Comment Letter to FASB on Portfolio Layer Method, Topic 815

Mr. Richard R. Jones
Chairman
Financial Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116

Via email

Dear Chairman Jones:

The American Bankers Association (ABA) welcomes the opportunity to comment on Proposed Accounting Standards Update— Derivatives and Hedging (Topic 815) Fair Value Hedging—Portfolio Layer Method (the Exposure Draft). The Exposure Draft seeks to expand the circumstances in which hedge accounting can be used to mitigate unnecessary volatility in reported profits and losses by allowing multiple-layer hedges on portfolios of certain assets. With this in mind, ABA supports FASB’s efforts to expand hedge accounting. Allowing multiple layer strategies will better align the accounting to the risk mitigating activities companies pursue to hedge the economic risks on these portfolios.

We have the following recommendations for your consideration:

Eliminate the “Follow the Asset Approach” for Breach Basis Adjustments

The Exposure Draft proposes that when the aggregate amount of the hedged layers within a closed portfolio exceeds the total amount of the related portfolio, a “breach” has occurred and the entity is then required to immediately adjust the cost basis of the specific assets that caused the breach, with the corresponding entry recognized within current period earnings (“breach basis adjustment”). The Exposure Draft proposes the classification of the breach basis adjustment within the income statement be based on the nature of the activity that caused the breach; for example, if the breach was caused by prepayment activity, the breach basis adjustment would be recorded within interest income; if the breach was caused by credit deterioration, the presentation would follow applicable impairment guidance. Question 6 in the Exposure Draft refers to this as the “Follow the Asset” method.

ABA requests the Follow the Asset method be excluded from any final guidance. If a breach occurs, the Follow the Asset method will require costly system enhancements to perform detailed transactional review for each of the assets in the closed pool to determine the specific transactions that actually caused the breach. While the Follow the Asset method strives to precisely classify each breach, in practice, the income statement classification will likely seem arbitrary and not meaningful nor comparative to financial statement users. For example, merely due to the order of their loan system processing of payment and credit loss activity, banks with the exact same portfolio layer hedges and transactions may report entirely different income statement classification. Additionally, even within a particular bank, the timing of processing payment and credit loss activity would result in arbitrary classification.

Having said that, entities are required to periodically update their analysis supporting their expectation of the aggregate outstanding amount of all hedged layers for the period hedged. If hedged layers are expected to exceed the amount of the closed portfolio, the entity is required to partially or wholly dedesignate the hedged layer or layers until a breach is no longer expected. These requirements will significantly limit the occurrence of an actual breach and if a breach does occur, the breach basis adjustments will likely be insignificant. The significant costs required to apply the Follow the Asset method will not exceed the expected benefits of detailed classification.

In lieu of requiring the Follow the Asset method, ABA recommends that breach basis adjustments be classified within a single line item within the income statement. Entities should be allowed to make a policy election regarding where breach basis adjustments are classified within the income statement and if amounts are material, require disclosure of the income statement classification. If the Board prefers to not allow a policy election, it could align the treatment to the single line item classification guidance for fair value hedges found within Accounting Standards Codification (ASC) topic 815-20-45-1A that would have the amounts in earnings in the same income statement line item that is used to present the earnings effect of the hedged item.

Provide Clarification on Documentation Requirements to Align with Operational Execution of a Layered Hedge.

ASC 815-20-25-3 outlines the formal documentation requirements to designate a hedge. The Exposure Draft updates paragraph 815-20-25-3.C.2 to allow for “one or more interest rate risk hedging relationships designated under the portfolio layer method.” In practice, designation of the various layers may occur over a period of time. A strict read of the documentation requirement would suggest that as each layer is added, updated hedge documentation would then be required. ABA believes this to be operationally burdensome. FASB should consider clarification that will allow for streamlined documentation of the hedge to align with the operational execution of a multiple layers. Following is example wording to clarify paragraph 815-20-25-3.C.2:

“For one or more interest rate risk hedging relationships designated under the portfolio layer method during the reporting period, an analysis to support the entity’s expectation that the hedged layer is anticipated to be outstanding for the period hedged.”

Add a Project to the Technical Agenda to Expand the Scope of the Portfolio Layer Method to Other Types of Financial Instruments

ABA believes that the portfolio layer method will significantly expand the use of hedge accounting, thus allowing financial institutions and other companies to better present the impact of their risk mitigation activities. To expedite this specific project, the Board limited the scope of the Exposure Draft to prepayable assets. ABA requests, therefore, when this narrow scope project is complete, that the Board add a future project to the technical agenda to expand the scope of the portfolio layer method to include both prepayable liabilities and non-prepayable financial assets. We believe such financial instruments face the same issues as prepayable assets and should, therefore, be easily integrated into this guidance.

Allow Early Adoption

Many ABA members have indicated that they would be able to quickly implement the new standard and that it will better align risk management activities to hedge accounting. ABA, therefore, requests that early adoption of the final standard be allowed. The Basis for Conclusions indicates the Board will be considering early adoption and ABA encourages the Board to allow it.

Thank you for considering our comments. If you need additional information or have questions, please contact me ([email protected]; 202-663-5318).

Sincerely,
Joshua Stein