If your credit union maintains investments in any type of mutual fund, exchange-traded fund or stock, then you'll want to seriously reconsider those investments. If your credit union is currently contemplating investing in these types of securities, then you'll want to pause and reevaluate.

The Financial Accounting Standards Board issued new accounting guidance on Jan. 5, 2016 (ASU 2016-01) that eliminates the available for sale classification for equity securities.

The new standard requires all entities to record equity securities at fair value through net income. In other words, price changes of equity securities can no longer be recorded as unrealized gains or losses in other comprehensive income. Price changes must instead be recorded directly in net income.

Here's the kicker. An equity security as defined by the FASB is “any security that represents an ownership interest in an entity.” This means stocks, all types of mutual funds, ETFs, trusts and limited partnerships. There is also no look-through provision, which means that “a mutual fund that is invested 100% in government securities is an equity security” per the FASB.

Equity securities such as mutual funds, ETFs and stocks 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 benefit pre-funding programs, charitable donation accounts and executive benefit plans. Now that these securities can no longer be classified as available for sale, credit unions that own these investments will experience unacceptable levels of earnings volatility on their income statements.

To put the magnitude of the problem caused by ASU 2016-01 into perspective, consider for a moment that under the new standard, a hypothetical $10 million portfolio that allocated 75% to the Barclays Aggregate Bond Index and 25% to the S&P 500 Index would have generated negative income of roughly $190,000 in January as of Jan. 21. This is not a good number.

Research conducted at my firm covering the period of 2007 through 2015 indicated income under the new standard for the above mentioned hypothetical $10 million portfolio was nothing short of unpredictable and erratic during those years, with wild monthly swings in either direction along with many months of brutishly negative income. The results of 2008 were simply disastrous with negative income of almost $2 million. In my 14 years working with credit unions, I have yet to meet any credit union stakeholder who was excited about earnings volatility of any kind, let alone at these levels.

The effective date of the new standard for private business entities, i.e. credit unions, is Dec. 15, 2018. Understanding the effective date of the standard is important to the extent that credit unions will likely choose to divest certain investments prior to the effective date in favor of other investment options.

Credit unions will need guidance transitioning portfolios and to understand the ramifications of carrying unrealized gains or losses in other comprehensive income on the effective date.

In making these decisions, credit unions will want to make certain they are working with a bona fide institutional advisor to ensure they are receiving best-in-class support, and that their portfolios are being optimally positioned leading up to the Dec. 15, 2018 effective date and beyond.

Credit unions should be mindful not to get lulled into thinking that the only solution is to sell all of their equity securities (such as mutual funds and ETFs) and buy a different “product.” Yet, this may be the most common form of advice given.

It is important for credit unions to understand that in spite of the challenges posed by ASU 2016-01, transparent institutional investment solutions exist that provide consistent, reliable and predictable income, allowing credit unions to carry on with successful strategies to help pre-fund employee benefit expenses, establish charitable donation accounts and implement executive benefit plans.

Above all, any investment program a credit union implements should be flexible enough to adapt to what is clearly an ever changing regulatory landscape. Between RBC2, CECL and a bevy of other changes on the horizon, credit unions should be invested in adaptable strategies that are void of the “gotchas” associated with so many investment products.

Matthew Butler is founder and managing principal of Elite Capital Management Group, LLC. He can be reached at 203-699-9662 or matthew.butler@elitecapgroup.com.

Instant Insights /

Gearing Up for the New FASB Standard

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