed disclosures in the likely circumstances of a business combination

where fair values of assets and liabilities are significantly different than those recorded

prior to the transaction.

Since new financial assets are being recorded and some are being measured on a different

basis (for example, loans have never been recorded at fair value and many unfunded loan

commitments have never before been recorded on balance sheet at all), more guidance is

required to determine whether a bank will qualify for the deferral. Further, changes that

occur as a result of convergence with IFRS (for example, the IASB’s Derecognition

project) or as a result of new standards (for example, in lease accounting) will also need

to be explained as to their impact on the deferral scope.

If the Board really believes that smaller, non-public entities need an increase in

sophistication in order to adequately comply with the proposed standards, then more

30

guidance regarding determining fair values is required in order to ensure an adequate

learning curve is achieved during this transition process.

Question 69: Do you agree with the proposed delayed effective date for certain aspects of the proposed

guidance for nonpublic entities with less than $1 billion in total consolidated assets? If not, why?

Response: ABA supports a delayed effective date for smaller entities. This will provide

community banks, which comprise approximately 90% of the nation’s banks, with additional

time to learn from the larger banks and develop the extensive and costly processes to provide the

fair values that are being proposed.

However, without a proposed effective date, we cannot determine how long that delay should be.

We are recommending at least four years between issuance of the final standard and the

implementation date for larger companies. If part of the goal is for the smaller companies – and

the accounting firms – to learn from the larger entities, then a four year delay is probably not

sufficient. We would recommend three additional years after the post-implementation review

has been done and there is confidence with the systems, processes, personnel, and audit firm

education.

Further, if the Board believes that a post-implementation review is necessary to determine that

the rest of the 90% of financial institutions should then comply with the remaining guidance, we

question whether the Board itself believes sufficient due process has been conducted to give

reasonable assurance that compliance can be achieved in a cost-effective manner. From a

practical perspective, therefore, such a deferral appears to equate to a field test. However, to

perform a “live” and “public” field test on an accounting standard that has significant procyclical

impact and lacks an improvement in transparency could well be dangerous because of its

anticipated systemic impact.

It has been noted that because of the level of sophistication at smaller, non-public institutions,

extra time is required in order to gain experience in estimating fair values in accordance with

“exit price” methodologies. We do not question whether experience is required. However, we

question how critical such experience will be to the stakeholders in these banks and whether the

larger bank implementation of the ED will give the Board a basis for concluding whether smaller

institutions should comply.

31

Effective date and Transition: For Preparers and Auditors

Question 70: How much time do you believe is needed to implement the proposed guidance?

Response: It is difficult to estimate the amount of time that will be needed to implement the

proposed rules, for many reasons, a few of which are:

New computer systems need to be developed and tested for all sizes of banks.

Bank personnel need to be trained.

Auditors need to be trained.

Internal controls processes need to be developed and tested.

Companies need to understand whether there will be auditing changes as a result of the

standard and whether those changes have an impact on internal controls processes and

management reports on internal controls.

We believe those banks for which the four year deferral does not apply will need a minimum of

four years after the release of the final standard. The four year deferral would also need to be

extended for the smaller banks, so that they can build on what the larger banks and their auditors

learn from their implementation.

Question 71: Do you believe the proposed transition provision is operational? If not, why?

Response: ABA believes that the transitional provision for a cumulative-effect adjustment to the

statement of financial position, while operational, presents challenges. Namely, key metrics (for

example, net interest margins) and bank capital will not be comparable to prior years. Indeed,

bank capital may often reflect deficits because of the requirement to use fair values upon

conversion. Therefore, historical data will likely be desired by users who perform analyses.

While we are not suggesting that this be required, some entities may choose to provide

supplemental (and perhaps, unaudited) data for years prior to the implementation date. With this

in mind, though presenting problems, we do believe the provision is operational.

®

JAMES D. MACPHEE Chairman SALVATORE MARRANCA Chairman-Elect JEFFREY L. GERHART Vice Chairman JACK A. HARTINGS Treasurer WAYNE A. COTTLE Secretary R. MICHAEL MENZIES SR. Immediate Past Chairman

CAMDEN R. FINE President and CEO

1615 L Street NW, Suite 900, Washington, DC 20036-5623 n (800)422-8439 n FAX: (202)659-1413 n Email: info@icba.org n Web site: www.icba.org

September 1, 2010

Russell Golden

Technical Director

Financial Accounting Standards Board

401 Merritt 7

PO Box 5116

Norwalk, CT 06856-5116

File Reference Number 1810-100

Dear Mr. Golden:

The Independent Community Bankers of America1 (ICBA) welcomes the opportunity to comment

on the Financial Accounting Standards Board’s Exposure Draft: Accounting for Financial

Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities.

The following contains our views on the Exposure Draft to date, but we are receiving comments

on it from community banks daily and plan to share additional comments with FASB by the

September 30 comment period deadline.

ICBA urges FASB to withdraw the proposal and not go forward with the accounting

changes contained in the Exposure Draft. In our view, the accounting that would result if

this proposal went forward would greatly misrepresent the operations of community banks

and many other financial institutions whose primary business practice is to hold financial

instruments to collect contractual cash flows, not to trade them on a regular basis. Community banks fund their operations by taking deposits and holding loans for the long term.

Most financial instruments community banks hold are not readily marketable. Community banks

are not in the business to create or purchase assets or liabilities for quick resale. If the proposed

accounting treatment goes forward, community banks will have to reconsider making longer-term

loans and deposits because of the impact of the changes in fair values they will need to record.

This will hurt community banks and other financial institutions that hold these instruments, but

1 The Independent Community Bankers of America represents nearly 5,000 community banks of all sizes and charter types

throughout the United States and is dedicated exclusively to representing the interests of the community banking industry and the communities and customers we serve. ICBA aggregates the power of its members to provide a voice for community banking interests in Washington, resources to enhance community bank education and marketability, and profitability options to help community banks compete in an ever-changing marketplace. With nearly 5,000 members, representing more than 20,000 locations nationwide and employing over 300,000 Americans, ICBA members hold $1 trillion in assets, $800 billion in deposits, and $700 billion in loans to consumers, small businesses and the agricultural community. For more information, visit ICBA’s website at www.icba.org.

2

1615 L Street NW, Suite 900, Washington, DC 20036-5623 n (800)422-8439 n FAX: (202)659-1413 n Email: info@icba.org n Web site: www.icba.org

more importantly it will hurt consumers and small businesses who now depend on the greater

certainty that longer-term deposits and loans offer. We do not believe that it is the role of

accounting to drive financial product offerings or limit financial choices.

Community banks tell ICBA that their investors also do not support this proposal, be they local

members of the bank’s community who own shares of the bank or professional analysts who

focus on the financial services industry, particularly publicly traded companies. Investors that

community banks have been discussing this proposal with do not see it as an improvement in

transparency. Community banks, along with other financial institutions will need to expend

significant resources to comply with this standard that is of questionable value. Current

accounting and reporting systems are not currently designed to implement the proposed changes.

Compliance will require adding additional staff, making significant system changes and in many

cases hiring outside consultants to provide valuation assistance. Banks will expend significant

amounts of funds to implement and comply with the accounting treatment, funds that would be

better used to provide needed credit to their communities.

While the intent of the proposal is to provide better transparency and comparability of financial

statements, the fair value measurements on which it is based depend on many subjective

assumptions. As a result, it will not achieve its goals. One larger publicly traded bank told ICBA

that the proposed accounting changes would greatly advantage bank insiders to the detriment of

outside shareholders because the financial information presented to the public as a result of the

accounting changes would not reflect the true financial condition of the institution; only insiders

would know its true condition.

Accounting standards and guidance should not be pro-cyclical. Recent market conditions have

demonstrated the pro-cyclical nature of mark-to-market accounting as declining values of

financial instruments necessitated write-downs and sales, causing further write-downs and sales.

We believe that the proposed accounting changes will exacerbate cyclicality in financial results

due to the greater reliance on fair value measurements, valuations that will be less accurate than

current accounting requirements.

Background

The proposal would require (1) presentation of both amortized cost and fair value on an entity’s

statement of financial position for most financial instruments held for collection or payment of

contractual cash flows and (2) the inclusion of both amortized cost and fair value information for

these instruments in determining net income and comprehensive income. It would also require

that financial instruments held for sale or settlement (primarily derivatives and trading financial

instruments) be recognized and measured at fair value with all changes in fair value recognized in

net income. FASB states that by presenting both amortized cost and fair value information on the

financial statements, the amortized cost would provide information about management’s

expectations about the instrument’s contractual cash flows, the fair value would provide the best

available information about the market’s assessment of the risk that the cash flows will occur.

Financial Instruments required to be classified using fair value with changes reflected in net

income include: trading instruments, derivatives, equity securities and hybrid instruments

containing embedded derivatives that would otherwise require bifurcation and separate

accounting.

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Financial Instruments (e.g. loans, debt securities, certain beneficial interests) would be measured

at fair value with certain changes in fair value recognized in other comprehensive income if:

a. It is a debt instrument with a principal amount that will be returned at maturity or other

settlement (the instrument cannot be contractually prepaid such that the holder would not recover

substantially all of its recorded investment).

b. The entity’s business strategy is to hold these debt instruments for collection or

payment of contractual cash flows rather than to sell or settle with a third party (based on how the

financial instruments are managed as a group rather than the intent for an individual financial

instrument; the entity must demonstrate it holds instruments for a significant portion of their

contractual terms).

Instruments measured at fair value with changes reflected in other comprehensive income will be

subject to a credit impairment model.

Core Deposits The Exposure Draft calls for a present value measurement approach for core deposit liabilities.

Core deposits would be re-measured each period using a present value method that reflects the

economic benefit (“intangible”) that an entity receives from this lower cost, stable funding source.

Deposits would be discounted at the rate differential between the rate charged for the next best

alternative source of funding and the all-in-cost-to-service rate over the implied maturity. Thus,

under the proposed model that creates “current” value information, the effects of changes in

market interest rates would be transparent on core deposits and other financial liabilities and the

financial assets they fund.

ICBA opposes the proposed change in accounting treatment for core deposits. We have concerns

about considering alternative funding sources to determine core deposit valuations. While this

may work for larger financial institutions that are active in the capital markets for various funding

alternatives, many smaller community banks have limited alternative funding sources, particularly

if they are located in small rural communities. As of June 30, 2010, the average loan to deposit

ratio of banks with less than $1 billion in assets was 93.4%. Community banks price their deposits

to maintain them and as a result the rates are quite stable. Yet a funding alternative such as

Federal Home Loan Bank advances will be priced by the capital markets and may behave quite

differently than core deposits. Thus, for many community banks the proposed “current” value

calculation would not provide accurate information. The calculations will also be expensive and

time consuming, particularly for smaller banks that have limited staff resources to conduct the

analysis.

We also have concerns about attempting to quantify the economic benefit or “intangible” that an

entity receives from core deposits. These benefits may be unique to the institution that holds

them. It would be impossible to determine the intangible benefit of providing a slightly higher

interest rate to municipal deposits so the school tax dollars get recycled within the bank’s own

community. Similarly, how does a bank value the “intangible” benefit of offering sweep accounts

to local businesses which provide employment and economic stimulus to its own community?

Those same dollars could go anywhere in the world and the loss to the local bank would go

beyond the cost of alternative funds.

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1615 L Street NW, Suite 900, Washington, DC 20036-5623 n (800)422-8439 n FAX: (202)659-1413 n Email: info@icba.org n Web site: www.icba.org

Demand deposits that are not considered core demand deposits would be valued at fair value.

FASB believes fair value is reasonably close to face amount because of the short-term nature of

these deposit liabilities. Since FASB recognized that the values are reasonably close, why force

financial institutions to expend the resources to determine a fair value that is not that different

from face value? ICBA opposes requiring institutions to record demand deposits at fair value.

Fair value does not include the value of relationships. For example, a deposit account may pay

higher interest or a loan may carry a lower rate so that bank may retain an extremely important

relationship which is very profitable overall. Some community banks have pointed out that if they

are forced to utilize some nationally based assumptions, new loans may be booked at a discount,

creating a loss on day one. Calculating a market value based on a nationwide constant, such as an

interest rate or term may be very misleading to financial statement users.

Liabilities

In our view it is very misleading to reflect changes in an entity’s own credit risk in the

measurement of a financial liability, recognizing a gain from a decrease in its own credit risk and

a loss for an increase in its own credit risk. Companies cannot often realize a gain in the liability

and it is misleading to financial statement users to suggest that it can.

Loans

ICBA also opposes requiring fair value calculations for loans that are held for the long-term to

collect cash flows. Community banks hold many loans that do not have a ready market, and

would require Level 3 measurements, such as small business loans and agricultural loans. These

loans are typically designed to meet a particular customer’s needs, and do not have the uniform

characteristics that would facilitate determining fair values for them. We question how fair value

measurements will provide a better understanding of illiquid agricultural loans held by a small

bank in a rural area. Also, community banks have often had difficulty selling rural residential

mortgages to Fannie Mae and Freddie Mac because the properties do not fit established secondary

market standards. As a result community banks make the loans and hold them in portfolio until

they are repaid or mature. Again, establishing fair values for the types of loans held by many

community banks would be costly and result in data of questionable reliability. Assumptions that

a bank in one community may use would differ significantly from those appropriate for another,

making it difficult to ensure comparable data.

Credit Impairments

According to the Exposure Draft, there would be a single credit impairment model for all

financial instruments that are measured at fair value with changes recorded in other

comprehensive income, and short-term receivables measured at amortized cost. FASB proposes

to remove the current incurred loss “probable” threshold for recognizing impairments on loans

and proposes a common approach to providing for credit losses on loans and debt instruments.

Instruments would be evaluated for credit impairment at the end of each reporting period; credit

impairments would be recognized in net income when the entity does not expect to collect either

all contractual amounts due for originated financial assets or all originally expected amounts to be

collected for purchased financial assets. Interest income would be recognized after considering

cash flows that are not expected to be collected. There would be a prohibition on forecasting

future events or changes in economic conditions. FASB believes that this accounting treatment

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1615 L Street NW, Suite 900, Washington, DC 20036-5623 n (800)422-8439 n FAX: (202)659-1413 n Email: info@icba.org n Web site: www.icba.org

should better reflect a financial instrument’s interest yield and credit losses will be recognized

earlier.

ICBA is continuing to discuss how best to treat credit impairments and address loan loss reserves

with its members. However, we find areas of the proposed guidance confusing in that it prohibits

the use of future events and conditions yet states that in assessing factors that shall be considered

when evaluating whether a credit impairment exists an entity shall consider relevant available

published data such as industry analyst and regulatory reports and sector rate credit ratings. Such

reports often contain forecasts or comments on future events or conditions.

Career bankers have experienced economic cycles, whether their banks are agriculturally focused,

operate in the oil patch, a mining area or other area that is not immune to down turns. Current

standards and guidance for the setting of the allowance for loan and lease losses give financial

institutions little ability to set aside reserves in good times to prepare for bad times, lest they be

seen as managing earnings. Yet, conservative community bankers (and bank regulators) see the

need for more flexibility in this regard, as they are well aware of economic cycles and the

difficulties of absorbing losses and raising capital during times of economic difficulties, such as

the current environment. The difficulties our economy is currently facing underscores the need to

provide some flexibility to prepare for economic changes going forward. Also, it is troubling that

some financial institutions are finding that current accounting standards are forcing them to

decrease their allowances at a time when they know more problems may be on the horizon. Such

an allowance change may well be misleading the users of their financial statements.

Comprehensive Income FASB is calling for a new continuous statement of comprehensive income to enhance the

prominence of the items reported as other comprehensive income. Other comprehensive income

would be presented below net income and for items where changes in fair value go through other

comprehensive income, both cost and fair value would be presented. Other comprehensive

income would not be reflected in earnings per share, but total comprehensive income would be

provided when earnings are released. Community bankers are in agreement that the expanded

reporting of comprehensive income is unnecessary and of little use to most financial statement

users.

Delayed Compliance for Non Public Companies

FASB has not proposed the implementation date for the changes. However, nonpublic entities

with less than $1 billion in total assets would be given an additional four years to implement the

new requirements relating to loans, loan commitments and core deposit liabilities that meet

certain criteria. FASB believes that such a deferral would allow these entities to develop and

refine the capabilities and processes necessary for valuing loans, loan commitments, and core

deposit liabilities before being required to recognize these amounts on the face their its financial

statements and allow FASB to perform a post-implementation review of the new requirements

two or three years after the initial effective date. It is our understanding that this deferral will

apply to over 90 percent of the banks and credit unions in the country. While additional time is

clearly needed, it underscores the complexity and magnitude of the changes. We agree with

FASB members Leslie Seidman and Lawrence Smith that the need for such a deferral calls into

question whether the basic classification and measurement model of the proposed guidance would

meet a cost-benefit test.

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1615 L Street NW, Suite 900, Washington, DC 20036-5623 n (800)422-8439 n FAX: (202)659-1413 n Email: info@icba.org n Web site: www.icba.org

While we appreciate FASB recognition that non public companies may need significantly more

time to prepare for the implementation of the changes, a number of community banks we

discussed this with told us that this delay will give them more time to develop an exit strategy.

They simply will not be able to continue to run an economically viable institution given the costs

to comply, the additional volatility to the financial statements the accounting changes will cause

and need for additional capital that will result. They have serious concerns that these accounting

changes will have such a significant impact on how they would manage their assets, liabilities and

capital that their business model will no longer be viable. The result will be industry consolidation

and loss of credit and other banking services to local communities.

Summary

ICBA strongly opposes the accounting changes contained in the Exposure Draft and urges FASB

not to go forward with it. The fair value accounting changes applied to financial institutions,

particularly community banks, are more likely to mislead investors and financial statement users

than provide them a clear picture of financial condition. The accounting changes that FASB

proposes are dramatic and would cause all financial institutions, particularly community banks, to

significantly change their accounting policies and practices. The changes will be expensive to

implement but be of questionable value. Unfortunately, all financial institutions will likely need

even more capital to offset the resulting increased volatility in financial instrument values.

We appreciate the opportunity to comment on this Exposure Draft. If you wish to discuss our

comments further, please contact the undersigned at 202-659-8111 or email at

ann.grochala@icba.org.

Sincerely,

/s/

Ann M. Grochala

Vice President

Lending and Accounting Policy