Sale of Securities Impaired by Interest Rates, Sector Spreads at Issue for FASB `Minor Impairment' Clarification
NORWALK, Conn. - The wording surrounding when and how securities can be sold to meet liquidity needs or are used as part of a credit union's risk management program is up for interpretation under a Financial Accounting Standards Board (FASB) proposal. Under its "The Meaning of Other-Than-Temporary Impairment and Its...
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NORWALK, Conn. – The wording surrounding when and how securities can be sold to meet liquidity needs or are used as part of a credit union’s risk management program is up for interpretation under a Financial Accounting Standards Board (FASB) proposal. Under its “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” EITF Issue 03-1-1, FASB provides implementation guidance with respect to debt securities that are impaired solely due to interest rates and/or sector spreads. FASB sought comments on whether the application guidance with respect to “minor impairments” should also be applied to securities analyzed for impairment under paragraphs 10-15 of Issue 03-1. That issue of “minor impairments” is not easily defined. In a Oct. 29 comment letter, NAFCU President/CEO Fred Becker said it “agrees that minor impairments can be considered temporary without further analysis because normal interest rate and/or sector spread volatility eliminates the impairments.” But it does not support defining a minor impairment by creating a bright-line test because it could create artificial assumptions about the volatility of the interest rate. “The degree of volatility is relative to the characteristics of the security and the institution’s asset-liability management practices,” Becker wrote. “However, NAFCU does support FASB providing guidance and examples of minor impairments for different types of securities, in order to achieve uniform compliance with the standard.” There are circumstances that “do not call into question the investor’s ability or intent to hold securities to recovery when the investor has sold another security that it had previously asserted its ability and intent to hold to recovery,” Becker noted. But a credit union’s unexpected changes in liquidity need or unexpected increases in interest rates would require it to divest itself of certain securities, but not all securities in a portfolio, he added. “This type of portfolio management should be permitted to continue without fear of a `taint’ on the entire class of securities,” Becker wrote. The Association of Corporate Credit Unions feels that the proposal should “specifically limit the requirement of an investor to assert the intent and ability to hold the securities in unrealized loss positions until recovery to those situations where the decline in market value below cost is caused by severe credit deterioration,” wrote Michael Canning, ACCU executive director in a Oct. 28 comment letter. “If the decline is solely due to changes in interest rates, no impairment charge needs to be made if a company asserts that it has the ability and intent to hold the security for a sufficient period of time to allow for recovery of fair value up to or beyond the cost of the investment,” Canning wrote. The value fluctuations of available-for-sale (AFS) securities are recorded as unrealized gains and losses directly in equity, in an account known as accumulated other comprehensive income (“AOCI”), he explained. “Corporates periodically sell some of these impaired securities in order to manage their businesses, and it is not uncommon for them to change their intentions regarding some AFS securities when considering ALM or hedging strategies in light of changes in the market, economy or other predictable factors,” Canning pointed out. In defining “minor impairments,” the ACCU believes the auditors and financial statement preparers will be able to apply the notion without any additional guidance from FASB. “Although, we do believe a threshold of 5% is too low based on historic trends a threshold around 10% would be more appropriate,” Canning wrote. “Security pricing can experience potential volatility over time and if the threshold is too low it may inadvertently reflect a temporary rather than a long-term change.” Canning said the selling of impaired securities “seems to be the triggering event for much of the confusion surrounding what we perceive to be a misapplication of EITF 03-1.” “Many financial institutions are being told by their auditors that the sale of impaired securities will likely lead to a determination that the entire portfolio is “tainted,” because the financial institution appears to have developed a pattern of selling securities for which it previously asserted that it intended to hold until full recovery,” Canning wrote. “We are concerned about the ambiguous meaning that is being attributed to the word “pattern” in this context.” About $1.69 trillion of securities may be subject to the rule, according to the Federal Deposit Insurance Corp. FASB will continue to take comments on the proposal. -
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