By Nilly Essaides

FAS 133 has far-reaching consequences. But will it reach as far as the emerging battle zone between investment and commercial banks? It will, if Goldman Sachs has its way. But so far, Goldman’s voice has been a lonely one – at least publicly.

Treasurers have always formed tight bonds with their credit banks. Indeed, credit lines are the bonds that hold banking relations together. Since banks (and treasurers) view credit as less of a profitable business and more of a “loss leader” into more lucrative, fee-generating products like cash management and custodial services, often a credit relationship is the key to other lines of business.

While the old relationship still holds, it has become more complex. Banks are now offering more than just commercial banking services, venturing deeper and deeper into investment banking territory. At the same time, the cost of credit is being recalculated as Basel II rules come into effect, against the backdrop of rising default rates and a slowing economy. These trends might force companies to look for credit in untraditional places.

All this has understandably put investment banks on the alert. They want to protect their traditional turf and ensure commercial banks do not take over some of their lucrative corporate business lines, such as underwriting, M&A finance and structured finance, as well as OTC trading in derivatives. At the same time, they’d like to capture some of the credit business, particularly the sort that pays well.

Where does that leave treasury?

The way the banking landscape is unfolding, it seems unlikely that I-banks will be able to match the balance sheet prowess of C-banks any time soon and therefore C-banks’ credit-extending capabilities. I-banks seem far happier with short-term, large financings and cannot really take on massive exposures onto their limited balance sheets. If anything, these pressures may force more I and C –bank marriages, going back to the “one-stop-shopping” mantra that predates the shift toward financial services specialization.

This inability to match commercial banks’ muscle may be the impetus for the Goldman Sachs’ letter to the FASB, seeking to force C-banks to mark to market their loan commitments. This would force commercial rivals to jack up the cost of credit to compensate for increased earnings volatility, thereby, making I-banks’ loan pricing more competitive.

The C13 outlook

But will the FASB agree? The issue falls under DIG issue C13, and so far the existing guidance says loan commitments are specifically scoped out of FAS 133, and therefore,  do not need to be marked to market. Goldman, in its letter, made the point that loan commitments meet FAS 133’s definition of a derivative, and hence should be carried at fair value on the balance sheet.

In their comment letters, meanwhile, commercial banks have strongly objected to the idea. JP Morgan Chase’s letter raises theoretical, practical and operational objections to a revision of C13.

In general, C-banks note that many loan commitments cannot be accurately valued, since they are not actively traded, as Goldman argues in its letter. Several banks point out that loan commitments come in two flavors: loan commitments for large, corporate loans and commitments for small business, residential and mortgage loans. While I-banks like Goldman, typically see only the first kind – and those do trade actively – C-banks have both on their balance sheets.

A letter from Deutsche Bank Securities makes the point that many bank loans also have consent clauses, whereby the loan cannot be assigned without the borrower’s expressed agreement, against hampering active trading (or the existence of a “market mechanism” as defined by FAS 133).

The I-banks’ arguments are understandable. What’s less understandable is the fact that not a single I-Bank wrote in support of the Goldman position – at least not yet.

The FASB was tentatively scheduled to discuss C13 at its Board Meeting on June 27 (see FASB cancels DIG June Meeting), but decided against it. The issue will be discussed at a future meeting. But if the comment letters are any indication, Goldman is quite alone in its effort and the FASB has already made it pretty clear that loan commitments were not intended to be part of FAS 133. Perhaps Goldman’s industry peers prefer to invest their efforts in finding commercial bank merger partners.

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