The FASB Financial Instruments Project

Background

The Financial Accounting Standards Board (FASB) has been working since 2009 on a project regarding the accounting for financial instruments. While dubbed "financial instruments" projects, these projects are really about bank accounting and represent the biggest overhaul of accounting principles ever.

In summary, there are three main issues:

  • Impairment: For those assets measured at amortized cost, how should the allowance for losses be measured?
  • Classification and measurement: What assets and liabilities should be measured at amortized cost (with an allowance for losses) and what should be measured at fair value?
  • Hedge accounting: for derivatives that are used in hedges, what requirements and accounting entries should there be?

Within each of these phases, footnote disclosure, as well as financial statement presentation issues, is addressed.

Impairment

See FASB Final CECL Standard issued June 2016

Classification and Measurement

The Final Standard was issued in January and effective 2018 with early adoption allowed for some aspects. In what started out as an effort to mark all financial assets and liabilities to market on the balance sheet, FASB has settled on a new standard that will have relatively little impact to bankers.  In fact, private banks will find relief.

So, what will change?

1.  All equity investments will be classified as trading securities: fair value changes now will go through net income. A practical expedient will allow non-marketable securities to be accounted for at cost with an impairment process. While the vast majority of banks will not experience a signficant impact because of this, certain banks may experience volatility in their reported net income due to this change. ABA has written the banking agencies to address this issue.

2.  “Own credit” changes for debt accounted for through the fair value option will go through other comprehensive income. This will avoid the situation, made famous by Lehman Brothers, which allows a company to record huge gains because its debt was downgraded.

3.  Public business entities (PBEs) will be required to disclose their loans at an exit price basis of fair value. The current widely-used practice of “entrance price” (essentially, the only changes of fair value occur because of changes in interest rates) will no longer be allowed.

Depending on how this gets implemented in specific practice, it may be very challenging for public community banks. Specific community-based and industry-based discounts may be very difficult to obtain. For example, a 5% loan to a pizza parlor in Austin, Texas (where the state capitol resides) will likely have different pricing than a 5% loan to a pizza parlor (or a 5% loan to an oil service company) in Odessa, Texas (where the price of oil is the primary driver for its economy).

On the happy side of this, banks that are not PBEs have been relieved of any requirement to disclose the fair value of any of their financial assets or liabilities. However, ABA understands that there is currently confusion throughout the industry on whether certain privately-held banks qualify as PBEs. Please see ABA's discussion paper on this matter.

In addition to dodging the bullet on mark to market accounting, bankers also avoided a costly disclosure on core deposits that possibly could have subjected asset-liability management systems to audit. Fortunately, FASB determined that auditable core deposit information (say, the core deposit amounts based on a regulatory definition) would not be relevant to investors and core deposit information that would be relevant to investors (say, amounts that would be net of the large macroeconomic surge balances that banks believe would leave the bank when interest rates rise, along with an expected life of the balance) would not be auditable.

Hedge Accounting

A hedge accounting proposal is expected to be issued by FASB in 2016. Upon issuance, ABA will provide an analysis.

​Questions? Please contact Mike Gullette, Vice President, Accounting and Financial Management.