ACCOUNTING FOR BANK´S VALUE GAPS / THE WALL STREET JOURNAL ( RECOMMENDED READING )

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DECEMBER 28, 2009, 6:01 P.M. ET.

Accounting for Banks' Value Gaps .

By MICHAEL RAPOPORT

Can investors count on consistency when it comes to bank accounting? As many banks struggle with piles of bad loans, it appears some auditors are being stricter than others when assessing their true value.

Banks using Ernst & Young and Deloitte in particular are showing much sharper declines in the fair value of their loans than those using other accounting firms, a Wall Street Journal analysis shows. Of course, it is quite possible Ernst and Deloitte simply have a less-healthy group of bank clients than other firms. But if it instead reflects different audit policies when it comes to assessing loans, it could have consequences on the strength of banks' regulatory capital.

Banks carry most loans on their balance sheet at their original cost. But they must also disclose the loans' fair value, or current market value, in financial-statement footnotes. At most banks, despite the carnage of recent years, fair value is only below cost by a small amount. Some banks, however, show much steeper declines. At Regions Financial, fair value was 19.3% lower than cost as of Sept. 30. The difference was 13.4% at Huntington Bancshares, 12% at KeyCorp, 9% at SunTrust Banks and 8.6% at Marshall & Ilsley. Regions, Key and SunTrust are all audit clients of Ernst; Huntington and M&I are Deloitte clients.

Among the top-25 U.S.-owned commercial banks, those five Ernst and Deloitte clients accounted for five of the six biggest gaps between fair value and cost as of Sept. 30. The average gap among Ernst and Deloitte clients in the 25-bank group was about 6%; among clients of PriceWaterhouseCoopers and KPMG, it was about 2%.

Those differences can affect how investors view a bank's loan portfolio, and could have a concrete effect on regulatory capital in the future. The Financial Accounting Standards Board is considering changes in banks' accounting for loans and may require them to carry loans on the balance sheet at fair value instead of cost.

If that happened, the current fair-value declines could reduce shareholder equity and regulatory capital—in some cases, to levels regulators would find troublesome. At Regions, the $16.9 billion gap between its loans' fair value and carrying value would wipe out its $13 billion in Tier 1 capital using a fair-value balance-sheet standard. Huntington, Key and M&I would see Tier 1 capital slashed to low levels. SunTrust would see a major Tier 1 reduction also.

A move by the FASB to require banks to use fair value as the balance-sheet standard doesn't have to hurt the banks' regulatory capital. Bank regulators could adjust the capital measures they use so that they wouldn't be affected by a fair-value change.

But big hits to the fair value of loans still matter to investors. Who audits a bank's books may have importance beyond whose name goes on the letter blessing the financial statements once a year.

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