New and Proposed GAAP Guidance -...

5/9/2014

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Accounting for Changes that Impact You

New and Proposed GAAP Guidance

Laura Conroy, Vice President & Controller

Kim Brunner, Assistant Controller & Director - Financial and Management Reporting

Abby Wegner, Director of Financial Reporting

May 14, 2014

• Finalized Generally Accepted Accounting Principles– No new guidance of significance to Farm Credit since 2011

• Impending Generally Accepted Accounting Principles– No guidance recently issued and pending implementation

• Proposed Guidance– Receivables – Troubled Debt Restructurings by Creditors – Classification of

Certain Government-Guaranteed Residential Mortgage Loans upon Foreclosure

– Accounting for Financial Instruments – Classification and Measurement

– Accounting for Financial Instruments – Credit Impairment

• New Proposals on the Horizon– Leases – no projected date for proposal

DISTRIBUTION: AGRIBANK DISTRICT

Overview of GAAP Updates

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• Residential mortgage loans may be made to borrowers with a100% government guarantee if the borrower defaults– Federal Housing Administration (FHA)

– Veterans Administration (VA) (not cited in proposed ASU)

– Federal Agricultural Mortgage Corporation (Farmer Mac) (not cited in proposed ASU)

– U.S. Department of Agriculture (USDA) (not cited in proposed ASU)

• Issue Cited:– Current GAAP does not provide guidance specific to the classification or the

measurement of foreclosed loans that are government guaranteed

• Application Diversity:– Reclassify the loans to real estate as with other foreclosed loans that do not

have guarantees

– Reclassify the loans to ‘Other Receivables’


Receivables – Troubled Debt Restructurings by CreditorsPROPOSED Classification of Certain Government-Guaranteed Residential Mortgage Loans upon Foreclosure

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• Primary Provisions:– Residential mortgage loan is derecognized and a separate ‘Other Receivable’

recognized upon foreclosure if the loan meets both of the criteria:• The government guarantee is not separable from the loan before foreclosure

entitling the creditor to the full unpaid principal balance of the loan

• At the time of foreclosure, the creditor has the intent to make a claim on theguarantee and the ability to recover the full unpaid principal balance of the loanvia the guarantee

– The ‘Other Receivable’ would be measured based on the current amount ofthe loan balance expected to be recovered under the guarantee

• Implementation Alternatives:– Modified retrospective (balance sheet reclassification to the beginning of

the annual reporting period)

– Prospective for all foreclosures on government-guaranteed residentialmortgage loans after the effective date (effective date is TBD)

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AgriBank District 100% Government GuaranteesAs of March 31, 2014

(In Millions)

• Unconditional Government Guarantees (GI – ‘8’); typically, loans acquired underMission Related Investment authority

• Proposed guidance has the highest potential to impact unconditionalguaranteed loans; however, demand is typically made with the originating bankand will not go to foreclosure

-

100

200

300

400

500

Federal AgriculturalMortgage Corporation

(Farmer Mac)

UnconditionalGovernment Guarantees

(FSA / SBA / USDA)

Other ConditionalGovernment Guarantees

(USDA)



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Farmer Mac

FHA

FSA USDA

• Guarantee never pays until conclusion (sale of foreclosed property)• Typically limited to a 90% Guarantee, although the Guaranteed

Portion can be purchased in the secondary market• District Associations may hold 100% of the guaranteed portion of the

loan which would qualify for the proposed guidance

• “Long Term Standby Purchase Commitment” - guarantee goes intoeffect 90 days past due – loan 100% guaranteed would never go intoforeclosed property

• Insured loan – may be serviced through conclusion (sale of foreclosedproperty); very limited exposure in the AgriBank District

SBA USDA

• Guarantee never pays until conclusion (sale of foreclosed property)• Typically limited to an 80% Guarantee, although the Guaranteed

Portion can be purchased in the secondary market• District Associations may hold 100% of the guaranteed portion of the

loan which would qualify for the proposed guidance

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• Preliminary Comment Letter Reactions:– The scope of the proposal is too limited

• FHA guarantees loans are broader than ‘residential mortgage’ propertiesincluding multifamily mortgages as well as hospitals, nursing homes, assistedliving facilities, and board/care facilities

• Other government guaranteed assets exist through the VA and USDA

– General consensus on the proposed classification as ‘Other Receivable’

– Some concern about ‘intent’ criterion and limited guidance if intent changes

– General consensus on implementation options

AgriBank Observation: Government guarantees not specifically mentioned in the proposedguidance may have a larger impact on Farm Credit Institutions, especially related to Mission

Related Investments classified as loans for GAAP purposes

– Loans accounted for as Held-to-Maturity or Held-for-Sale

– Debt/Equity Investments accounted for as Held-to Maturity,Available-for-Sale, or Trading

– While there has been deliberation and proposals to combinethe guidance for loans and investments, at the March 12, 2014meeting the FASB decided to retain the separate models inexisting U.S. GAAP for determining classification of loans andsecurities

DISTRIBUTION: AGRIBANK DISTRICT 8

• Accounting Guidance Today

Accounting for Financial InstrumentsPROPOSED Classification and Measurement

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– FASB and IASB Convergence – joint projects

– 2010 proposal focused on full fair value measurement for allfinancial instruments and received a significant amount ofconcerns from respondents


• Issues Cited:


– All debt investments/loans will be measured using either:• Fair Value through OCI

• Fair Value through Net Income

• Amortized Cost

– All financial liabilities will be measured using either:• Amortized Cost

• Fair Value


• Primary Provisions of 2013 Proposal


AgriBank Observations:Leases and financial guarantees are currently out-of-scope for this project/proposal

For debt investments/loans that are initially measured at transaction price, certain loan originationfees, net of direct loan origination costs, are deferred and accounted for as a yield adjustment overthe life of the related financial asset in accordance with ASC 310-20, Receivables, Non refundablefees and costs – ie: no change to ‘FAS 91’

For financial assets and financial liabilities that are subsequently measured at fair value through netincome, transaction fees and costs will not be deferred and will be recognized in net income atinception of the transaction

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– Debt investments (loans and debt securities) would be evaluated using acash flow characteristics test and consideration of the business model inwhich the instrument is managed

• Instruments that pass the cash flow characteristics test are classifiedand measured at amortized cost or fair value with changes in fair valuerecognized in other comprehensive income based on the businessmodel assessment

• Fair value with changes in fair value recognized in net income is theresidual category


• Primary Provisions (CONTINUED)


AgriBank Observation: If a company does not hold an asset with the sole intention of selling it, thecompany will need to perform the cash flow characteristics assessment to determine if the asset is

eligible for measurement at amortized cost or fair value through other comprehensive income

– Business Model Criterion

• Amortized Cost: consists of debt investments for which the primaryobjective is to hold the assets to collect the contractual cash flows

• Fair Value through OCI: consists of debt investments for which theprimary objective is to hold the assets to collect contractual cash flowsand realize changes in fair value through sale

• Fair Value through Net Income: consists of all other debt investmentsand will include debt investments that do not meet the cash flowcharacteristics criterion and those that are held for sale




AgriBank Observation: The exposure draft states that when an entity does not know if it will hold orsell a debt investment, the investment will be measured at fair value through other comprehensive

income

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– Amortized Cost Assessment & Clarification

• Sales due to significant asset credit deterioration = Amortized Cost

• Sales to manage credit risk ĐŽŶĐĞŶƚƌĂƟŽŶ�т��ŵŽƌƟǌĞĚ��ŽƐƚ

• Sales close to maturity of asset = Amortized Cost

• Sales required by regulation for whole industry = Amortized Cost

• Sales required by regulation for entity ≠ Amortized Cost




AgriBank Observations:At inception debt investments/loans may be held with the intention of collecting the contractualcash flows. However, as a company's overall credit profile or risk appetite changes, it may decide tosell a portion of those investments. Prohibiting sales that are meant to manage credit riskconcentrations may constrain sound business and risk management practices.

Unlike under current GAAP, the proposed model does not contain a tainting concept. It does,however, provide guidance on the types of sales that will be consistent with the amortized costcategory and requires disclosure when these assets are sold. Sales that occur more often than veryinfrequently and are not due to a significant credit deterioration would not taint the existingportfolio's amortized cost classification, but could still call into question the accuracy of the initialclassification and future classification for similar instruments.

– Equity investments that are not accounted for under the equity methodwould be measured at fair value through net income

– Financial liabilities will generally be measured at amortizedcost; however, financial liabilities that can only be settled withcash flows from specified financial assets would be measuredon the same basis as the specified financial assets

– Numerous proposed presentation and disclosure requirementsfor all financial instruments




AgriBank Observation: Although an exception was provided in the 2013 Proposal, recent re-deliberations indicate equity investments will also be measured at fair value through net

income

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– Current practice of participations may need to be reviewed todetermine if accounting for the assets as amortized cost iscompliant with the guidance as proposed

– The final guidance is currently anticipated for the second half of2014; implementation prior to 2016 seems unlikely


• Proposed Guidance Impact to Farm Credit


AgriBank Observation: This will likely be an issue for institutions outside of Farm Credit – AgriBank is

monitoring Comment Letters for consistent themes regarding this concern; however, few comment letterswith substance have been submitted

– The business model criteria do not take into account the business activitiesof financial institutions

• Paragraph 825-10-55-31 states that “sales of financial assets that resultfrom managing the credit exposure because of concentrations of creditrisk would not be consistent with the objective of amortized costclassification” puts into question normal practices of financialinstitutions, including FCS institutions

• Financial institutions manage credit concentrations through loanparticipations, syndications and assignments as these regulatedinstitutions are required to comply with regulatory lending limits

• Even though financial institutions may sell loan participations to others,they generally hold the remainder of the loan for the collection ofcontractual principal and interest


• Farm Credit Comment Letter


AgriBank Observation: This would likely inhibit amortized cost accounting for a large portion of the Farm

Credit loan portfolio requiring the loans be accounted for at fair value through OCI

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– Significant concern raised regarding the complexity in applyingthe cash flow characteristics test

– Similar to Farm Credit, clarification guidance was requested forapplying the cash flow characteristics test for specific financialinstruments, including loan participation and syndicationarrangements

– Strong support by users of financial statements forparenthetical disclosure of fair value for items measured atamortized cost on the face of the balance sheet

• However, preparers and other stakeholders strongly opposed thispresentation


• Other Comment Letter Reactions


• Current Expected Credit Loss (CECL) model for assets measured at amortizedcost

• Assets measured at fair value with changes recognized in OCI, expected creditlosses should be recognized as follows:– No credit loss recognition if the fair value is equal to or greater than the amortized cost basis

– If the fair value is less than amortized cost, the expected credit losses limited to the differencebetween the financial asset’s fair value and its amortized cost should be recognized in netincome

• Objective: Reflect the estimate of the amount of contractual cash flows notexpected to be collected

• Scope:– Loans– Debt securities (Investments)– Trade receivables– Lease receivables– Loan commitments


Accounting for Financial InstrumentsPROPOSED Credit Impairment

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• Requires an entity to recognize an allowance for ALL expectedcredit losses on debt instruments on Day 1

• No threshold or “trigger” required to recognize losses

• Expected credit losses are “an estimate of all contractual cashflows not expected to be collected from a recognized financialasset (or group of financial assets) or commitment to extendcredit”



• Expanding on ‘Expected Credit Losses’:– Consider all contractual cash flows over the life of the related financial

assets including expected prepayments

– Unless there is a reasonable expectation a troubled debt restructuring willbe executed, the following scenarios should not be considered in estimatingexpected credit losses:

• Extensions

• Renewals

• Modifications

– Even when remote, risk of loss must be considered



AgriBank Observation: Although risk of nonpayment is greater than zero, this does not necessitate a

recognition of loss

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• Expanding on ‘Expected Credit Losses’:– An estimate of credit losses may be made using loss rate methods, default

probabilities or a provision matrix using loss factors

– For periods beyond which an entity is able to make or obtain reasonableand supportable forecasts, historical average loss experience may be usedfor the remaining life of the asset



AgriBank Observation: The FASB has yet to provide clarifying guidance as to the appropriate average loss

period or define a reasonable supportable forecast. The final pronouncement is expected to containimplementation guidance covering these topics.

AgriBank Observation: This does not preclude an entity from using a discounted cash flow model to

estimate credit losses, but the method may be used in addition to a cash flow model analysis

• Proposed Guidance Impact to Farm Credit

– A longer-term loss model may impact regulatory capitalrequirements and various key financial metrics

– The final guidance is currently anticipated for the second half of2014; implementation prior to 2016 seems unlikely



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• Farm Credit Comment Letter– Applying the proposed methodology could be complex and result in

additional disclosures for items already disclosed in other areas ofShareholder Reports

• The impact on assessing an allowance for loan commitments could be verydifficult to manage as FIN 45 is a very manual process today

• Accounting and disclosures associated with investments would be timeconsuming to move to this type of analysis versus our current OTTI analysis

• Expanded disclosures for investments including by rating (credit quality),rollforwards, reconciliation of FV and amortized cost, past due securities, andnonaccrual (if any). (Rollforward components are already included in Statementof Cash Flows)

• Calculation of Day 1 loss for amortized cost investment securities and loans

• Operational concerns if we would be expected to do a DCF analysis on a loan-by-loan basis – how much can collateral be considered in the analysis?

• Does a one-size-fits-all approach reflect the economics of the different assets?

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AgriBank Observation: Significant complexity and modification to current processes as well as potential

for a much higher allowance which would have a direct impact on capital ratios

– Positions varied greatly between investors/users and preparers• Investors/users preferred the proposed model of all expected credit

losses

• Preparers preferred the current model of some credit losses.

– Financial institutions and some investors raised concern on impact ofregulatory capital ratios

– Concern of failure to match the cost of credit loss expense with thetiming recognition of compensation for expected credit losses (in theform of interest income)

– Forecasts beyond two years could result in unreliable (potentiallycookie jar) estimates and volatile revisions


• Other Comment Letter Reactions


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• Potential for significant impacts to accounting for Farm CreditInstitutions on the horizon– Impact to primary assets on balance sheet

– Impact to key assumptions and methodology

• AgriBank Financial Reporting Service– Representatives maintain knowledge of new guidance and status of

proposed guidance

– Representatives participate in System Accounting Standards Work Group

– As necessary, further communication on updates

• Controller News

• Webcasts

• Changes to Shareholder Report Model


Summary of GAAP Updates

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For questions or comments, please contact:Your Financial Reporting Analyst

Abby Wegner at [email protected] or 651-282-8732Kim Brunner at [email protected] or 651-282-8874

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