New and Proposed GAAP Guidance

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New and Proposed GAAP Guidance Accounting for Changes that Impact You Laura Conroy, Vice President & Controller Kim Brunner, Assistant Controller & Director - Financial and Management Reporting Abby

1 New and Proposed GAAP Guidance Accounting for Changes that Impact You Laura Conroy, Vice President & Controller Kim Brunner, Assistant Controller & Director - Financial and Management Reporting Abby Wegner, Director of Financial Reporting May 14, 2014 Overview of GAAP Updates Finalized Generally Accepted Accounting Principles No new guidance of significance to Farm Credit since 2011 Impending Generally Accepted Accounting Principles No guidance recently issued and pending implementation Proposed Guidance Receivables Troubled Debt Restructurings by Creditors Classification of Certain Government-Guaranteed Residential Mortgage Loans upon Foreclosure Classification and Measurement Credit Impairment New Proposals on the Horizon Leases no projected date for proposal 2 1

2 Receivables Troubled Debt Restructurings by Creditors PROPOSED Classification of Certain Government- Guaranteed Residential Mortgage Loans upon Foreclosure Residential mortgage loans may be made to borrowers with a 100% government guarantee if the borrower defaults Federal Housing Administration (FHA) Veterans Administration (VA) (not cited in proposed ASU) Federal Agricultural Mortgage Corporation (Farmer Mac) (not cited in proposed ASU) U.S. Department of Agriculture (USDA) (not cited in proposed ASU) Issue Cited: Current GAAP does not provide guidance specific to the classification or the measurement of foreclosed loans that are government guaranteed Application Diversity: Reclassify the loans to real estate as with other foreclosed loans that do not have guarantees Reclassify the loans to Other Receivables 3 Receivables Troubled Debt Restructurings by Creditors PROPOSED Classification of Certain Government- Guaranteed Residential Mortgage Loans upon Foreclosure Primary Provisions: Residential mortgage loan is derecognized and a separate Other Receivable recognized upon foreclosure if the loan meets both of the criteria: The government guarantee is not separable from the loan before foreclosure entitling the creditor to the full unpaid principal balance of the loan At the time of foreclosure, the creditor has the intent to make a claim on the guarantee and the ability to recover the full unpaid principal balance of the loan via the guarantee The Other Receivable would be measured based on the current amount of the loan balance expected to be recovered under the guarantee Implementation Alternatives: Modified retrospective (balance sheet reclassification to the beginning of the annual reporting period) Prospective for all foreclosures on government-guaranteed residential mortgage loans after the effective date (effective date is TBD) 4 2

Receivables Troubled Debt Restructurings by Creditors PROPOSED Classification of Certain Government- Guaranteed Residential Mortgage Loans upon Foreclosure AgriBank District 100% Government

3 Receivables Troubled Debt Restructurings by Creditors PROPOSED Classification of Certain Government- Guaranteed Residential Mortgage Loans upon Foreclosure AgriBank District 100% Government Guarantees As of March 31, 2014 (In Millions) Federal Agricultural Mortgage Corporation (Farmer Mac) Unconditional Government Guarantees (GI 8 ); typically, loans acquired under Mission Related Investment authority Proposed guidance has the highest potential to impact unconditional guaranteed loans; however, demand is typically made with the originating bank and will not go to foreclosure Unconditional Government Guarantees (FSA / SBA / USDA) Other Conditional Government Guarantees (USDA) 5 Receivables Troubled Debt Restructurings by Creditors PROPOSED Classification of Certain Government- Guaranteed Residential Mortgage Loans upon Foreclosure FSA USDA SBA USDA Farmer Mac FHA Guarantee never pays until conclusion (sale of foreclosed property) Typically limited to a 90% Guarantee, although the Guaranteed Portion can be purchased in the secondary market District Associations may hold 100% of the guaranteed portion of the loan which would qualify for the proposed guidance Guarantee never pays until conclusion (sale of foreclosed property) Typically limited to an 80% Guarantee, although the Guaranteed Portion can be purchased in the secondary market District Associations may hold 100% of the guaranteed portion of the loan which would qualify for the proposed guidance Long Term Standby Purchase Commitment - guarantee goes into effect 90 days past due loan 100% guaranteed would never go into foreclosed property Insured loan may be serviced through conclusion (sale of foreclosed property); very limited exposure in the AgriBank District 6 3

4 Receivables Troubled Debt Restructurings by Creditors PROPOSED Classification of Certain Government- Guaranteed Residential Mortgage Loans upon Foreclosure Preliminary Comment Letter Reactions: The scope of the proposal is too limited FHA guarantees loans are broader than residential mortgage properties including multifamily mortgages as well as hospitals, nursing homes, assisted living facilities, and board/care facilities Other government guaranteed assets exist through the VA and USDA AgriBank Observation: Government guarantees not specifically mentioned in the proposed guidance may have a larger impact on Farm Credit Institutions, especially related to Mission Related Investments classified as loans for GAAP purposes General consensus on the proposed classification as Other Receivable Some concern about intent criterion and limited guidance if intent changes General consensus on implementation options 7 Accounting Guidance Today Loans accounted for as Held-to-Maturity or Held-for-Sale Debt/Equity Investments accounted for as Held-to Maturity, Available-for-Sale, or Trading While there has been deliberation and proposals to combine the guidance for loans and investments, at the March 12, 2014 meeting the FASB decided to retain the separate models in existing U.S. GAAP for determining classification of loans and securities 8 4

5 Issues Cited: FASB and IASB Convergence joint projects 2010 proposal focused on full fair value measurement for all financial instruments and received a significant amount of concerns from respondents 9 Primary Provisions of 2013 Proposal All debt investments/loans will be measured using either: Fair Value through OCI Fair Value through Net Income Amortized Cost All financial liabilities will be measured using either: Amortized Cost Fair Value AgriBank Observations: Leases and financial guarantees are currently out-of-scope for this project/proposal For debt investments/loans that are initially measured at transaction price, certain loan origination fees, net of direct loan origination costs, are deferred and accounted for as a yield adjustment over the life of the related financial asset in accordance with ASC , Receivables, Non refundable fees and costs ie: no change to FAS 91 For financial assets and financial liabilities that are subsequently measured at fair value through net income, transaction fees and costs will not be deferred and will be recognized in net income at inception of the transaction 10 5

6 Primary Provisions (CONTINUED) Debt investments (loans and debt securities) would be evaluated using a cash flow characteristics test and consideration of the business model in which the instrument is managed Instruments that pass the cash flow characteristics test are classified and measured at amortized cost or fair value with changes in fair value recognized in other comprehensive income based on the business model assessment Fair value with changes in fair value recognized in net income is the residual category AgriBank Observation: If a company does not hold an asset with the sole intention of selling it, the company will need to perform the cash flow characteristics assessment to determine if the asset is eligible for measurement at amortized cost or fair value through other comprehensive income 11 Primary Provisions (CONTINUED) Business Model Criterion Amortized Cost: consists of debt investments for which the primary objective is to hold the assets to collect the contractual cash flows Fair Value through OCI: consists of debt investments for which the primary objective is to hold the assets to collect contractual cash flows and realize changes in fair value through sale Fair Value through Net Income: consists of all other debt investments and will include debt investments that do not meet the cash flow characteristics criterion and those that are held for sale AgriBank Observation: The exposure draft states that when an entity does not know if it will hold or sell a debt investment, the investment will be measured at fair value through other comprehensive income 12 6

7 Primary Provisions (CONTINUED) Amortized Cost Assessment & Clarification Sales due to significant asset credit deterioration = Amortized Cost Sales to manage credit risk ĐŽŶĐĞŶƚƌĂƟŽŶтŵŽƌƟǌĞĚŽƐƚ Sales close to maturity of asset = Amortized Cost Sales required by regulation for whole industry = Amortized Cost Sales required by regulation for entity Amortized Cost AgriBank Observations: At inception debt investments/loans may be held with the intention of collecting the contractual cash flows. However, as a company's overall credit profile or risk appetite changes, it may decide to sell a portion of those investments. Prohibiting sales that are meant to manage credit risk concentrations may constrain sound business and risk management practices. Unlike under current GAAP, the proposed model does not contain a tainting concept. It does, however, provide guidance on the types of sales that will be consistent with the amortized cost category and requires disclosure when these assets are sold. Sales that occur more often than very infrequently and are not due to a significant credit deterioration would not taint the existing portfolio's amortized cost classification, but could still call into question the accuracy of the initial classification and future classification for similar instruments. 13 Primary Provisions (CONTINUED) Equity investments that are not accounted for under the equity method would be measured at fair value through net income AgriBank Observation: Although an exception was provided in the 2013 Proposal, recent redeliberations indicate equity investments will also be measured at fair value through net income Financial liabilities will generally be measured at amortized cost; however, financial liabilities that can only be settled with cash flows from specified financial assets would be measured on the same basis as the specified financial assets Numerous proposed presentation and disclosure requirements for all financial instruments 14 7

8 Proposed Guidance Impact to Farm Credit Current practice of participations may need to be reviewed to determine if accounting for the assets as amortized cost is compliant with the guidance as proposed AgriBank Observation: This will likely be an issue for institutions outside of Farm Credit AgriBank is monitoring Comment Letters for consistent themes regarding this concern; however, few comment letters with substance have been submitted The final guidance is currently anticipated for the second half of 2014; implementation prior to 2016 seems unlikely 15 Farm Credit Comment Letter The business model criteria do not take into account the business activities of financial institutions Paragraph states that sales of financial assets that result from managing the credit exposure because of concentrations of credit risk would not be consistent with the objective of amortized cost classification puts into question normal practices of financial institutions, including FCS institutions Financial institutions manage credit concentrations through loan participations, syndications and assignments as these regulated institutions are required to comply with regulatory lending limits Even though financial institutions may sell loan participations to others, they generally hold the remainder of the loan for the collection of contractual principal and interest AgriBank Observation: This would likely inhibit amortized cost accounting for a large portion of the Farm Credit loan portfolio requiring the loans be accounted for at fair value through OCI 16 8

9 Other Comment Letter Reactions Significant concern raised regarding the complexity in applying the cash flow characteristics test Similar to Farm Credit, clarification guidance was requested for applying the cash flow characteristics test for specific financial instruments, including loan participation and syndication arrangements Strong support by users of financial statements for parenthetical disclosure of fair value for items measured at amortized cost on the face of the balance sheet However, preparers and other stakeholders strongly opposed this presentation 17 Current Expected Credit Loss (CECL) model for assets measured at amortized cost Assets measured at fair value with changes recognized in OCI, expected credit losses should be recognized as follows: No credit loss recognition if the fair value is equal to or greater than the amortized cost basis If the fair value is less than amortized cost, the expected credit losses limited to the difference between the financial asset s fair value and its amortized cost should be recognized in net income Objective: Reflect the estimate of the amount of contractual cash flows not expected to be collected Scope: Loans Debt securities (Investments) Trade receivables Lease receivables Loan commitments 18 9

10 Requires an entity to recognize an allowance for ALL expected credit losses on debt instruments on Day 1 No threshold or trigger required to recognize losses Expected credit losses are an estimate of all contractual cash flows not expected to be collected from a recognized financial asset (or group of financial assets) or commitment to extend credit 19 Expanding on Expected Credit Losses : Consider all contractual cash flows over the life of the related financial assets including expected prepayments Unless there is a reasonable expectation a troubled debt restructuring will be executed, the following scenarios should not be considered in estimating expected credit losses: Extensions Renewals Modifications Even when remote, risk of loss must be considered AgriBank Observation: Although risk of nonpayment is greater than zero, this does not necessitate a recognition of loss 20 10

11 Expanding on Expected Credit Losses : An estimate of credit losses may be made using loss rate methods, default probabilities or a provision matrix using loss factors AgriBank Observation: This does not preclude an entity from using a discounted cash flow model to estimate credit losses, but the method may be used in addition to a cash flow model analysis For periods beyond which an entity is able to make or obtain reasonable and supportable forecasts, historical average loss experience may be used for the remaining life of the asset AgriBank Observation: The FASB has yet to provide clarifying guidance as to the appropriate average loss period or define a reasonable supportable forecast. The final pronouncement is expected to contain implementation guidance covering these topics. 21 Proposed Guidance Impact to Farm Credit A longer-term loss model may impact regulatory capital requirements and various key financial metrics The final guidance is currently anticipated for the second half of 2014; implementation prior to 2016 seems unlikely 22 11

12 Farm Credit Comment Letter Applying the proposed methodology could be complex and result in additional disclosures for items already disclosed in other areas of Shareholder Reports The impact on assessing an allowance for loan commitments could be very difficult to manage as FIN 45 is a very manual process today Accounting and disclosures associated with investments would be time consuming to move to this type of analysis versus our current OTTI analysis Expanded disclosures for investments including by rating (credit quality), rollforwards, reconciliation of FV and amortized cost, past due securities, and nonaccrual (if any). (Rollforward components are already included in Statement of Cash Flows) Calculation of Day 1 loss for amortized cost investment securities and loans Operational concerns if we would be expected to do a DCF analysis on a loanby-loan basis how much can collateral be considered in the analysis? Does a one-size-fits-all approach reflect the economics of the different assets?. AgriBank Observation: Significant complexity and modification to current processes as well as potential for a much higher allowance which would have a direct impact on capital ratios 23 Other Comment Letter Reactions Positions varied greatly between investors/users and preparers Investors/users preferred the proposed model of all expected credit losses Preparers preferred the current model of some credit losses. Financial institutions and some investors raised concern on impact of regulatory capital ratios Concern of failure to match the cost of credit loss expense with the timing recognition of compensation for expected credit losses (in the form of interest income) Forecasts beyond two years could result in unreliable (potentially cookie jar) estimates and volatile revisions 24 12

13 Summary of GAAP Updates Potential for significant impacts to accounting for Farm Credit Institutions on the horizon Impact to primary assets on balance sheet Impact to key assumptions and methodology AgriBank Financial Reporting Service Representatives maintain knowledge of new guidance and status of proposed guidance Representatives participate in System Accounting Standards Work Group As necessary, further communication on updates Controller News Webcasts Changes to Shareholder Report Model 25 For questions or comments, please contact: Your Financial Reporting Analyst Abby Wegner at or Kim Brunner at or

FASB Financial Instruments Project

FASB Financial Instruments Project June 18, 2013 2:00 3:15 pm Presented by: Jean Joy, CPA Director of Financial Institutions Wolf & Company, P.C. 99 High Street Boston, MA 02110 P: (617) 428-5432 E: jjoy@wolfandco.com