During the months of January and February our A/L BENCHMARKS report sets are heavily scrutinized. Most of our clients use the fair value data we prepare for their formal year-end reporting. Bank auditors usually have plenty of questions for our analysts about the balance sheet values.

One thing many folks initially have trouble with is the reported present value of deposits (or any liability). They look at the fair value report and see a fair value or present value that is less than the end-of-period book value and wonder why their deposits aren’t worth more. For example, the book value of a bank’s NOW account portfolio is $32,586; and the reported present value might be only $30,630. It’s common to initially think that the model is *under-valuing* the bank’s deposits…but it’s not!

To understand why, it helps to visualize the basic accounting equation: Equity = Assets – Liabilities. Ultimately we’re interested in the value of the net (i.e. Equity) What is the value of all of the bank’s assets minus the value of all the bank’s liabilities. In the case of a deposit liability, it’s more beneficial to the bank to have a value that’s less than book. Here’s a quick look at the calculation.

VE = VA – VL

VE = value of equity

VA = value of assets, lets assume that this value is $100,000

VL = value of liabilities, lets assume that the bank has two liabilities. One is the NOW accounts mentioned above, and the other is borrowings with a value of $60,500.

VE = $100,000 minus ($60,500 + $30,630) = $8,870

The lower the present value of NOW accounts is, the more net equity there will be. Let’s suppose the present value of the NOW accounts was $29,410.

VE = $100,000 minus ($60,500 + $29,410) = $10,090

There is more net equity, or ultimately more value for the bank. Remember when you’re looking at balance sheet values, you have to switch your way of thinking when looking at the funding side.

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