Tuesday, March 24, 2009

Will FASB Mark-to-Market Relief Help Income Property Borrowers?

The short answer is I think not – the relief does not appear to affect the accounting treatment of individual loans.

In general, when a borrower defaults on an income property loan and the lender does not expect to recover full contractual principal and interest, FASB 114 requires the lender to write the loan down to the fair market value of the collateral, including a further discount for the cost to sell the collateral. If a lender follows the rules it might as well foreclose and sell the property and avoid the risk of further declines.

In a distressed market like today’s, when it is very difficult to obtain financing for almost any income property project, the fair market value can be difficult to determine. The proposed FASB changes, summarized in this Housing Wire article, provide additional discretion and guidance for determining value other than relying on current distressed trades.

This changes how securities might be valued, but it doesn’t change how real estate collateral is valued in a distressed market. The mechanism for that is an appraisal, and appraisal guidelines already provide for adjusting values to non-distressed levels. From FDIC Laws, Regulations, Related Acts 2000 – Rules and Regulations Part 323 – Appraisals:

Market value means the most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and the passing of title from seller to buyer under conditions whereby:
    (1)  Buyer and seller are typically motivated;
    (2)  Both parties are well informed or well advised, and acting in what they consider their own best interests;
    (3)  A reasonable time is allowed for exposure in the open market;
    (4)  Payment is made in terms of cash in U.S. dollars or in terms of financial arrangements comparable thereto; and
    (5)  The price represents the normal consideration for the property sold unaffected by special or creative financing or sales concessions granted by anyone associated with the sale.

Of course, without non-distressed comparable sales it’s difficult for appraisers to figure out what the correct market value is. But, that’s already their call; the FASB changes won’t help them.

Here are links to some other posts on the FASB changes:

Zero Hedge: “Brutalizing the FASB’s Attempts at Piglipsticking”

The Big Picture: “What Does the FASB Proposal Mean for Financials?