Remarks at the Financial Accounting Standards Board

Wriston, Walter B.


As a very early and continuing supporter of the Financial Accounting Standards Board, I appreciate the opportunity to appear before you today. The position you occupy in the private sector in establishing and interpreting accounting concepts is not only important in its own right, but is essential if we wish to keep this important function in the private sector, and out of the hands of a government bureaucracy. The process you have established to permit the users of financial data to comment on whether or not proposed changes in accounting standards would benefit the public is a good one.

My position as Chairman of Citicorp by necessity carries with it the obligation to look at accounting conventions from several different viewpoints. As a chief executive officer, I must be as sure as I can that Citicorp's accounting practices provide my colleagues and myself with accurate information upon which to base sound business decisions in the best interests of our stockholders, our staff and our depositors. To this end it is critical that accounting accurately reflect business decisions, rather than be designed to motivate them. As a banker, I want accounting to be consistently reflective of a borrower's financial condition, in order that lending officers at Citibank can make reasonable, informed judgments about a borrower's prospect of repaying his debts. Citicorp is also a fiduciary, which has been entrusted to invest a great deal of other people's money to assure, among other things, the payment of pensions to retired workers. These investments must be made on the basis of information supplied in certified statements of balance sheet and profit and loss figures. In none of these capacities, that is, as a manager, as a lender, or as an investor do we feel any need to adopt any form of current value accounting. As a heavily regulated industry, banking also has a fourth constituency - the various governmental regulatory bodies to whom we supply thousands of reports each year. Dr. Burns, chairman of the federal reserve board, has made very clear in his letter of July 8 to this board, that he is against changing the way in which banks account for their restructured loans. Dr. Burns feels from his perspective and we feel from ours that we are both already getting the kind of information we need. In short, there is no consumer demand whatsoever for a change in your product, particularly on a piecemeal basis.

While accounting can be described as both an art and a science, to my mind it is basically a convention. So long as anybody who takes the trouble to study the matter understands the convention and what it means, businessmen, stockholders, regulators and other consumers can make intelligent judgments based upon the numbers produced. Anyone experienced in dealing with the general public recognizes the difference between perception and reality. The reality to you gentlemen, as expressed by your chairman, is that the restructured debt discussion memorandum is not intended to prejudge a decision, nor is it intended to convey an impression that you intend to adopt current value accounting concepts. You have said this very clearly, but I have to say to you the perceptions of businessmen and bankers place a different interpretation on this proposal in light of other recent decisions. A series of accounting changes including the accounting for equity securities and accounting for foreign exchange translation gains and losses, which have emanated from you and the SEC's dictums on replacement value disclosure make me, and many of my corporate colleagues, apprehensive about the direction which accounting appears to be taking. Whatever you feel to be the reality, we must face the fact that a very large portion of your constituency believes it is true, and this fact is attested to by the numbers of people who have responded either in writing or plan to make oral presentations to this discussion draft.

Since this perception exists and since it is known that you are hard at work on the establishment of a conceptual framework concerning financial statements, it puzzles us as to why you feel it imperative to address restructured debt as a discrete issue prior to the completion of the study just mentioned. If we are going to replace the present accounting conventions with a whole new set of ideas, let us do it in a coordinated, orchestrated, systematic, planned and coherent manner and not piecemeal. A piecemeal attack will generate no useful additional information but, on the contrary, will cause disruptions with no countervailing value. Uneven application causes disruptions because the impact is felt on some firms, some industries and not others. It seems to me, and to most users of financial data, that once the conceptual issues have been finally ventilated, discussed and accepted, the critical parts of this particular issue will fall into place.

There is no demand for the proposed changes because so many people see clearly that the secondary consequences of a move to current value accounting will cause tremendous disruption in the business world with no offsetting benefits. The long term debt markets as we know them today would be drastically changed, because the holding of long term debt instruments would entail a degree of risk by the very nature of its term, not incurred by short term debt. Long term debt, therefore, would become attractive to a holder only on a floating rate basis. An accounting convention that would penalize the sound principle that long term assets should be financed by long term debt is counterproductive to our society. An accounting convention that would make the reported earnings of a financial intermediary resemble a yo-yo if long term investments were repriced every month end to market not only is bad for society, but would present an untrue picture of economic reality. This would hit states and municipalities the hardest. Who would buy their school and general obligation bonds? To arbitrarily disadvantage a significant section of the capital market in a world said to be short of capital makes little sense unless we can show an overwhelming gain to society as a whole. No such great benefits as far as I am aware have ever been articulated as accruing from current value accounting.

From a banker's standpoint, continuity and consistency of presentation and of accounting principles used is critical in the evaluation of a borrower's past performance as an indicator of future prospects. Lenders must be comfortable that swings in the numbers derive from underlying business decisions and conditions, because it is ultimately those decisions and their impact on the company which will enable our loans to be repaid.

Debt restructuring is as old, as fundamental, and as inevitable as banking itself. It has been going on since the first loan was made. Prior to World War II many commercial banks bought long term bonds of commercial enterprises. This practice by commercial banks helped finance the long term capital needs of railroads and industrial companies. When companies which issued these bonds got into trouble, banks found they had no loan covenants to lean on, and thus had no leverage to exert to work out a credit program. As these bonds were sold off during the War, banks went out of the business of buying long term corporate bonds and replaced these assets with term loans to these companies. Today the business of banking involves making loans with maturities ranging out to 30 years on home mortgages. The lengthening of loan portfolios increases the need for financial flexibility to work with our borrowers. One of the principal advantages to a corporation in borrowing term money from a bank is flexibility. Corporate needs change and banks accommodate those changes. We rarely write a term loan, and we write billions of dollars over the course of a year, that is fully repaid both in principal and interest on every due date, without some change in terms and conditions, i.e., restructuring. In fact, a good lending officer builds into every term loan agreement a number of trigger covenants to force the borrower to come back for discussion if his financial condition changes because none of us can forecast the future with very much accuracy. We want to be a cautious and a good lender, and we want to be able to accommodate loan terms to the borrower's changed conditions. Rewriting loan agreements frequently saves jobs and enhances the expectation of full repayment. We see no necessity to apply new rules to the natural process of debt restructuring which goes on every day and which has been recorded on one conceptual basis for decades.

If the proposal were to be limited to the restructuring of truly troubled loan situations where repayment of principal is in doubt, then I must ask a very fundamental question. What is so wrong with what we are doing now? Whenever line management, or any of our numerous credit review processes, identifies a loan or other asset whose total repayment at maturity appears to be in doubt, all or an appropriate portion of the asset is immediately written off. In the case of loans, the write-off is charged to a reserve for losses which was previously established by a charge to earnings. If an investment security were written off where there were no reserve, a write-off would be charged off directly to current earnings. The amount written off would be the maximum amount we believe, in our judgment, we will lose over time. In the past, these judgments have proved to be conservative, because the record shows that a substantial portion of loans written off are ultimately recovered. Implicit in the decision to write off only a portion of the loan, is the value judgment that the remaining balance will be fully collected some day. The decision to write off a portion of the loan, may or may not also involve a decision to restructure the loan. The restructuring might include lengthening the maturities and/or reducing the interest rate, it is important to recognize that after the restructuring, the asset remaining on the books is the principal amount we expect to have repaid over time, conservatively estimated, and we have in fact strengthened, not weakened, our position.

To me, this is conservative, realistic and focuses management's attention on the assets that are earning at less than internally acceptable rates. It makes no sense to me to write down the asset below the amount we expect ultimately to recover by an amount which reflects a market value return on similar assets, and to take that discount against earnings today, and then reflect that asset as a full earning asset at market rates from that point forward. As the proposals have been explained to me and as I understand them, it appears that if at the time of the restructuring, management's judgments as to the ultimate amount of the restructured asset which will be collected is accurate, the difference between the change now being proposed and how we are currently accounting is just a difference in timing of earnings and expenses. Under your proposal we would charge today's earnings by an amount representing a cost to carry the asset or an estimated market earnings rate for the asset. We would then accrete that discount back into earnings over the time that the asset remains on the books. Our current earnings would decline, our future earnings would increase by the amount of the discount, and there would be no total earnings impact over time, but reported earnings would fluctuate more widely. These artificial fluctuations would not reveal any useful business information to managers, investors, bankers or regulators. You have abundant testimony to support this conclusion. If banks front-ended these charges, it would have the effect of slowing capital growth through retained earnings today, but increasing capital funds faster in the future. Because the market and bank regulators perceive there should be a relationship between capital and loans, the immediate reduction in capital would mean a reduction in our ability to make loans.

The dialogue about changing the accounting for restructured debt seems to have resulted from a few recent, widely publicized restructurings, notably those relating to new york city obligations. That situation illustrates clearly the potential dangers of the proposed change in accounting rules. If the banks that held the city's obligations had been required to record an immediate write-down of, say, 25% of principal as a result of the restructuring, that restructuring just might not have happened. Several of the banks whose cooperation was essential might not have been able to afford it - not from an economic point of view, but in terms of the way that readers of their financial statements would interpret such a charge to earnings. Some New York City banks were, at the time, under severe earnings pressure, and the prospect of a significant additional charge with a corresponding reduction in capital would have been unacceptable. Neither the present accounting treatment, nor the proposed one, has any effect whatsoever on whether the bonds will be paid. What did affect the quality of the asset was the ability to restructure the debt. In other words, the restructuring enhanced the chances of the debt being paid. If the new proposal were in effect, it is highly unlikely that the banks could have adopted the cooperative attitude they did. At the very least, there would have been a strong bias towards shorter maturities in the debt as restructured. The effect would have been to reduce the reported accounting impact, but also to exacerbate the current cash flow problems experienced by the city.

Banks are now faced with a further decision regarding Municipal Assistance Corporation obligations. MAC has come to us and asked us to accept a stretch-out of maturities, from 10 to 15 years. How are we to respond to this request? We must evaluate the request in economic terms, taking into account such factors as rate of return and degree of risk, and we must consider our responsibilities to the community. However, we must also consider our responsibility to our shareholders. Even though the 6% return we receive on MAC bonds is a reasonable market rate, and even though MAC's request is not made in the face of imminent default or bankruptcy, their proposal would clearly constitute a restructuring under the terms of the discussion memorandum. The prospect that banks might be required to record a substantial loss from the restructuring would certainly constitute a significant incentive to go along with their request. It is apparent, that under your proposals, there is substantially greater market risk for a 15 year maturity issue compared to one of 10 years.

Let me assure you that I am not merely speculating as to what effect result the FASB were to adopt a current value approach to restructured debt. In this period of uncertainty, as we await your final pronouncement on the subject, the possible. Consequences are already an element in our decision process.

The potential accounting treatment that could result from application of the more extreme alternatives under consideration points up what we believe to be a serious conceptual weakness. Under present market conditions, lengthening of the maturities by five years would drop the nearly hypothetical market value of the obligations. Although there is a very limited market for such securities and the market price would not necessarily reflect a price at which we would be willing to sell, under the proposals we would have to record a sizable loss immediately. This loss would be required to be taken even though we had no intention to sell prior to maturity and had the ability to hold for the period.

Whatever other impacts may or may not be estimated, it is clear to me as a Manager, that a change in the accounting for restructured debt would bring administrative problems which I would find difficult to justify since there are no benefits to be gained. When you are dealing, as we are, in over 100 countries around the world, with a wide range in the levels of financial sophistication with vastly differing practices and functions in the money markets, your proposal could be an administrative nightmare. There is no intelligent way to determine the current market value of a loan you restructure in a place like Greece where there is no developed money market. The banking system is the only source of long term funds although most bank loans are typically made on a short term basis. What market interest rate would one use to apply the discount? There really isn't one. If you apply a market value concept to a restructured loan in a country with no long term debt market, and a prime bank rate of 25-30% (and there are a number of countries where this is true) you would be better off to take a complete write-off immediately, because if you estimate more than about 2-3 years to effect the repayment, the carrying costs under your concepts would bring the value to zero. This would not be the real world, because in such a situation, we would be understating the ultimate collectability of the asset on our balance sheet, overstating our loan losses and overstating our future interest revenue. This would constitute misleading information. We hold the view that the balance sheet should reflect the value of loan principal we expect to collect over time, and that all interest rate factors, including cost of carrying, are now and should continue to be reflected in the income statement. If we now assign income characteristics to asset values on the balance sheet, we have a problem in comprehension and explanation. Neither as a manager, a lender, or an investor would I desire such a course of action.

Our letter of reply and that of the New York Clearing House has covered all the technical points involved in a restructured debt situation including whether or not a so-called transaction has occurred and whether this gives rise to an accounting event which must be recognized. Without restating these, I seriously question whether the change, even if it would be shown conclusively to be more accurate in a purely accounting sense, is justified by presenting better data for management purposes, for investment decisions, for credit decisions, or for better understanding of the health and well being of an enterprise by the general public.

As our society has developed, our legal system has evolved in response to society's needs. Laws have been enacted in response to felt needs. Accounting conventions have followed the same path, and they too now have all the force of law, since failure to follow them can produce a qualified statement which in turn can close the capital markets to the corporation. This would be the equivalent of the death penalty since delisting from a stock exchange would signal the end of the availability to that company of capital markets. Your decisions, then, have serious impacts on our society and are not just intellectual exercises; it is the difference between a high court's decision and a moot court debate in law school. This being so, every care must be exercised to be sure users of the accounting product would be better served by the changes proposed. So far as I know, no investor, no banker, no businessman has requested such a change, no major user is of the opinion that information will become more meaningful, and no regulator of banks or bank holding companies desires it. Change without benefit to the consumers must be justified on other grounds, but to date no one has come forward to spell these out - on the contrary the effects in our society would be negative.

  • The document was created from the speech, "Remarks at the Financial Accounting Standards Board," written by Walter B. Wriston for the Public Hearing on Accounting by Debtors and Creditors When Debt is Restructured circa 1980s. The original speech is located in MS134.001.004.00007.
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