Bank Notes
January/February 2008
A timely information and idea statement
FASB accounting standard could create surprises for community banks
The Financial Accounting Standards Board issued its
Fair Value Measurements Statement No. 157 (FAS 157)
in the fall of 2006. The objectives of FAS 157 include
creating a single definition of fair value, establishing
a framework for fair value and expanding disclosures
about fair value measurements. This results in raising
the bar for measuring fair values currently required by
generally accepted accounting principles. With a few
exceptions, including share-based payment transactions,
FAS 157 applies to fair value measurements already
permitted or required under other accounting
pronouncements where the FASB has concluded that
fair value is the relevant measurement attribute.
FAS 157 doesn’t expand the use of fair value
measurements by community banks for balance
sheet items. In addition, there may be some confusion
over fair value accounting due to the issuance of
FASB Statement No. 159 (FAS 159) in early 2007.
The Fair Value Option for Financial Assets and
Financial Liabilities includes the opportunity to
mitigate income statement volatility without applying
hedge accounting rules and expanding the use of fair
value. Though applicability of FAS 159 is an option,
it isn’t for FAS 157. However, both FAS 157 and FAS 159
are effective for years beginning after Nov. 15, 2007,
which may add to the confusion.
FAS 157 defines fair value as the price that would be
received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants
at the measurement date. This definition means that
the “exit” price versus the “entry” price is a better
measurement of fair value.
The primary focus of FAS 157 is the description of the
hierarchy for determining fair value. This ranking
explains the inputs into valuation techniques for
measurement of fair values using the following data:
Level 1 –Quoted prices (unadjusted) in active
markets for identical assets or liabilities
Level 2–Inputs other than quoted market prices
included in level 1 that are observable
for the asset or liability, either directly
or indirectly
Level 3–Unobservable inputs
Examples of how these inputs might be employed by a
community bank for its financial reporting could be:
Level 1 –U.S. Treasury securities
Level 2–Restricted investments
Level 3–Mortgage servicing rights, municipal
securities or goodwill
Other areas that need considering include loans, loans
held for sale, impaired loans, other real estate owned,
goodwill and core deposits.
FAS 157 indicates that valuation techniques utilized to
measure fair value shall maximize the use of observable
inputs and minimize the use of unobservable inputs.
Disclosure requirements about the use of fair value used
to measure assets and liabilities focus on the inputs
used to measure fair value. For reoccurring fair value
measurements using significant unobservable (level 3)
inputs, the focus is the effect of the measurements on
earnings for the period.
To meet this objective, the bank will need to disclose the
following information for each major category of asset
or liability:
• The fair value measurements at the reporting date
• The level within the fair value hierarchy in which the
fair value measurements fall, segregating fair value
measurements into level 1, level 2 or level 3
• The reconciliation of beginning and ending
balances — for assets or liabilities using level 3
unobservable inputs
• The gain or loss recognized in earnings that are
attributable to the change in unrealized gains
or losses
• The valuation techniques used to measure fair value
and a discussion of changes in valuation techniques,
if any, during the period
What does this mean to community banks? Since FAS
157 will apply to the financial statements issued in 2008,
FASB accounting standard, continued on page 3
Be a fearless — not a fearful — leader
“The only thing we have to fear is fear itself.”
This famous quote from Franklin Roosevelt speaks as
clearly to leaders today as it did in the 1940s. In their
book, Play to Win, Larry and Hersch Wilson present
psychologist Maxie Maultsby’s concept of the Four Fatal
Fears. Maultsby believes these fears impede our ability to
interact effectively with others and take relevant action.
Consider how the following four fears possibly affect your
ability to lead your bank.
1. I fear failure; therefore, I need to succeed
When leaders operate from a fear of failure, they
are often reluctant to act. They may procrastinate in
making decisions and miss opportunities. A fear of
failure can manifest itself as a need to have every piece
of available information before making a decision.
Leaders who fear failure can become imaginatively
stuck and in the constant mode of finding answers,
rather than reframing questions.
2. I fear being wrong; therefore, I must be right
For leaders, the fear of being wrong can make it
extremely difficult to tolerate members of their
management team who challenge their ideas or
conclusions. Ultimately, leaders’ fear of being wrong
leads to an increased likelihood that they will be
wrong. Leaders who need to be right tend to dominate
discussions and attempt to control the thinking of
others, rather than see others as resources who can
expand their understanding of issues and opportunities.
3. I fear rejection; therefore, I need to be accepted
Fear of rejection makes it difficult for leaders to take
a stand and define themselves in situations where
relationships feel endangered. These leaders tend to
rely exclusively on a consensus decision-making style
because they believe it’s more important to be liked
than respected. More introverted leaders deal with the
fear of rejection by pulling away from relationships and
cutting themselves off from the very people with whom
they desire connection.
2 BankNotes
4. I fear being emotionally uncomfortable;
therefore, I need to be comfortable
When leaders need emotional comfort, they lack the
capacity to remain present and engaged when faced
with resistance or anger from others. They tend to
avoid emotionally charged discussions and miss the
opportunity for mutual learning and growth.
When leaders act out of fear, their actions and decisions
are guarded and restrictive. Their fears and anxieties
are transmitted to their organizations, which creates
dependency, indecisiveness and lack of personal
responsibility. These shared fears can replace the firm’s
shared values and lead to ethical lapses, poor and
untimely decisions, ineffective communication and
dysfunctional relationships.
To help determine how fear impacts your leadership, ask
yourself – for the next week, twice daily (midday and day’s
end) – the following questions:
[I fear failure; therefore, I must succeed]
• What didn’t I attempt today because I was afraid I
would fail?
• How did I rationalize not trying?
• What was the worst outcome that could have come out
of my trying?
• What didn’t move forward because I didn’t try?
[I fear being wrong; therefore, I need to be right]
• In what situation did I feel the need to be right or to
avoid being wrong?
• How did I respond?
• How did other people respond to me?
• How could I have responded that would have been
more useful?
[I fear rejection; therefore, I need to be accepted]
• In what situation did I feel rejected today?
• How did I respond?
• How could I have responded more effectively to
stay connected?
• What situation did I avoid today because I was afraid
of rejection?
• What was the result of my avoidance?
• How could I have engaged that person?
[I fear being emotionally uncomfortable;
therefore, I need to be comfortable]
• What made me emotionally uncomfortable today?
• Why was I uncomfortable?
• What did I do to avoid or eliminate the discomfort?
• What didn’t get resolved because I avoided discomfort?
Your answers might surprise you, however they’re vital:
You’ll not only learn a little more about yourself but also
how you can improve your leadership.
Bank Notes
Does your bank have sufficient liquidity?
According to an article in the most recent FDIC
Supervisory Insights, liquidity analysis and risk
assessment for financial institutions has become more
complex in the last 15 years. Why? Changes in funding.
Insufficient liquidity could cause a bank to fail, making
liquidity a significant risk and uncertainty.
Community banks are currently struggling to
attract and retain core deposits. As a result, the
banks are turning to alternative funding sources
including wholesale funding such as federal funds,
Federal Home Loan Bank (FHLB) advances,
repurchase agreements and brokered deposits. Each
has certain risks from a liquidity perspective.
The FHLB continuously monitors a bank’s credit risk
profile. In the event of asset quality deterioration, the
FHLB may take various actions including refusing
to renew advances upon maturity, accelerating
repayment of advances due to covenant breech, raising
collateral requirements or reducing funding lines.
Lines of credit for many federal funds lines contain
provisions allowing the correspondent bank to
terminate the line or reduce the amount available to
borrow at any time. Banking regulations limit the use
of brokered deposits whenever a bank drops below
“well capitalized.” Finally, Internet deposits have
similar risks to brokered deposits as they involve
premium rates, no relationship with the depositor
and less stability.
As many banks struggle to attract and retain deposits,
many have altered their investment strategy from
liquidity to yields. This may involve investing in longer
term securities and more complex, riskier investments.
Another liquidity risk is that the banks have been
pledging their securities on FHLB borrowings.
Often, the best or most liquid securities are those
pledged to secure FHLB borrowings.
Statement of Position (SOP) 94-6 Disclosure of
Certain Significant Risks and Uncertainties requires
disclosure in the financial statements about risks
and uncertainties in four specific areas — nature
of operations, use of estimates, significant estimates
and vulnerability due to certain concentrations.
SOP 94-6 says risks and uncertainties arising from
concentrations should be disclosed when they
could have a severe “impact in the near term”
(i.e., within one year). Severe impact is defined as
“a significantly financially disruptive effect on the
normal functioning of the entity.” SOP 94-6 clarifies
that severe impact is higher threshold than material,
but less than catastrophic.
Liquidity risk may be a significant risk for community
banks due to the current economic environment,
including the subprime market, and trends throughout
the past 15 years. Bankers should consider whether
their bank has sufficient liquidity to meet short term
needs and appropriately disclose liquidity risks in the
financial statements.
FASB accounting standard, continued on page 3
there are some implementation issues that should be
addressed, which include:
• Allocating adequate resources in addressing the issues
in FAS 157
• Developing an inventory of the fair value
measurements (both recorded and unrecorded)
which identifies the source of the fair value
• Discussing with third party providers, who or
what should be held to ensure that they understand
the needs of the bank in developing the fair
value measurements
• Understanding the documentation and disclosure
requirements for the fair values items
Keep in mind, the previous information isn’t meant
to be a complete argument of the issues or concerns
surrounding the implementation of FAS 157. It highlights
the central theme of the statement and is intended to
assist bankers in getting focused on issues that need to be
addressed to adopt this statement for interim and annual
reporting in 2008.
BankNotes 3
Bank Notes
Inside this issue:
• FASB accounting standard could
create surprises for community banks
• Be a fearless — not a fearful — leader
• Does your bank have sufficient
liquidity?
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Bank Notes
January/February 2008
Printed in U.S.A.