FASB Financial Instruments Project

Transcription

1 FASB Financial Instruments Project June 18, :00 3:15 pm Presented by: Jean Joy, CPA Director of Financial Institutions Wolf & Company, P.C. 99 High Street Boston, MA P: (617) E:

2 Project Overview May 2010 proposed Accounting Standards Update: Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities Global crisis highlighted gaps and inconsistencies in current model Objective: single converged model that provides useful, transparent, relevant information Fair value model for all financial instruments 2

3 Project Overview December 20, 2012 FASB issues proposed ASU, Financial Instruments Credit Losses (Subtopic ) Comments due May 31, 2013 February 14, 2013 FASB issues proposed ASU, Financial Instruments Overall (Subtopic ) Recognition and Measurement of Financial Assets and Financial Liabilities Comments due May 15,

4 Project Overview Project consists of three components: 1. Classification and Measurement 2. Impairment 3. Hedging 4

5 Proposed ASU, Financial Instruments Overall (Subtopic ) Recognition and Measurement of Financial Assets and Financial Liabilities 5

6 Classification and Measurement - General In this latest proposal, FASB has moved from its original full FV proposal to a mixed measurement model; amortized cost would be allowable for financial assets that are held to collect cash flows. Changes will broadly converge the accounting for debt investments and financial liabilities, but significant differences in accounting for equity investments will remain. 6

7 Classification and Measurement - Scope Noteworthy exclusions: Loan commitments and commercial LOCs (classify based on underlying loan to be made, unless exercise is remote) Derivative instruments Others Depository and lending entities continue to follow Topic 942 guidance on: FHLB and FRB stock NCUSIF deposits 7

8 Classification of Financial Assets Upon recognition, financial assets will be classified into the appropriate subsequent measurement category. Initial measurement Instruments that will be measured at FV through net income will initially be recorded at FV. Transaction fees and costs will not be deferred and will be recognized in net income at inception of the transaction. All other instruments will initially be recorded at their transaction price. 8

9 Measurement of Financial Assets Subsequent measurement of financial assets is based on both of the following: 1. Contractual cash flow characteristics of the asset Financial assets that do not pass the contractual cash flow characteristics assessment are measured at FV-NI. 2. Business model for managing the asset The business model assessment leads to three categories: Amortized cost (AC) Fair value through OCI (FV-OCI) Fair value through net income (FV-NI) 9

10 Step 1 Assessment of Contractual Cash Flow Characteristics Contractual cash flow characteristics are satisfied if the contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. Financial assets not meeting the above characteristics must be measured at FV-NI. Financial assets with elements of the following may not meet the characteristics: Contingent cash flows Prepayment or extension options Timing and nature of interest rate resets 10

11 Step 2 - Business Model Assessment Only applies to financial assets that pass the contractual cash flows characteristics assessment Based on business activities for managing financial assets 11

12 Business Model Assessment - AC Assets qualifying for the AC category would be held and managed within a business model that has the objective of holding the assets to collect contractual cash flows. Part of the management activities would focus on managing credit risk to maximize the collection of contractual cash flows. 12

13 Business Model Assessment - AC Sales of assets classified in the AC category: Sales based on deterioration of the issuer s credit worthiness would not be inconsistent with this classification if the purpose is to maximize contractual cash flows. Sales for other reasons should be very infrequent. Sales that result from events that are isolated, non-recurring, unusual for the entity, and could not have been reasonably anticipated are inconsistent with this classification. 13

14 Business Model Assessment - AC Sales of assets classified in the AC category (concluded): Allowable reasons under SFAS 115 for selling HTM securities would generally be consistent with this classification. When assessing a business model s objective, consideration should be given to pertinent historical experience, such as historical sales and reasons therefore. 14

15 Business Model Assessment FV-OCI Assets held in the FV-OCI category will be managed within a business model that has the objective of both: a) Holding financial assets to collect contractual cash flows, and b) Selling financial assets to realize changes in fair values (that is, at recognition, the entity has not yet determined whether it will hold the individual asset to collect contractual cash flows or sell the asset) The following activities are consistent with this classification: Managing exposure to interest rate risk Managing liquidity 15

16 Business Model Assessment FV-OCI The following will be recognized in net income: Current period income, including amortization of premiums, discounts and deferred origination fees/costs Current period credit losses Change in FV attributable to hedged risk if the instrument is the hedged item in a FV hedge Realized gains/losses on sale Foreign currency gains/losses 16

17 Business Model Assessment FV-NI This is the residual category; assets that fail the business model assessment to qualify for AC or FV-OCI are included in this category. Equity securities must be in this category, unless: The investment qualifies for the equity method of accounting The investment is consolidated in accordance with GAAP A practicability exception is elected (each reporting period) that would allow certain equity investments without a readily determinable fair value to be measured at cost with adjustments for impairment and observable price changes that meet certain conditions 17

18 Reclassification of Financial Assets Reclassification is allowed only if the business model within which the assets are held and managed changes. This is expected to occur very infrequently. Reclassify as of the last day of the reporting period in which the change occurs. 18

19 Classification and Measurement Liabilities Generally recognized at amortized cost FV-NI required for: Short sales Financial liabilities for which the business strategy at inception is to subsequently transact at FV If a non-recourse liability is required to be settled with only cash flows from the related financial assets, the accounting model would be based on that of the related financial assets. 19

20 Classification and Measurement Hybrid Instruments Hybrid financial assets would no longer be bifurcated between the host contract and the embedded derivative; the entire instrument would be assessed for cash flow characteristics and business model. Hybrid financial liabilities will continue to be bifurcated. 20

21 Fair Value Option Would be limited to: Certain hybrid financial liabilities Groups of financial assets and liabilities that are managed on a net exposure basis Financial assets otherwise eligible to be classified as FV OCI Hybrid non-financial liabilities under certain circumstances 21

22 Presentation Assets and liabilities on face of balance sheet grouped by measurement category AC category public companies to disclose all FVs on face of balance sheet, except for receivables/payables due within one year and demand deposit liabilities FV NI category separate income statement line item for aggregated realized and unrealized gains/losses Other presentation issues 22

23 Disclosure Applies to each interim and annual reporting period AC category public companies to disclose significant FV information (hierarchy, assumptions, changes, etc.) AC category significant information concerning sales of such financial assets Assets measured at FV-OCI various disclosures Information relating to reclassifications 23

24 Disclosure Core deposit liabilities by significant type of core deposit accounts: balance, implied weighted average maturity and the estimated all-in-cost-to-service rate. Disclosure required of public companies only. Nonrecourse financial liabilities Financial liabilities measured at FV under the FV Option Equity investments without readily determinable FVs 24

25 Transition Adoption will result in a cumulative-effect adjustment to beginning retained earnings. Early adoption is prohibited, with one limited exception. Exception: An entity may early adopt the provision that requires OCI presentation of the changes in fair value due to changes in an entity s own credit risk for financial liabilities that are designated under the fair value option. An effective date will be decided during final deliberations. 25

26 Proposed ASU, Financial Instruments Credit Losses (Subtopic ) 26

27 Project Objective Provide financial statement users with more decision-useful information about expected credit losses Reduce complexity by replacing the numerous existing impairment models in current U.S. GAAP with a consistent measurement approach 27

28 Concerns with Current GAAP Delayed recognition of losses Probable threshold Incurred loss notion Limitations on ability to incorporate reasonable forward looking information 28

29 Scope Applies to all entities Applies to the following financial assets that are subject to credit risk and are not classified at FV-NI: Loans Debt instruments Lease receivables Loan commitments Reinsurance recoverables Trade receivables 29

30 Recognition An allowance will be recognized for current expected credit losses (CECL): a current estimate of all contractual cash flows not expected to be collected Practical expedient: For financial assets measured at FV-OCI, an entity may elect not to recognize expected credit losses if both of the following conditions are met: The FV of the asset is greater than (or equal to) AC Expected credit losses are insignificant 30

31 Estimation of Expected Credit Losses Based on internally and externally available information, including: Information about past events, including historical loss experience Current conditions Reasonable and supportable forecasts Quantitative and qualitative factors specific to borrowers and the economic environment in which the entity operates Specific approaches or policy elections are not mandated. 31

32 Estimation of Expected Credit Losses The allowance must reflect the time value of money. If using DCF model, the discount rate used is the asset s effective interest rate. Neither a worst-case or best-case scenario. Consider at least two possible scenarios; one with a credit loss and one without a credit loss. Reflects how credit enhancements (excluding separate freestanding instruments) mitigate expected losses 32

33 Collateral-Dependent Financial Assets New definition expands collateral-dependent to include financial assets for which repayment is expected to be primarily or substantially through operation (by the lender) or sale of the collateral Practical expedient allows for comparison of the FV of the collateral to the AC basis to determine the allowance for credit losses 33

34 Purchased Credit Impaired Assets Accounting will change from current practice. ALL established at acquisition for buyer s expected credit losses. Portion of original discount related to credit losses will not be recognized in income; remaining portion will be recognized in interest income over the remaining life using the effective yield method. Effective yield determined upon acquisition will remain constant; changes in expected cash flows will be recorded as gains/losses through the credit loss provision. 34

35 Interest Income ASU only addresses interest income recognition related to the following: PCI financial assets When to cease accrual When it is not probable that substantially all of the principal or substantially all of the interest will be received If substantially all of the principal is not expected to be received, cash receipts will reduce the carrying amount of the asset. When reduced to zero, future amounts will be recognized as recoveries with any excess recognized as interest income. If substantially all principal is expected, but it is not probable that substantially all interest will be received, interest income will be recognized on a cash basis when received. 35

36 Write-offs Reduce the cost basis in the period in which it is determined there is no reasonable expectation of future recovery. Recoveries will be recorded as an adjustment to the allowance only when consideration is received. 36

37 Presentation For assets measured at AC, an allowance for credit losses is reflected on the balance sheet as a reduction of the AC of the asset. For assets measured at FV-OCI, the estimate of expected credit losses is a contra-asset that reduces the AC of the asset. For PCI assets not measured at FV-NI, the estimate of expected credit losses is reflected as an allowance that reduces the sum of the asset s purchase price and the expected credit losses on the asset at the time of acquisition. For loan commitments, the estimate of expected credit losses is reflected as a liability. 37

38 Development of the Estimate Assets evaluated individually: An entity may identify assets for individual evaluation; there is no specific requirement to do so. Impairment is based on a present value technique using the asset s effective interest rate. Practical expedient for collateral-dependent assets 38

39 Development of the Estimate Examples provided in exposure draft Loss-rate approach Base component and credit risk adjustment By-vintage Collective estimate and individual estimate Provision matrix All methods are judgmentally adjusted. 39

40 Example Estimation Methods Loss-rate approach Historical loss rate, updated for current conditions and reasonable and supportable forecasts of future cash flows, is applied to the amortized cost basis for applicable financial assets. Base component and credit risk adjustment In lieu of adjusting individual loss rates, develop base statistical estimate of credit loss for financial assets with similar risk characteristics and include credit risk adjustment to reflect current conditions and reasonable and supportable forecasts of future cash flows. 40

41 Example Estimation Methods By Vintage Track losses on loans by year of origination. Patterns of credit loss are developed and applied to assets by vintage. Make adjustments for changes in current conditions as necessary. Collective and Individual Estimation Methods Methods can be combined or changed over time. Example: Loss-rate method is applied to performing loans in the segment and discounted cash flow method, weighted for loss probability, is applied to non-performing loans in the same segment. 41

42 Example Estimation Methods Provision Matrix Example: Loss-rate method by aging Factor Aging 0.3% Current 8% 1-30 days past due 25% days past due 50% days past due 75% 90+ days past due 42

43 Disclosures Significant disclosures: Credit-quality information Allowance for expected credit losses Roll forward for certain debt instruments Reconciliation between fair value and amortized cost for FV-OCI Past-due status Nonaccrual status Purchased credit-impaired financial assets Collateralized financial assets 43

44 Transition Effective date to be established when final amendments are issued Proposed amendments to be applied by a cumulative-effect adjustment Early adoption prohibited 44

45 Questions? THANK YOU. 45