CREDIT UNIONS SURVIVAL GUIDE CLASSIFICATION AND MEASUREMENT OF FINANCIAL INSTRUMENTS (ASU 2016-01) Presented by Matthew P. Butler CLU, ChFC Founder & Managing Principal Elite Capital Management Group, LLC
WELCOME! A Bona Fide Institutional Advisor regulated by the Securities and Exchange Commission & held to the fiduciary standard of the Investment Advisors Act of 1940 We work exclusively with credit unions We offer privately managed award-winning investment strategies combined with automated accounting and reporting We are an industry leader and a best-kept secret pioneered the concept of employee benefits pre-funding in 2007 but rarely if ever advertise Average client: $1B assets Average portfolio: $30M
WHAT S HAPPENED? The Financial Accounting Standards Board (FASB), a private, non-profit organization whose primary purpose is to establish and improve generally accepted accounting principles (GAAP) for public and private entities within the US, issued new accounting guidance on January 5, 2016 (ASU 2016-01) that eliminates the available for sale classification (AFS) for Equity Securities. ASU 2016-01 is a 232 page Standard covering several topics, with relatively benign changes made to GAAP with the exception of the Investments - Equity Securities Topic. Credit Unions are specifically mentioned on Page 48 of the Standard as being subject to the Investments Equity Securities Topic.
WHAT IS AN EQUITY SECURITY? The FASB definition of Equity Security is any security representing an ownership interest in an entity at fixed or determinable prices. Examples of Equity Securities include: common & preferred stock, all types of mutual funds, ETFs, Trusts, limited partnerships, CUSOs, options, etc. There is no look through provision available. For instance, a mutual fund that is invested 100% in government securities is an equity security, per the FASB.
WHY IS THE NEW STANDARD ALARMING? ASU 2016-01 requires all entities to record Equity Securities at Fair Value through Net Income (FVTNI). In other words, price changes of Equity Securities can no longer be recorded as unrealized gains or losses in other comprehensive income (OCI). Price changes must instead be recorded directly in net income. The Standard will increase earnings volatility significantly for institutions who utilize such investments. Equity Securities such as stocks, mutual funds, and ETFs have been widely marketed to credit unions over the years as suitable mechanisms to fund a variety of 701.19(c) investment programs i.e., employee benefits pre-funding, charitable donation accounts, and executive benefit plans. The earnings volatility these programs will generate under the new Standard will be unacceptable to credit union stakeholders.
EARNINGS VOLATILITY EXAMPLES 2008 (Old) AFS Income ($) Jan 27,271 (59,981) Feb 24,392 (20,853) Mar 33,907 (12,176) Apr 22,592 150,760 May 19,445 10,173 Jun 36,300 (312,934) Jul 23,392 1,796 Aug 25,436 10,026 Sep 46,992 (585,379) Oct 26,363 (996,661) Nov 25,430 (221,923) Dec 49,842 416,903 (New) FVTNI Income ($) 2013 (Old) AFS Income ($) Jan 27,373 132,696 Feb 21,756 63,021 Mar 39,802 134,415 Apr 31,268 139,060 May 25,212 (125,774) Jun 44,355 (185,136) Jul 29,993 109,806 Aug 23,910 (150,180) Sep 37,278 149,111 Oct 31,473 163,352 Nov 22,433 (9,358) Dec 72,379 29,563 (New) FVTNI Income ($) 2008 Income $361,362 ($1,620,250) 2013 Income $387,651 $450,576 $10M PORTFOLIO: 75% FIXED INCOME 25% STOCKS 2008: S&P 500-43% BONDS +6% 2013: S&P 500 +28% BONDS -2%
WHAT SHOULD CREDIT UNIONS DO? Seek Advice from a Bona Fide Institutional Advisor A Bona fide Institutional Advisor excels in the areas that matter most to institutional investors: 1 Product transparency in terms of risk Audit quality data and reporting Automated processes Specialization 1 PricewaterhouseCoopers/Clearwater Analytics 2014 Corporate Benchmark Survey
WHAT SHOULD CREDIT UNIONS DO? Take Action Now The effective date of the Standard for private business entities, i.e. credit unions, is for fiscal years beginning after December 15, 2018. Portfolio changes are going to be necessary leading up to the effective date and especially post-fasb implementation. Getting an early start and cementing a game-plan are critically important.
WHAT SHOULD CREDIT UNIONS DO? Maximize Income During Transition A cumulative-effect adjustment to the statement of financial position will occur in the beginning of the fiscal year in which the guidance is adopted (2018). This means amounts reported in other comprehensive income (OCI) attributable to equity securities that were previously classified as available-for-sale will need to be reclassified to retained earnings (undivided earnings). This will impact net worth ratios.
WHAT SHOULD CREDIT UNIONS DO? Avoid Traps Credit unions may be advised that this FASB change is not a big deal. We ve already seen that this is a big deal. Earnings volatility is highly undesirable. Many firms are suggesting that credit unions replace their existing investments with life insurance (COLI). This is simply poor advice! Buying life insurance is the best answer FOR THE BROKER, not the credit union. Because most advisors offer very little, if any, accounting support, they are not in a position to provide optimal investment guidance. Accounting and reporting is paramount to institutional investing! Transparent, customizable solutions do exist that allow credit unions to carry on with successful investment planning.
WHAT SHOULD CREDIT UNIONS DO? Maintain Flexibility & Ensure Their Program is Regulatory Friendly In an ever changing regulatory environment, investment portfolios must be transparent, liquid, high quality, and flexible. ASU 2016-01 (Classification & Measurement) RBC2 ASU 2016-13 (CECL)
SUMMARY ASU 2016-01 eliminates the available for sale classification for equity securities. Earnings volatility will increase significantly for credit unions who hold such investments. Careful planning should be carried out during the transition to implementation of ASU 2016-01. A bona fide institutional advisor can help.
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