The Financial Accounting Standards Board recently released aproposed accounting standards update for financial instrumentsconcerning new financial statement disclosures of liquidity riskand interest rate risk. The proposal is one portion of a jointproject between FASB and the International Accounting StandardsBoard on the subject of accounting for financial instruments. FASBhas opened a 90-day comment period on the proposal, which expireson Sept. 25. There was no effective date listed in the proposal.The exposure draft states that the effective date will bedetermined after the board considers feedback on theamendments.

The proposal would require all financial institutions, includingcredit unions, to provide detailed disclosures about liquiditypositions and interest rate sensitivities as part of the financialreporting process. Nonpublic entities would provide the disclosureson an annual basis. This article examines explains and analyzes thedisclosure requirements applicable to credit unions and discussesaction steps credit unions might take to prepare for implementationin 2013.

The genesis for proposing to require additional liquidity riskand interest rate risk financial statement disclosures was the May2010 FASB issuance of proposed standards update, “Accounting forFinancial Instruments and Revisions to the Accounting forDerivative Instruments and Hedging Activities.” Extensive feedbackreceived from users, preparers and auditors during the commentperiod indicated measurement attributes alone were insufficientwhen attempting to define both the “financial instrument's inherentrisks and the broader risks to which an entity is exposed.”Additionally, the consensus of feedback indicated that asupplemental disclosure was necessary to communicate these risks.The stakeholders identified three important risks during the 2010proposal comment period: credit risk, liquidity risk and interestrate risk. 

The rationale for requiring nonpublic entities to furnish theproposed disclosures makes no distinction between the types ofnonpublic entities and their differing forms of ownership, capitalstructure and taxation. For credit unions, the NCUA appears to have addressed IRR issues via the recent  regulations on policies andprocedures that become effective Sept, 30.

Liquidity risk disclosures. Financialinstitutions must furnish an annual liquidity gap maturity analysiscategorized into specified time intervals for the various classesof financial assets and liabilities based upon expected maturitiesof the underlying financial instruments.

The exposure draft defines expected maturity as “the expectedsettlement of the instrument resulting from contractual terms (forexample, call dates, put dates, maturity dates and prepaymentexpectations).” Additionally, financial institutions would berequired to disclose available liquid funds in tabular format.Unencumbered cash, highly liquid assets (such as governmentsecurities and investment-grade corporate bonds) and availableborrowings, such as loan commitments,  unpledgedsecurities and lines of credit, qualify as available liquid funds.The proposal calls for depository institutions to furnish detailedinformation about time deposit liabilities. Cost of funding wouldbe disclosed via a table quantifying (1) the amount of insured anduninsured time deposits issued and brokered deposits acquiredduring each of the last four quarters and (2) the weighted-averagecontractual yield and weighted-average contractual life for thedeposits issued or acquired during each of the last four quarters.

Interest rate risk disclosures. The sections ofthe proposal concerning the disclosure of IRR would apply tofinancial institutions only. Under the proposal, two tables willneed to be submitted annually. 

The first table is a re-pricing gap analysis, classifiedaccording to the different classes of financial assets andfinancial liabilities, which shows how the respective carryingamounts re-price over specified time intervals. The analysis mustalso include (1) the weighted-average contractual yield for eachtime interval by class of financial instrument, (2) the durationfor each class of financial instrument and (3) a total carryingamount column that reconciles to the amount presented in thestatement of financial position and a total weighted-averagecontractual yield for each class of financial instrument. Theproposal is silent about specifying a particular methodology whencalculating duration. However, most depository institutions havesignificant exposure to option risk embedded within many classes offinancial assets and liabilities, which makes effective duration amore precise method when preparing the re-pricing gap analysis.

The second table is an interest rate sensitivity analysis thatdiscloses the effects on after-tax net income (for the 12-monthperiod after the reporting date) and shareholders' equity ofhypothetical, instantaneous interest rate shifts as of themeasurement date. The proposal requires applying multiple interestrate scenarios, including yield curve slope changes, when producingan interest rate sensitivity table.

FASB's drive to produce uniform accounting standards forfinancial institutions when accounting for financial instrumentsappears to ignore the unique ownership and taxation aspects ofnatural person credit unions. The most likely users of credit unionfinancial statements are regulatory bodies. Therefore, requiringadditional liquidity risk and IRR disclosures constitutes a furtherregulatory compliance burden given the NCUA's pre-existingregulatory focus for 2012. The best way for credit unions to opineon the proposal is by submitting a comment letter to the FASB nolater than Sept. 25.  Instructions for a comment lettermay be found at  FASB.org.

Assuming the proposal becomes a final amendment to theaccounting standards codification, the previously discussedliquidity risk and IRR disclosures must be included in credit unionfinancial statements. The most likely scenario would require thedisclosures beginning with the 2013 reporting year, given that FASBhas not provided an effective date for the proposal. Be mindfulthat some asset/liability models may not be capable of producingthe requisite yield curve scenarios or may be incapable of valuingembedded options when calculating effective duration.  Anounce of preparatory prevention now may indeed be well worth apound of cure. 

Michael Gagliardi is a director at Sterne Agee and Leach.
Contact 205.414.3389 [email protected]