INVESTMENT SECURITIES
1A. Investments in Debt and Equity Securities
Bank Accounting Advisory Series
11
August 2018
Question 20
If the underlying mortgages that collateralize this CMO experience prepayments at a rate
significantly different from the estimated rate, how should the difference be accounted for?
Staff Response
The bank should calculate a new effective yield on the investment to reflect the actual
prepayment results and anticipated future prepayments. The net investment in the CMO should
be adjusted to the amount that would have existed had the new amortization rate (effective yield)
been applied since acquisition of the CMO. The investment should be adjusted to the new
balance with a corresponding charge or credit to the current period’s interest income. This
method is commonly referred to as the “retroactive” method. The “prospective” method, which
amortizes the adjustment into the yield over the remaining life of the security, is not
consistent
with ASC 310- 20-35-26.
INVESTMENT SECURITIES
1B. Other-Than-Temporary Impairment
Bank Accounting Advisory Series
12
August 2018
1B.
Other-Than-Temporary Impairment
Question 1
What is OTTI?
Staff Response
An investment security is impaired if the fair value is less than the amortized cost. ASC 320
requires institutions to determine whether the impairment is other-than-temporary. OTTI occurs
when the investor does not expect to recover the entire cost basis of the investment security. As a
holder of an investment in a security for which changes in fair value are not regularly recognized
in earnings (such as securities classified as AFS and HTM), the bank must determine whether to
recognize a loss in earnings when the investment is impaired.
Question 2
Does other-than-temporary mean permanent?
Staff Response
No. The staff believes that the FASB consciously chose the phrase “other-than-temporary”
because FASB did not intend that the test be “permanent impairment,” as has been used
elsewhere in the accounting literature. Specific facts and circumstances dictate whether OTTI
recognition is appropriate. Therefore, this determination should be made on a case-by-case basis.
The staff believes that “other-than-temporary” should be viewed differently than the absolute
assurance that “permanent” impairment implies. This response is consistent with
ASC 320-10-S99.
Question 3
What factors indicate that impairment may be other-than-temporary for an equity security
classified as AFS?
PBEs and non-PBEs
Under ASU 2016-01, equity securities must generally be measured at fair value, with changes
in fair value recognized through net income. Therefore, an
evaluation of OTTI is not
applicable (ASC 321-10-35-1). Certain equity securities, such as those accounted for using the
equity method, investments in consolidated subsidiaries, and FHLB and FRB stock, are
outside the scope of this guidance.
The following staff responses comply with existing GAAP guidance; to the extent that staff
interpretations differ under ASU 2016-01, these are
provided in separate
green text boxes.
INVESTMENT SECURITIES
1B. Other-Than-Temporary Impairment
Bank Accounting Advisory Series
13
August 2018
Staff Response
ASC 320-10-S99 and AICPA Statement on Auditing Standards No. 92, “Auditing Derivative
Instruments, Hedging Activities, and Investments in Debt Securities,” provide criteria that are
helpful in making the OTTI assessment. There are several factors to consider that, individually or
in combination, may indicate that an OTTI of an AFS equity security has occurred.
These factors
include the following:
•
Length of time and extent to which fair value has been less than cost.
•
Financial condition, industry environment, and near-term prospects of the issuer.
•
Downgrades of the security by rating agencies.
•
Intent and ability of the bank to hold the security for a period of time sufficient to allow for
any anticipated recovery in fair value.
PBEs and non-PBEs
Under ASU 2016-01, equity securities must generally be measured at fair value, with changes
in fair value recognized through net income. Therefore, the evaluation of OTTI is not
applicable.
If an equity security does not have a readily determinable fair value,
a bank may generally
elect to carry the equity security at cost minus impairment, if any, plus or minus observable
price changes in orderly transactions for the identical or similar investment of the same issuer.
Question 4
What factors indicate that impairment may be other-than-temporary for a debt security classified
as AFS or HTM?
Staff Response
In certain cases, the OTTI determination for a debt security will be straightforward. For example,
impairment would generally be considered other-than-temporary if the investor has the intent to
sell, it is more likely than not the investor will be required to sell before the anticipated recovery,
or the issuer of the security defaults.
Outside of these situations, management must evaluate impairment based on the
specific facts
and circumstances surrounding the security. The following are examples of factors that should be
considered for debt securities, as described in ASC 320. This list is not meant to be all inclusive.
Some factors are
•
the length of time and the extent to which the fair value has been less than the amortized cost
basis.
•
adverse conditions specifically related to the security, an industry, or a geographic area (for
example, changes in the financial condition
of the issuer of the security, or in the case of an
asset-backed debt security, in the financial condition of the underlying loan obligors).
