Predicting Credit Losses: Loan Fair Values versus Historical Costs

51 Pages Posted: 12 Apr 2011 Last revised: 23 Mar 2014

Brett Wooten Cantrell

University of Mississippi - Patterson School of Accountancy

John M. McInnis

University of Texas at Austin - Department of Accounting

Christopher G. Yust

Texas A&M University

Date Written: May 20, 2013

Abstract

Standard setters and many investors argue that loan fair values provide more useful information about credit losses than historical cost information while bankers and others generally disagree. We examine the ability of reported loan fair values to predict credit losses relative to the ability of net historical costs currently recognized under U.S. GAAP. Our analysis is important because credit losses in the banking sector can have severe and widespread economic effects, as the recent financial crisis demonstrates. Overall, we find that net historical loan costs are a better predictor of credit losses than reported loan fair values. Specifically, we find that historical cost information is more useful in predicting future net chargeoffs, non-performing loans, and bank failures over both short and long time horizons. Further tests indicate that the relative predictive ability of reported loan fair values improves in higher scrutiny environments, suggesting that a lack of scrutiny over reported loan fair values may contribute to our findings.

Keywords: fair value, loans, historical cost, chargeoffs, impairments, credit loss, bank failure

JEL Classification: M41, M44, M45

Suggested Citation

Cantrell, Brett Wooten and McInnis, John M. and Yust, Christopher G., Predicting Credit Losses: Loan Fair Values versus Historical Costs (May 20, 2013). Accounting Review, Vol. 89(1), pp. 147-176, January 2014. Available at SSRN: https://ssrn.com/abstract=1807081 or http://dx.doi.org/10.2139/ssrn.1807081

Brett Wooten Cantrell

University of Mississippi - Patterson School of Accountancy ( email )

P.O. Box 1848
Conner Hall
University, MS 38677
United States

John M. McInnis (Contact Author)

University of Texas at Austin - Department of Accounting ( email )

Austin, TX 78712
United States
512-232-6791 (Phone)

Christopher G. Yust

Texas A&M University ( email )

430 Wehner
College Station, TX 77843-4353
United States

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