As we usher in the New Year, we also ring in FAS 157 which will be effective for reporting entities as of 01/01/08. FAS 157 provides a consistent definition to value balance sheet items and, different from the past, looks at not what you paid for an item, but a best estimation of what you could sell a position for. While disclosure of the market value of loans is not new, FAS 157 changes the way institutions have to document and determine market value.
Basically, FAS 157 establishes a 3 level framework to derive fair value. Level 3, are those instruments, like loans, that have no observable inputs. As you can imagine, the calculation of a Level 3 instrument requires significant judgment on the part of management. This is exactly what is happening in terms of the subprime market and credit crisis. In order to assist banks help price and value their loans, as of January 2008, we began publishing a matrix of loan pricing (sent out in the monthly ALCO report) based on the following factors: 1) Where we have seen actual loans trade (we keep a log of loan types and where they have priced); and, 2) To the extent we do not observe actual trades, we are using our Loan Pricing model to create a risk-based pricing level, using observed trades as a basis for price.
As a caveat, since no two loans are alike, we have established a benchmark cost of funds, borrower quality, fees and loan size. Banks will have to make adjustments, either by using their own loan pricing model or estimating using the matrix price for their own particular differences in credit, cost of funds, fees, etc. This loan pricing matrix will be published monthly as part of our normal End-of-Month Report that is sent out via e-mail after the close of each month (we just sent one out last Thursday). This matrix gives banks yet another frame of reference, which may be incorporated into mark-to-market methodology documentation.
If you are not already a subscriber to the month-end report, contact us via e-mail and we will enroll you (and send you the latest version). Given the ongoing market volatility in all areas of lending, many bankers wish FASB would revert back to the old fashioned cost accounting methodology of yore (since the price would be quantifiable and indisputable). However, since risk changes, FASB these days is more interested not in what a bank paid for an asset, but what it can be valued at today. Put another way, while many may argue that pricing is difficult since "beauty is in the eye of the beholder," for accounting purposes, beauty really only pertains to the bid side of the equation.