The Financial Accounting Standards Board recently released a proposed accounting standards update for financial instruments concerning new financial statement disclosures of liquidity risk and interest rate risk. The proposal is one portion of a joint project between FASB and the International Accounting Standards Board on the subject of accounting for financial instruments. FASB has opened a 90-day comment period on the proposal, which expires on Sept. 25. There was no effective date listed in the proposal. The exposure draft states that the effective date will be determined after the board considers feedback on the amendments.

The proposal would require all financial institutions, including credit unions, to provide detailed disclosures about liquidity positions and interest rate sensitivities as part of the financial reporting process. Nonpublic entities would provide the disclosures on an annual basis. This article examines explains and analyzes the disclosure requirements applicable to credit unions and discusses action steps credit unions might take to prepare for implementation in 2013.

The genesis for proposing to require additional liquidity risk and interest rate risk financial statement disclosures was the May 2010 FASB issuance of proposed standards update, “Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities.” Extensive feedback received from users, preparers and auditors during the comment period indicated measurement attributes alone were insufficient when attempting to define both the “financial instrument's inherent risks and the broader risks to which an entity is exposed.” Additionally, the consensus of feedback indicated that a supplemental disclosure was necessary to communicate these risks. The stakeholders identified three important risks during the 2010 proposal comment period: credit risk, liquidity risk and interest rate risk.

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

Liquidity risk disclosures. Financial institutions must furnish an annual liquidity gap maturity analysis categorized into specified time intervals for the various classes of financial assets and liabilities based upon expected maturities of the underlying financial instruments.

The exposure draft defines expected maturity as “the expected settlement of the instrument resulting from contractual terms (for example, call dates, put dates, maturity dates and prepayment expectations).” Additionally, financial institutions would be required to disclose available liquid funds in tabular format. Unencumbered cash, highly liquid assets (such as government securities and investment-grade corporate bonds) and available borrowings, such as loan commitments, unpledged securities and lines of credit, qualify as available liquid funds. The proposal calls for depository institutions to furnish detailed information about time deposit liabilities. Cost of funding would be disclosed via a table quantifying (1) the amount of insured and uninsured time deposits issued and brokered deposits acquired during each of the last four quarters and (2) the weighted-average contractual yield and weighted-average contractual life for the deposits issued or acquired during each of the last four quarters.

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

The first table is a re-pricing gap analysis, classified according to the different classes of financial assets and financial liabilities, which shows how the respective carrying amounts re-price over specified time intervals. The analysis must also include (1) the weighted-average contractual yield for each time interval by class of financial instrument, (2) the duration for each class of financial instrument and (3) a total carrying amount column that reconciles to the amount presented in the statement of financial position and a total weighted-average contractual yield for each class of financial instrument. The proposal is silent about specifying a particular methodology when calculating duration. However, most depository institutions have significant exposure to option risk embedded within many classes of financial assets and liabilities, which makes effective duration a more precise method when preparing the re-pricing gap analysis.

The second table is an interest rate sensitivity analysis that discloses the effects on after-tax net income (for the 12-month period after the reporting date) and shareholders' equity of hypothetical, instantaneous interest rate shifts as of the measurement date. The proposal requires applying multiple interest rate scenarios, including yield curve slope changes, when producing an interest rate sensitivity table.

FASB's drive to produce uniform accounting standards for financial institutions when accounting for financial instruments appears to ignore the unique ownership and taxation aspects of natural person credit unions. The most likely users of credit union financial statements are regulatory bodies. Therefore, requiring additional liquidity risk and IRR disclosures constitutes a further regulatory compliance burden given the NCUA's pre-existing regulatory focus for 2012. The best way for credit unions to opine on the proposal is by submitting a comment letter to the FASB no later than Sept. 25. Instructions for a comment letter may be found at FASB.org.

Assuming the proposal becomes a final amendment to the accounting standards codification, the previously discussed liquidity risk and IRR disclosures must be included in credit union financial statements. The most likely scenario would require the disclosures beginning with the 2013 reporting year, given that FASB has not provided an effective date for the proposal. Be mindful that some asset/liability models may not be capable of producing the requisite yield curve scenarios or may be incapable of valuing embedded options when calculating effective duration. An ounce of preparatory prevention now may indeed be well worth a pound of cure.

Michael Gagliardi is a director at Sterne Agee and Leach.
Contact 205.414.3389 or mgagliardi@sterneagee.com

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Guest Opinion: FASB&rsquo;s Proposal on Liquidity and Rate Risk

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