Title: Amendments to the Impairment Guidance of EITF Issue No

Transcription

1 FASB STAFF POSITION No. EITF Title: Amendments to the Impairment Guidance of EITF Issue No Date Issued: January 12, 2009 Objective 1. This FASB Staff Position (FSP) amends the impairment guidance in EITF Issue No , Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, to achieve more consistent determination of whether an other-than-temporary impairment has occurred. The FSP also retains and emphasizes the objective of an otherthan-temporary impairment assessment and the related disclosure requirements in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, and other related guidance. Background 2. If the fair value of an available-for-sale or held-to-maturity debt security is less than its cost 1 basis at the measurement date, U.S. generally accepted accounting principles (GAAP) require that the reporting entity assess the impaired security to determine whether the impairment is other than temporary. Other-than-temporary impairments are recognized in earnings. 3. U.S. GAAP has two different models for determining whether the impairment of a debt security is other than temporary. For debt securities that are beneficial interests in securitized financial assets within the scope of Issue 99-20, an impairment is considered other than temporary if, based on the reporting entity s best estimate of cash flows that a market participant would use in determining the current fair value of the beneficial 1 FSP FAS and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, indicates that cost includes adjustments made to the cost basis of an investment for accretion, amortization, previous other-than-temporary impairments, and hedging. FSP on EITF Issue (FSP EITF ) 1

2 interest, there has been an adverse change in those estimated cash flows. 2 For debt securities that are not within the scope of Issue 99-20, Statement 115 applies. Statement provides an example indicating that an impairment is other than temporary because it is probable that the holder will be unable to collect all amounts due according to the contractual terms The differences in the two models are summarized as follows: a. Issue requires the use of market participant assumptions about future cash flows. This cannot be overcome by management judgment of the probability of collecting all cash flows previously projected. b. Statement 115 does not require exclusive reliance on market participant assumptions about future cash flows. Rather, Statement 115 permits the use of reasonable management judgment of the probability that the holder will be unable to collect all amounts due. Some constituents commented that because Issue requires entities to use market participant assumptions about future cash flows but does not permit consideration of whether it is probable that all previously projected cash flows will not be collected (as is permitted under Statement 115), applying Issue in a dislocated market can automatically result in an other-than-temporary impairment when the fair value is less than the cost basis. Numerous constituents expressed concern about this result, especially in cases where after an analysis of current information the underlying assets are still expected to fully perform. 5. The Board also considered the following in evaluating whether Issue should be amended: a. Issue only applies to certain beneficial interests in securitized financial assets. Other impaired debt securities with similar economic risks (for example, credit quality) are assessed for other-than-temporary impairment in accordance with the Statement 115 model. For example, an entity would apply the Issue model to a beneficial interest, while an entity would apply the Statement 2 See paragraph 12(b) of Issue References to Statement 115 or the Statement 115 model equally apply to not-for-profit organizations that report a performance indicator that have available-for-sale or held-to-maturity debt securities. See footnote 3(a) of paragraph 7 of FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. 4 See paragraph 16 of Statement 115. FSP on EITF Issue (FSP EITF ) 2

3 115 model to a corporate bond with similar economic risks (for example, credit quality). b. Similar beneficial interests with the same current credit quality might be assessed for other-than-temporary impairment under different models depending on the credit quality when the beneficial interest was initially recognized. 6. The Board obtained input from a range of constituents, including investors, preparers, auditors, regulators, and others, on financial reporting issues encountered during the credit crisis, including input on impairments of securities. That input came from (a) observing the SEC s fair value roundtable discussions (and considering the resulting Report and Recommendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-To-Market Accounting, which was issued on December 30, 2008), (b) participating in the joint FASB and IASB roundtables on the global financial crisis, and (c) engaging in discussions with other constituents such as the Investors Technical Advisory Committee, the Center for Audit Quality, the American Council of Life Insurers, individual investors, and the SEC. These forums each raised issues with the current guidance on other-than-temporary impairments. In December 2008, the Board issued proposed FSP, Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue Approximately 300 organizations and individuals responded to the proposed FSP, including investors, preparers, auditors, regulators, and others. Guidance Applicable to Other-Than-Temporary Impairment Assessments 7. This FSP retains and emphasizes the other-than-temporary impairment assessment guidance and required disclosures in Statement 115, FSP FAS and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, SEC Staff Accounting Bulletin (SAB) Topic 5M, Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities, and other related literature. FSP on EITF Issue (FSP EITF ) 3

4 8. The objective of an other-than-temporary impairment analysis is to determine whether it is probable that the holder will realize some portion of the unrealized loss 5 on an impaired security. U.S. GAAP indicates that the holder may ultimately realize the unrealized loss on the impaired security because, for example, (a) it is probable that the holder will not collect all of the contractual or estimated cash flows, considering both the timing and amount or (b) the holder lacks the intent and ability to hold the security to recovery. 9. It is inappropriate to automatically conclude that a security is not other-thantemporarily impaired because all of the scheduled payments to date have been received. However, it also is inappropriate to automatically conclude that every decline in fair value represents an other-than-temporary impairment. Further analysis and judgment are required to assess whether a decline in fair value indicates that it is probable that the holder will not collect all of the contractual or estimated cash flows from the security. In addition, SAB Topic 5M states that the length of time and extent to which the [fair] value has been less than cost can indicate a decline is other than temporary. The longer and/or the more severe the decline in fair value, the more persuasive the evidence that is needed to overcome the premise that it is probable that the holder will not collect all of the contractual or estimated cash flows from the security. 10. In making its other-than-temporary impairment assessment, the holder should consider all available information relevant to the collectibility of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of future cash flows. Such information generally should include the remaining payment terms of the security, prepayment speeds, the financial condition of the issuer(s), expected defaults, and the value of any underlying collateral. To achieve that objective, the holder should consider, for example, industry analyst reports and forecasts, sector credit ratings, and other market data that are relevant to the collectibility of the security. The holder also should consider how other credit enhancements affect the expected performance of the security, including consideration of the current financial condition of the guarantor of a security (if the guarantee is not a 5 See paragraph 6 of FSP FAS and FAS FSP on EITF Issue (FSP EITF ) 4

5 separate contract 6 ) and/or whether any subordinated interests are capable of absorbing estimated losses on the loans underlying the security. The remaining payment terms of the security could be significantly different from the payment terms in prior periods (such as for some securities backed by nontraditional loans 7 ). Thus, the holder should consider whether a security backed by currently performing loans will continue to perform when required payments increase in the future (including balloon payments). The holder also should consider how the value of any collateral would affect the expected performance of the security. If the fair value of the collateral has declined, the holder needs to assess the effect of that decline on the ability of the holder to collect the balloon payment. 11. An unrealized loss might be realized because as SAB Topic 5M states, [The holder does not have] the intent and ability... to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value. Paragraph 14 of FSP FAS and FAS states:... questions sometimes arise about whether an investor shall recognize an other-than-temporary impairment only when it intends to sell a specifically identified available-for-sale debt or equity security at a loss shortly after the balance sheet date. When an investor has decided to sell an impaired available-for-sale security and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale, the security shall be deemed other-than-temporarily impaired in the period in which the decision to sell is made. However, an investor shall recognize an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made. [Emphasis added.] 6 As discussed in paragraph 8 of FSP FAS and FAS As indicated in FSP SOP , Terms of Loan Products That May Give Rise to a Concentration of Credit Risk, nontraditional loans may have features such as (a) terms that permit principal payment deferral or payments smaller than interest accruals (negative amortization), (b) a high loan-to-value ratio, (c) multiple loans on the same collateral that when combined result in a high loan-to-value ratio, (d) option adjustablerate mortgages (option ARMs) or similar products that may expose the borrower to future increases in repayments in excess of increases that result solely from increases in the market interest rate (for example, once negative amortization results in the loan reaching a maximum principal accrual limit), (e) an initial interest rate that is below the market interest rate for the initial period of the loan term and that may increase significantly when that period ends, and (f) interest-only loans that should be considered in developing an estimate of future cash flows. FSP on EITF Issue (FSP EITF ) 5

6 12. The following are additional citations from U.S. GAAP and other sources referred to in footnote 4 of Statement 115 that support the objective and principles in paragraphs 8 11 of this FSP: a. SAB Topic 5M states, The market price may be affected by general market conditions which reflect prospects for the economy as a whole or by specific information pertaining to an industry or an individual company. Such declines require further investigation by management. Acting upon the premise that a write-down may be required, management should consider all available evidence to evaluate the realizable value of its investment. There are numerous factors to be considered in such an evaluation and their relative significance will vary from case to case. b. SAB Topic 5M states, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential. SAB Topic 5M concludes by stating, Unless evidence exists to support a realizable value equal to or greater than the carrying value of the investment, a write-down to fair value accounted for as a realized loss should be recorded. c. Paragraph 6(a) of APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, indicates, A series of operating losses of an investee or other factors may indicate that a decrease in value of the investment has occurred which is other than temporary and should accordingly be recognized (footnote reference omitted). d. Paragraph 47 of AICPA Statement on Auditing Standards No. 92, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities, states: Regardless of the valuation method used, generally accepted accounting principles might require recognizing in earnings an impairment loss for a decline in fair value that is other than temporary. Determinations of whether losses are other than temporary often involve estimating the outcome of future events. Accordingly, judgment is required in determining whether factors exist that indicate that an impairment loss has been incurred at the end of the reporting period. These judgments are based on subjective as well as objective factors, including knowledge and experience about past and current events and assumptions about future events. The following are examples of such factors. Fair value is significantly below cost and FSP on EITF Issue (FSP EITF ) 6

7 - The decline is attributable to adverse conditions specifically related to the security or to specific conditions in an industry or in a geographic area. - The decline has existed for an extended period of time. - Management does not possess both the intent and the ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. The security has been downgraded by a rating agency. The financial condition of the issuer has deteriorated. Dividends have been reduced or eliminated, or scheduled interest payments have not been made. The entity recorded losses from the security subsequent to the end of the reporting period. [Emphasis added.] Disclosures 13. The objective of the disclosures required by paragraphs 17 and 18 of FSP FAS and FAS is to provide information about all investments in an unrealized loss position (including those within the scope of Issue 99-20) for which other-than-temporary impairments have not been recognized. That information includes the evidence considered by the holder in reaching its conclusion that the investment is not other-thantemporarily impaired. International Convergence 14. Reducing the number of impairment models for debt securities in U.S. GAAP eliminates one of the differences between U.S. GAAP and International Financial Reporting Standards. The FASB and International Accounting Standards Board (IASB) joint project to address complexity in existing standards of accounting and reporting for financial instruments will include a reconsideration of the remaining impairment models. All paragraphs in this FSP have equal authority. Paragraphs in bold set out the main principles. FSP on EITF Issue (FSP EITF ) 7

8 FASB Staff Position Scope 15. This FSP applies to beneficial interests within the scope of Issue Amendment to Impairment Requirements of Issue This FSP amends paragraphs 12, 13, and 15 of Issue to align the impairment guidance in Issue with that in paragraph 16 of Statement 115 and related implementation guidance. Those amendments can be found in the attached appendix. Amendment of Statement This FSP amends footnote 21c of FASB Statement No. 157, Fair Value Measurements, as added by FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, as follows: [Added text is underlined and deleted text is struck out.] The discount rate adjustment technique described in paragraphs B7 B11 of Statement 157 would not be appropriate when determining whether there has been an other-than-temporary the change in fair value results in an impairment and/or necessitates a change in yield under EITF Issue No , Recognition of Interest Income and Impairment on Purchased Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, because that technique uses contractual cash flows rather than estimated cash flows expected by market participants. Effective Date and Transition 18. The FSP shall be effective for interim and annual reporting periods ending after December 15, 2008, and shall be applied prospectively. Retrospective application to a prior interim or annual reporting period is not permitted. 19. Consistent with paragraph 15 of FSP FAS and FAS 124-1, any other-thantemporary impairment resulting from the application of Statement 115 or Issue shall FSP on EITF Issue (FSP EITF ) 8

9 be recognized in earnings equal to the entire difference between the investment s cost 8 and its fair value at the balance sheet date of the reporting period for which the assessment is made (for example, December 31, 2008, for a calendar year-end entity). The provisions of this FSP need not be applied to immaterial items. This FSP was adopted by the affirmative votes of three members of the Financial Accounting Standards Board. Messrs. Linsmeier and Siegel dissented. Messrs. Linsmeier and Siegel dissent from issuance of this FSP because they believe this short-term project does not provide sufficient improvements to financial reporting to support its issuance on an expedited basis with limited due process. Messrs. Linsmeier and Siegel believe that accounting standards should be focused on serving the needs of investors, who did not request this urgent change. They note that the majority of investors who responded strongly opposed the FSP. Investors are exhibiting a current lack of confidence in financial statement information prepared in conformity with current GAAP, as demonstrated by the high percentage of bank stocks that have market valuations below their tangible book values. As a result, these investors favor valuing all financial instruments at fair value through net income and believe this FSP represents a step away from that goal by failing to require that all changes in the reported fair values of Issue assets be recognized in income. Messrs. Linsmeier and Siegel note that this FSP conforms the application of otherthan-temporary impairment guidance for securities within the scope of Issue to the Statement 115 impairment model used for other debt and equity securities. While conforming the application of impairment models could lead to a better understanding by investors of which losses are reported within income in financial reports, Messrs. Linsmeier and Siegel believe that the Statement 115 impairment model is primarily based on assessments about both the ability to collect cash flows of individual instruments and the ability to hold those individual instruments to recovery. In contrast, the rapid disappearance of certain financial institutions that appeared able to hold such instruments to recovery has reduced investors confidence in whether impairments are not being 8 See footnote 2 of FSP FAS and FAS FSP on EITF Issue (FSP EITF ) 9

10 recognized in earnings based on questionable assertions that the entity can withstand market conditions for a sufficient time period to recover the estimated cash flows. As a result, Messrs. Linsmeier and Siegel do not believe the focus of the Statement 115 impairment model on the ability to recover individual instrument s cash flows will result in a realistic representation of current economic losses in earnings. This will fail to reduce investor s uncertainty in these markets and perhaps lead to even greater skepticism about reported accounting information. Thus, they believe that issuance of this FSP does not result in sufficient benefits to investors to warrant its issuance. Additionally, the FASB already has added a joint project with the IASB to reconsider the full model for accounting for financial instruments on an expedited basis. Messrs. Linsmeier and Siegel do not believe it is cost-beneficial to conform the impairment model for Issue securities to the Statement 115 impairment model that already has been designated for potential pervasive reconsideration. Messrs. Linsmeier and Siegel believe that difficulties regarding Issue may be related more so to other issues relating to the reporting of fair values in current, illiquid market conditions. These issues relate to (1) determining whether more meaningful presentation of fair value losses in income could facilitate investors decisions, (2) deciding whether potential write-downs to potentially depressed fair values in these markets should result in issuing new guidance permitting recognition in income of any subsequent recoveries in fair values, and (3) evaluating the potential need for additional guidance to identify when distressed sales have occurred in these markets to help in identifying when Level 3 estimates rather than observable broker prices/estimates are likely to result in fair values estimates most consistent with the exit price objective. Messrs. Linsmeier and Siegel note that the Board will be addressing the issues of recoveries and further disclosures to supplement Statement 107. Additionally, they believe that investors have requested additional disclosures to provide better insights into the judgments and uncertainties underlying fair value estimates to help reduce investors uncertainties about reported financial statement information in the current challenging market conditions. Messrs. Linsmeier and Siegel also are concerned that the overwhelming preparer response to the proposed FSP (including over 200 form letters) could be based on the expectation that it automatically will permit the deferral of recognition of other-than- FSP on EITF Issue (FSP EITF ) 10

11 temporary losses in income. They believe that the FSP does not permit an automatic deferral of other-than-temporary losses. However, if in the rapid implementation of this guidance any deferral of the recognition of other-than-temporary losses in income occurs, Messrs. Linsmeier and Siegel are concerned that it might exacerbate investors lack of confidence. They also are concerned that this FSP could increase pressure placed on standard setters and regulators to make additional emergency changes to the accounting models for financial instruments. Messrs. Linsmeier and Siegel believe that paragraphs 9 and 10 of this FSP will provide benefits by reminding constituents about the specific assessments that must be undertaken in making evaluations about whether other-than-temporary impairments have occurred, including clarifying that other-than-temporary impairment evaluations require assessment of the collectibility of all future estimated cash flows for securities both within and outside the scope of Issue However, on balance they believe that this shortterm project does not sufficiently improve financial reporting to merit its issuance, especially on an expedited basis. Members of the Financial Accounting Standards Board: Robert H. Herz, Chairman Thomas J. Linsmeier Leslie F. Seidman Marc A. Siegel Lawrence W. Smith FSP on EITF Issue (FSP EITF ) 11

12 Appendix AMENDMENTS TO EITF ISSUE A1. Issue is shown below, marked for amendments to paragraphs 12, 13, 15, and other paragraphs that required status updates for the issuance of FASB Statements No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and No. 154, Accounting Changes and Error Corrections, and other literature: [Added text is underlined and deleted text is struck out.] ISSUE 1. Existing generally accepted accounting principles (GAAP) do not provide specific interest income recognition and measurement guidance for interests that continue to be held by a transferor in a securitization transaction accounted for as a sale. In addition, interest income recognition and measurement guidance is provided by a variety of different accounting models in existing GAAP for purchased beneficial interests or not at all. Beneficial interests that continue to be held by a transferor and purchased beneficial interests are collectively referred to as beneficial interests 1 [Note: See paragraph 20 of the STATUS section.] in this Issue. 2. Multiple interest income accounting models have been developed to accommodate the characteristics of particular types of investments and changes in estimated future cash flows. Changes in estimated future cash flows might arise from prepayments, from credit concerns, changes in interest rates, or for other reasons. 1 Paragraph of Statement defines beneficial interests as rights to receive all or portions of specified cash inflows to a trust or other entity, including senior and subordinated shares of interest, principal, or other cash inflows to be passed-through or paid-through, premiums due to guarantors, commercial paper obligations, and residual interests, whether in the form of debt or equity. FSP on EITF Issue (FSP EITF ) 12

13 3. Questions arise relating to the timing and amount of interest income to be recognized over the term of interests that continue to be held by a transferor, and over the recognition of impairment, particularly since the interest that continues to be held by a transferor often contains a risk profile that is different from the assets transferred (typically, the risks present in the transferred assets are concentrated in the interest that continues to be held by a transferor or subordinated beneficial interest). 4. The issue is how a transferor that continues to hold an interest in securitized financial assets, or an enterprise that purchases a beneficial interest in securitized financial assets, should account for interest income and impairment. EITF DISCUSSION Scope 5. The scope of this Issue includes beneficial interests that continue to be held by a transferor in securitization transactions that are accounted for as sales under Statement [Note: See paragraph 20 of the STATUS section.] and purchased beneficial interests in securitized financial assets. The scope includes beneficial interests that: a. Are either debt securities under Statement 115 or required to be accounted for like debt securities under Statement 115 pursuant to paragraph 14 of Statement b. Involve securitized financial assets that have contractual cash flows (for example, loans, receivables, debt securities, and guaranteed lease residuals, among other items). Thus, the consensus in this Issue does not apply to securitized financial assets that do not involve contractual cash flows (for example, common stock equity securities, among other items). The Task Force observed that the guidance in Issue No , Recognition of Interest Income and Balance Sheet Classification of Structured Notes, may be applied to those beneficial interests involving securitized financial assets that do not involve contractual cash flows. c. Do not result in consolidation of the entity issuing the beneficial interest by the holder of the beneficial interests. [Note: See STATUS section.] d. Are not within the scope of Practice Bulletin 6 (as amended by Statements 114 and 115 and SOP 03-3) or SOP [Note: See paragraph 10 of this Issue.] FSP on EITF Issue (FSP EITF ) 13

14 e. Are not beneficial interests in securitized financial assets that (1) are of high credit quality (for example, guaranteed by the U.S. government, its agencies, or other creditworthy guarantors, and loans or securities sufficiently collateralized to ensure that the possibility of credit loss is remote) and (2) cannot contractually be prepaid or otherwise settled in such a way that the holder would not recover substantially all of its recorded investment. Instead, interest income on such beneficial interests should be recognized in accordance with the provisions of Statement 91, and determining whether an other-than-temporary impairment of such beneficial interests exists should be based on FSP EITF , FSP FAS 115-1/124-1, Statement 115, SAB 59, SAS 92, and the Statement 115 Special Report. 6. The Task Force observes that a beneficial interest in securitized financial assets that are in equity form may meet the definition of a debt security in paragraph 137 of Statement 115. For example, some beneficial interests issued in the form of equity represent solely a right to receive a stream of future cash flows to be collected under preset terms and conditions (that is, a creditor relationship), while others, according to the terms of the special-purpose entity, must be redeemed by the issuing enterprise or must be redeemable at the option of the investor. Consequently, those beneficial interests would be within the scope of this Issue, since they are required to be accounted for as debt securities under Statement Beneficial interests issued in the form of equity that do not meet the above criteria should be accounted for under the applicable provisions of Opinion 18, the applicable consolidation guidance, [Note: See STATUS section.] or Statement The Task Force decided to include within the scope of this Issue, for income recognition purposes, beneficial interests classified as trading because it is practice for certain industries (such as banks and investment companies) to report interest income as a separate item in their income statements, even though the investments are accounted for at fair value. The Task Force observes that the method used for recognizing and measuring the amount of interest income on a beneficial interest should not differ based on whether FSP on EITF Issue (FSP EITF ) 14

15 that beneficial interest is classified as held-to-maturity, available-for-sale, or trading. The carrying amount of the beneficial interest used for purposes of measuring interest income should be adjusted based on the application of the accounting model described in this Issue. Thus, the same amount of interest income should be recognized each period regardless of whether the beneficial interest is classified as held-to-maturity, available-forsale, or trading. The difference between the carrying amount and the fair value of a beneficial interest classified as a trading security would be recorded through earnings as a gain or a loss. 9. The scope of this Issue includes the host contract portion of a hybrid beneficial interest that requires separate accounting of an embedded derivative under paragraphs of Statement 133 when the host contract meets the scope of this Issue. The issue of when and how a hybrid contract is to be separated into its component parts is an implementation issue of Statement 133 and, therefore, not within the scope of this Issue (see Implementation Issue D1). [Note: See paragraph 256 of the STATUS section.] The scope of this Issue does not include hybrid beneficial interests measured at fair value pursuant to paragraph 16 of Statement 133 for which the transferor does not report interest income as a separate item in its income statements. 10. The Task Force observes that when the proposed SOP on accounting for certain purchased loans is issued and becomes effective, beneficial interests subject to that SOP would be excluded from the scope of this Issue. [SOP 03-3 was issued in December 2003.] Consensuses FSP on EITF Issue (FSP EITF ) 15

16 11. The Task Force reached a consensus that the holder should recognize the excess of all cash flows attributable to the beneficial interest estimated at the acquisition/transaction date (referred to herein as the transaction date) over the initial investment (the accretable yield) as interest income over the life of the beneficial interest using the effective yield method. If the holder of the beneficial interest is the transferor, the initial investment would be the allocated carrying amount after application of the relative fair value allocation method required by Statement [Note: See paragraph 20 of the STATUS section.] The amount of accretable yield should not be displayed in the balance sheet. 12. The Task Force reached a consensus that the[the original Task Force consensus was superseded by FSP EITF ] The holder of a beneficial interest should continue to update the estimate of cash flows over the life of the beneficial interest. If upon evaluation: a. Based on current information and events that the holder of the beneficial interest estimates a market participant would use in determining the current fair value of the beneficial interest, it is probable that there is a favorable (or an adverse) change in estimated cash flows from the cash flows previously projected, then the investor should recalculate the amount of accretable yield for the beneficial interest on the date of evaluation as the excess of estimated cash flows over the beneficial interest s reference amount (the reference amount is equal to (1) the initial investment less (2) cash received to date less (3) other-than-temporary impairments recognized to date [as described in paragraph 12(b)]) plus (4) the yield accreted to date). The adjustment should be accounted for prospectively as a change in estimate in conformity with Opinion 20Statement 154 [Note: See paragraph 25 of the Status section.], with the amount of periodic accretion adjusted over the remaining life of the beneficial interest. Based on estimated cash flows, interest income may be recognized on a beneficial interest even if the net investment in the beneficial interest is accreted to an amount greater than the amount at which the beneficial interest could be settled if prepaid immediately in its entirety. b. The fair value of the beneficial interest has declined below its reference amount, an enterprise should determine whether the decline is other-than-temporary. An entity should apply the impairment of securities guidance in paragraph 16 of Statement 115 and the related implementation guidance (see paragraphs 13, 13A, FSP on EITF Issue (FSP EITF ) 16

17 13B, and 15 of this Issue). If, based on current information and events it is probable that a holder s best estimate of cash flows that a market participant would use in determining the current fair value of the beneficial interest, there has been an adverse change in estimated cash flows (in accordance with paragraph 12(a) above), then the condition in paragraph 8(a) of Statement 5 is met and (1) an otherthan-temporary impairment should be considered to have occurred and (2) the beneficial interest should be written down to fair value with the resulting change being included in income. Determining whether there has been a favorable (or an adverse) change in estimated cash flows from the cash flows previously projected (taking into consideration both the timing and amount of the estimated cash flows) involves comparing the present value of the remaining cash flows as estimated at the initial transaction date (or at the last date previously revised) against the present value of the cash flows estimated at the current financial reporting date. The cash flows should be discounted at a rate equal to the current yield used to accrete the beneficial interest. If the present value of the original cash flows estimated at the initial transaction date (or the last date previously revised) is less than the present value of the current estimated cash flows, the change is considered favorable (that is, an other-than-temporary impairment should be considered to have not occurred under the consensus in this Issue). If the present value of the original cash flows estimated at the initial transaction date (or the last date previously revised) is greater than the present value of the current estimated cash flows, the change is considered adverse (that is, an other-than-temporary impairment should be considered to have occurred under the consensus in this Issue). However, absent any other factors that indicate an other-than-temporary impairment has occurred, changes in the interest rate of a plain-vanilla, variablerate beneficial interest generally should not result in the recognition of an otherthan-temporary impairment (see footnote 2, Exhibit 99-20A) (a plain-vanilla, variable-rate beneficial interest does not include those variable-rate beneficial interests with interest rate reset formulas that involve either leverage or an inverse floater). 13. All cash flows estimated at the transaction date are defined as the holder s estimate of the amount and timing of estimated future principal and interest cash flows used in determining the purchase price or the holder s fair value determination for purposes of determining a gain or loss under Statement [Note: See paragraph 20 of the STATUS section.] Subsequent to the transaction date, estimated cash flows are defined as the holder s estimate of the amount and timing of estimated principal and interest cash flows based on the holder s best estimate of current information and events that a market participant would use in determining the current fair value of the beneficial interest. In this Issue, a favorable (or an adverse) change in estimated cash flows (as FSP on EITF Issue (FSP EITF ) 17

18 used in paragraph 12(a)) is considered in the context of both timing and amount of the estimated cash flows. 13A. It is inappropriate to automatically conclude that a security is not other-thantemporarily impaired because all of the scheduled payments to date have been received. However, it also is inappropriate to automatically conclude that every decline in fair value represents an other-than-temporary impairment. Further analysis and judgment are required to assess whether a decline in fair value indicates that it is probable that the holder will not collect all of the contractual or estimated cash flows from the security. In addition, SAB Topic 5M states that the length of time and extent to which the [fair] value has been less than cost can indicate a decline is other than temporary. The longer and/or the more severe the decline in fair value, the more persuasive the evidence that is needed to overcome the premise that it is probable that the holder will not collect all of the contractual or estimated cash flows from the issuer of the security. 13B. In making its other-than-temporary impairment assessment, the holder should consider all available information relevant to the collectibility of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of future cash flows. Such information generally should include the remaining payment terms of the security, prepayment speeds, the financial condition of the issuer(s), expected defaults, and the value of any underlying collateral. To achieve that objective, the holder should consider, for example, industry analyst reports and forecasts, sector credit ratings, and other market data that are relevant to the collectibility of the security. The holder also should consider how other credit enhancements affect the expected performance of the security, including consideration of the current financial condition of the guarantor of a security (if the guarantee is not a separate contract 1a ) and/or whether any subordinated interests are capable of absorbing estimated losses on the loans underlying the security. The remaining payment terms of the security could be significantly different from the payment terms in prior periods (such 1a As discussed in paragraph 8 of FSP FAS 115-1/ FSP on EITF Issue (FSP EITF ) 18

19 as for some securities backed by nontraditional loans 1b ). Thus, the holder should consider whether a security backed by currently performing loans will continue to perform when required payments increase in the future (including balloon payments). The holder also should consider how the value of any collateral would affect the expected performance of the security. If the fair value of the collateral has declined, the holder needs to assess the effect of that decline on the ability of the holder to collect the balloon payment. 14. Consistent with the guidance in Topic No. D-75, When to Recognize Gains and Losses on Assets Transferred to a Qualifying Special-Purpose Entity, and the guidance provided by the FASB staff in its answers to questions of the Statement Special Report, the application of this consensus to securities accounted for as availablefor-sale by the transferor prior to the transfer should not result in recognition of an unrealized gain or loss as interest income before the gain or loss on those securities is realized. [Note: See paragraph 20 of the STATUS section.] That is, under this consensus, an entity should retain the available-for-sale classification of the interest that continues to be held by a transferor and should not recognize, as interest income over the life of that interest that continues to be held by a transferor, the unrealized gain or loss that was recorded in other comprehensive income prior to the transfer unless a portion of the unrealized gain or loss recorded in other comprehensive income must be included in income as a component of the recognition of an other-than-temporary impairment. This 1b As indicated in FSP SOP , nontraditional loans may have features such as (a) terms that permit principal payment deferral or payments smaller than interest accruals (negative amortization), (b) a high loan-to-value ratio, (c) multiple loans on the same collateral that when combined result in a high loan-tovalue ratio, (d) option adjustable-rate mortgages (option ARMs) or similar products that may expose the borrower to future increases in repayments in excess of increases that result solely from increases in the market interest rate (for example, once negative amortization results in the loan reaching a maximum principal accrual limit), (e) an initial interest rate that is below the market interest rate for the initial period of the loan term and that may increase significantly when that period ends, and (f) interest-only loans that should be considered in developing an estimate of future cash flows. FSP on EITF Issue (FSP EITF ) 19

20 guidance would only apply to the extent of the interest that continues to be held by a transferor, not the interest considered sold under Statement The Task Force observes that, consistent with Topic No. D-44, Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value, when an entity intends to sell a specifically identified beneficial interest classified as available-for-sale at a loss shortly after the balance sheet date whose fair value is less than its carrying amount and the entity does not expect the fair value to recover prior to the expected time of the sale, a write-down for other-than-temporary impairment should be recognized in earnings in the period in which the decision to sell is made. [Note: See paragraph 28 of the STATUS section.] Furthermore, SAB 59, SAS 92, the Statement 115 Special Report, and FSP FAS115-1/124-1 provide additional guidance to consider when determining whether an other-than-temporary impairment exists. For example, an other-than-temporary impairment exists if as SAB Topic 5M states, [The holder does not have] the intent and ability... to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value. 16. The Task Force also reached a consensus that in situations in which it is not practicable for a transferor to estimate the fair value of the beneficial interest at the initial transfer date, interest income should not be recognized using the interest method. For these beneficial interests (that is, those beneficial interests that continue to be held by a transferor that are recorded at $0 pursuant to Statement ), the transferor should use the cash basis for recognizing interest income because the beneficial interest will have an allocated carrying amount of zero. FSP on EITF Issue (FSP EITF ) 20

21 17. This Issue does not address when a holder of a beneficial interest would place that interest on nonaccrual status or when a holder cannot reliably estimate cash flows. However, for beneficial interests placed on nonaccrual status or when a holder cannot reliably estimate cash flows, the cost recovery method should be used. 18. The Task Force noted that the consensuses in this Issue entirely supersede the guidance in Issues No. 89-4, Accounting for a Purchased Investment in a Collateralized Mortgage Obligation Instrument or in a Mortgage-Backed Interest-Only Certificate, and No , Recognition of Impairment for an Investment in a Collateralized Mortgage Obligation Instrument or in a Mortgage-Backed Interest-Only Certificate. This Issue s scope would overlap that of Issue for certain beneficial interests and the Task Force agreed that Issue should apply to those beneficial interests. Transition [Not reproduced to avoid confusion.] STATUS 20. Statement 140 replaced Statement 125 in September Statement 140 nullified Topic D-75 because the activities described in that Topic are no longer appropriate for qualifying special-purpose entities. However, Statement 140 carried over from Statement 125 without reconsideration the standards that underlay the guidance in Topic D-75: a sale can be recognized only to the extent that consideration other than beneficial interests in the transferred asset is received in exchange, and a sale and the resulting gain or loss is to be recognized upon completion of a transfer of assets that satisfies the conditions to be accounted for as a sale. 21. Interpretation 46 and Interpretation 46(R) address consolidation by business enterprises of variable interest entities, which include many special-purpose entities used FSP on EITF Issue (FSP EITF ) 21

22 in securitization transactions if they are not qualifying special-purpose entities. Interpretation 46 and Interpretation 46(R) require a variable interest entity to be consolidated by an enterprise if that enterprise will absorb a majority of the entity s expected losses or is entitled to receive a majority of the entity s expected residual returns or both. 22. Interpretation 46 was issued in January The consolidation requirements of Interpretation 46 apply immediately to variable interest entities created after January 31, The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. 23. FSP FIN46-6 deferred the effective date for applying the provisions of Interpretation 46 for: a. Interests held by a public entity in variable interest entities created before February 1, 2003, if the public entity has not issued financial statements reporting that interest in accordance with Interpretation 46. The application of Interpretation 46 to those interests is deferred until the end of the first period ending after December 15, b. Nonregistered investment companies accounting for their investments in accordance with the specialized accounting guidance in the investment company Guide. 24. Interpretation 46(R) was issued on December 24, 2003, and replaced Interpretation 46. An enterprise with an interest in an entity to which the provisions of Interpretation 46 were not applied as of December 24, 2003, must apply the effective date and transitions provisions in Interpretation 46(R) to that entity. Application by public companies of Interpretation 46 or Interpretation 46(R) to entities commonly referred to as specialpurpose entities is required no later than as of the end of the first reporting period that FSP on EITF Issue (FSP EITF ) 22

23 ends after December 15, Public enterprises must apply Interpretation 46(R) to all entities no later than the end of the first reporting period that ends after March 15, 2004 (public enterprises other than small business issuers) or December 15, 2004 (small business issuers). Nonpublic enterprises must apply Interpretation 46(R) to entities created after December 31, 2003, immediately and to all other entities by the beginning of the first annual period beginning after December 15, An enterprise that has applied Interpretation 46 to an entity prior to the effective date of Interpretation 46(R) shall either continue to apply Interpretation 46 until the effective date of Interpretation 46(R) or apply Interpretation 46(R) at an earlier date. 25. Statement 154, which was issued in May 2005, supersedes Opinion Statement 155, which was issued in February 2006, amends Statement 133. Statement 155 provides a fair value measurement election for certain hybrid financial instruments with embedded derivatives that otherwise would require bifurcation. A hybrid financial instrument that is elected to be accounted for in its entirety at fair value cannot be used as a hedging instrument in a Statement 133 hedging relationship Statement 156, issued in March 2006, amends Statement 140 with respect to the accounting for separately recognized servicing assets and servicing liabilities. Statement 156 does not affect any of the consensuses reached in this Issue; however, this Issue reflects the Board s decision in Statement 156 to replace the term retained interests with interests that continue to be held by a transferor. 28. FSP FAS 115-1/124-1 supersedes Topic No. D-44, Recognition of Other-Than- Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair FSP on EITF Issue (FSP EITF ) 23