2
$913
$1.8
$100
Below is an example of the distortion that occurs when using mark to market (MTM) accounting. Thisexample involves an actual case study from an anonymous bank that made loans and securitized themas a mortgage backed security (MBS). Expected losses and expected cash flows for the MBS differdramatically from MTM write downs.
The Bank is required to record MTM losses of $913 million as opposed to the maximum expected lifetime losses of $100 million, resulting in a significant overstatement of losses and having a negative impact on tangible common equity.
Losses on MBS Held By Bank
(In Millions)
Mark to Market AccountingExpected Losses vs. Mark to Market Write-downs
MBS description:
•
The Bank holds a pool of MBS totaling $3.65 billion as of December 31, 2008.
•
The underlying loans are not sub-prime and are generally quality loans (average ofapproximately 17 months of seasoning, original FICO scores of 749, and original loan-to-value ratio of 73%).Losses based on MTM:
•
The MBS has subordinated collateral of $172 million.
The amount of subordinated collateral exceeds the worst-case loss projections, which means the Bank does not expect to incur any losses on its senior MBS positions (positions that MTM rules have required be written down by $913 million).
•
The MTM write-down required on this pool is more than nine times the maximumestimated lifetime losses.
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