Level 3 Rules

The deadline fast approaches…
November 15th is the day of reckoning.

Banks Face $100 Billion of Writedowns on Level 3 Rule, RBS Says: “U.S. banks and brokers face as much as $100 billion of writedowns because of Level 3 accounting rules, in addition to the losses caused by the subprime credit slump, according to Royal Bank of Scotland Group Plc.

The Financial Accounting Standards Board's rule 157 will make it harder for companies to avoid putting market prices on securities considered hardest to value, known as Level 3 assets, Royal Bank's Chief Credit Strategist Bob Janjuah in London wrote in a note today. The new rule is effective Nov. 15, he said.

“This credit crisis, when all is out, will see $250 billion to $500 billion of losses,” London-based Janjuah said. “The heat is on and it is inevitable that more players will have to revalue at least a decent portion” of assets they currently value using “mark-to-make believe.”

Morgan Stanley has the equivalent of 251 percent of its equity in Level 3 assets, according to Janjuah. Goldman Sachs Group Inc. has 185 percent, Lehman Brothers Holdings Inc. has 159 percent and Citigroup Inc. has 105 percent, Janjuah wrote.

Merrill Lynch & Co., which wrote down $8.4 billion of subprime mortgage debt and related securities, has Level 3 assets equal to 38 percent of its equity “and may well come out of all of this in the best health,” Janjuah said.

Under FASB terminology, Level 1 means mark-to-market, where an asset's worth is based on a real price. Level 2 is mark-to- model, an estimate based on observable inputs and used when there aren't any quoted prices available. Level 3 values are based on “unobservable” inputs reflecting companies' “own assumptions” about the way assets would be priced.

ABX indexes, which investors use to track the subprime-bond market, are showing “observable levels” that would eat up institutions' capital if the benchmark's prices were used to value their Level 3 assets, according to Janjuah.

The indexes have tumbled this year because investors expected rising numbers of borrowers to default on home loans, cutting the cash flowing to the bonds that package the mortgages.”

Want to Know More?
Summary of Statement 157
Summary of Statement 159

Mish shows Citigroup Fighting For Its Financial Life
“In a quarterly regulatory filing Monday Citigroup reports $134.8 billion in 'level 3' assets.

Level 3 assets are holdings that are so illiquid, or trade so infrequently, that they have no reliable price, so their valuations are based on management's best guess. The investment bank said its total liabilities related to level 3 assets at quarter-end were $40.36 billion, according to the Form 10-Q. Citigroup said it often hedges its level 3 positions.”