Wednesday, October 27, 2010

Majority Do Not Favor Fair Value For Loans, Liabilities, FASB Told

At today’s Financial Accounting Standards Board meeting, FASB staff presented a summary of feedback received from over 2,800 comment letters and other feedback on FASB’s proposed changes to accounting for financial instruments.

Staff noted a majority of constituents do not favor fair valuing loans, core deposits, or liabilities, and that users generally do not support retention of the fair value option for financial liabilities, although nonusers support use of the fair value option for liabilities in certain circumstances.

(In other action at today's board meeting, FASB clarified that its proposal amending disclosure of loss contingencies - including lawsuits - would not be effective this year; see separate post in the FEI blog.)

On the subject of financial instruments, FASB’s official Summary of Board Decisions, notes that staff summarized significant feedback on the May 2010 Exposure Draft, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities—Financial Instruments (Topic 825) and Derivatives and Hedging (Topic 815), that FASB plans to redeliberate the proposed credit impairment and interest income recognition models jointly with the IASB beginning with the November 10-12 joint board meetings, and that FASB plans to begin redeliberations of its proposed classification and measurement approach in December.

If you had been a fly on the wall among the observers at today's FASB board meeting (or a fly with headphones on listening to the webcast of the meeting like me), here are some additional highlights you would have heard from the live discussion.

Over 2800 Comment Letters Received On Proposal
Feedback received from preparers, investors and others, as detailed in today’s FASB board handout, included feedback from:

· 2,812 comment letters received to date,

· 5 public roundtables,

· 28 questionnaires allowing investors to provide confidential feedback

· 8 field visits with various entities, on a confidential basis, to discuss the operationality and the costs and benefits of the proposed [Accounting Standards] Update. Field visit participants included banking institutions of various asset sizes, nonfinancial entities, and an insurance company.

· 120+ investors and other users of financial statements employed by more than 60 firms through face-to-face meetings and calls with individual investors and groups of investors representing a variety of perspectives. Approximately 80 percent of these investors were buy-side analysts, with two thirds of these buy-side analysts investing on a long-only basis and the remainder employing a long/short strategy. The remaining investors were sell-side analysts specializing in either bank/insurance-related sectors or accounting, and ratings agencies analysts.

· numerous preparers, auditors, valuation specialists, and regulators through face-to-face meetings or calls with individual organizations or professional associations.

Majority Of Constituents Do Not Support Fair Valuing Loans, Core Deposits, Liabilities
Following are brief highlights from the staff’s verbal summary of feedback on the proposal:

Loans: almost all constituents agree fair value should not be the primary [measurement] attribute; [they] believe fair value for these instruments would increase subjectivity…. and potential negative effects to bank capital, lending…

Core deposits: virtually all constituents do not support fair value for core deposits, [they] believe [the] inputs are too subjective; a few users did support reporting value of core deposits; however, many of these users preferred full fair value, as opposed to [revaluing core deposits]

Liabilities: almost all constituents do not support fair valuing liabilities unless the entity has the ability and intent [to sell/liquidate the liability]… [these constituents] also believe that measuring a liability at fair value results in counterintuitive [treatment]… [in terms of] realizing gains from deterioration in credit quality of the entity; in most cases [those] gains will not be realized…

Fair value option: (1) Most users believe the fair value option should not be provided for financial liabilities; others believe [the fair value option should be] limited to [certain] situation[s]… a few users believe the fair value option should not be limited. Nearly all users believe disclosure [is important]. (2) Most nonusers support retention of the fair value option [in certain circumstances]; a few nonusers did not support the fair value option [in terms of reduction of comparability].

Hybrid instruments: Some nonusers [e.g. preparers, auditors] believe hybrid instruments should be bifurcated, but not assets, because they believe liabilities should be at amortized cost.

Path Forward Includes Identifying the 'Objective;' Convergence Considerations
Upon conclusion of their presentation summarizing feedback on the financial instruments proposal, staff asked the board if they agreed they would like to have staff bring all of the issues presented for more formal redeliberation at a future board meeting(s); the board agreed on that plan. Staff noted such meetings are currently slated to take place the week of November 11-12 and November 17.

FASB Board Member Marc Siegel observed, “We said at the [joint FASB-IASB board meeting, during the discussion of] Offsetting in London, there is a cross cutting issue when it comes to risk… whether or not we deal with risk in measurement, presentation, or disclosures.” He added, “When I started at my analyst firm, and we hired people to analyze banks, [using a] risk dashboard... credit, one of the [considerations]… interest, duration, liquidity, sort of morph together, and [the question of] do you have enough capital to support those risks. When we think about measurement, we have to also think about those risks.” A brief discussion ensued about providing information about risk and fair value through disclosure vs. measurement.

“Staff are thinking about it," noted a member of the FASB staff, including that the staff believes they should, "first think about the objective of classification and measurement, about the risk, the criteria, and work from there to understand what the board’s objective is.”

FASB Acting Chair Leslie Seidman suggested the staff’s approach could include, ”How we might want to proceed on the accounting model, and then, is there more information we need to provide, to provide a complete picture; that[‘s what] we thought we heard consensus on from investors.”

Following staff remarks about various types of approaches to organizing the redeliberation of the proposal, including feedback suggestion 2 categories or 3 categories to classify financial instruments, FASB Board Member Tom Linsmeier said, "I don’t know whether I think most productive to talk about loans by themselves, debt securities by themselves; I think it would be more productive for me, if we decide [that there should be] 2 categories or 3 [for classification of financial instruments], therefore, loans could be in 2-3 categories, debt could be in 2-3 categories; [the question is] is it an instrument specific approach, or debt specific approach; then disclosure issues [could be] address[ed], once we have a measurement basis in that category."

FASB staff observed, "I think most of the feedback we received, people focus on the criteria - not necessarily the legal form, but the intent. We would say, come back and look at the criteria, not the legal form, there are different risks from holding [certain] assets/liabilities, we don’t want to delay the conversation… we want to say, the perspective depend[s] on your perspective as holder of the instrument." FASB staff added that some constituent feedback suggested a model for measuring and/or classifying certain financial instruments based on management's intent, the 'business model' of the entity, and./or the characteristics of the underlying instrument (e.g. if the only way to sell or liquidate an instrument is in an active market, vs. instruments for which a market could become illiquid).

Staff noted some feedback recommended the board consider providing "detailed guidance on portfolio turnover, and on tainting."

Seidman instructed the FASB staff, "I want to give you some latitude to decide the best way to handle issues, [however] I just want a sense in the reasonably near future [of where we are going]."

Regarding the staff's suggestion to step back and consider the objective for the standard, Seidman advised, "It is important to have that discussion; [however] I see some practical issues with it; I want to make sure the issues are brought in a way [to show us] whether we will have a basis for possible convergence with the IASB." She emphasized, "I would like to have a sense in the relatively near term, whether we are going to pursue the approach in the ED for loans, core deposits, liabilities, so we can have a plan whether we’ve got a converged solution or not."

"I heard overwhelming feedback from investors," added Seidman, "even those who do not support fair value for these items in the balance sheet, they would like some information [about fair value, interest rate risk and liquidity risk]... I’d like to see it grounded in feedback from investors, on other feedback, so we can respond. I don’t think we can address all of this at the same time; with convergence, there is a need to address [the issues] in some order."

Board Member Larry Smith asked, "How are we going about redeliberations, vis-a-vis the IASB…" particularly with respect to impairment and derivatives.

Board Member Russell Golden (who recently was appointed to the board to fill the vacancy created by former FASB Chairman Robert Herz' retirement; Golden was formerly Technical Director of the FASB) noted, "I would recommend, we go through redeliberations; once we think we have a model on measurement, classification, we go ahead and present to [the IASB]; in the event [the models are] not identical, we have a discussion with them about opening up IFRS 9 [the IASB's standard on financial instruments]."

Board Member Tom Linsmeier said, "To be completely honest, this isn’t our decision, they have decided not to engage with us until we are done with our model."

Seidman said, "I thought we had an understanding we would start our redeliberations, see what the shape of our basic accounting model would be [for financial instruments]; once we have a sense whether we have a lot of things with common ground, or a few things, we would know if [we could] bring together as a converged standard. [Let's]find out where these deliberations go, and find out whether we have enough decisions to bring our standards together."

Wildcard: Impact Of New Board Members, When Appointed
Linsmeier raised a question as to the potential impact of new board members in finalizing the financial instruments proposal. (As announced by the Financial Accounting Foundation in August, the FAF decided to increase the size of the FASB board to seven members, from its current five members. The FASB had traditionally consisted of seven members from its founding in 1973 until 2008, when the FAF restructured some FASB operations.)

"We know new board members will be joining us, we won’t know timing of that for a while, but do we move on [identifying various] buckets [for purposes of classification and/or measurement], or wait?"

Smith responded, "Personally, I think we’ll be able to move [on redeliberations], take a vote; if [the vote is] 5-nothing, it's fairly obvious, if 3-2, we know it could change; unfortunately the [potential new board members'] selection and timing is out of our control; we can’t just sit back, we need to think about how to get them up and running, that’s a separate discussion."

Seidman noted, "We as an organization have [a responsibility] to [new] board members... I looked back to what was on our agenda when I joined the board, [we were] in the middle of stock comp.. [and other major projects]… we as a regular matter should proceed in a thoughtful manner, and we will do what we need to do to bring new board members up to speed. New board members can ask for help, if they feel they need to abstain [they can], our goal would be to bring them up to speed, on this project and every other project."

She then asked the staff to recap their immediate plans and what's on board for further discussion of this project.

Staff noted, "We will bring you a plan at some point in the next few days," adding they plan to come back to the board on November 12 with four issues:

1 yield and income , if you would include impact of credit losses or not

2. what we should include in how we determine the amount of (credit?) losses, (if we would… forecast or not, as well as if you are going to PV or not the cash flows, when we deal with the amount, as well as, if we are going to look at amt of losses you expect to incur thru life, vs. part of

3. when: timing of the recognition of a loss

4. some talk on an approach referred to as the 'Good Book/Bad Book,' a way for , if losses are not recognized on Day 1, at a certain point in time, if losses are going to be [recognized over] time.

Staff added, "We have November 10-12 [at the joint FASB-IASB board meeting noted above]; also dates the following week [including] November 17." Staff also noted they planned to have board memos available next week to share with the board, with 3 memos being prepared by FASB staff, and one by the IASB staff.

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