INVESTMENT SECURITIES
1B. Other-Than-Temporary Impairment
Bank Accounting Advisory Series
14
August 2018
•
the historical and implied volatility of the fair value of the security.
•
the payment structure of the debt security (for example, nontraditional loan terms) and the
likelihood of the issuer being able to make payments that increase in the future.
•
failure of the issuer of the security to make scheduled interest or principal payments.
•
any changes to the rating of the security by a rating agency.
•
recoveries or additional declines in fair value subsequent to the balance sheet date.
Question 5
What additional expectations exist for bank management in the assessment and documentation of
OTTI for debt securities?
Staff Response
Banks should consider the following when evaluating and documenting whether impairment of
debt securities is other-than-temporary:
•
Banks should apply a systematic methodology for identifying and evaluating fair value
declines below cost that includes the documentation of all factors considered.
•
Once a debt security is in an unrealized loss position, banks must consider all available
evidence relating to the realizable value of the security and assess whether the decline in
value is other-than-temporary.
•
The longer the debt security has been impaired and the greater the decline in value, the more
robust the documentation should be to support a conclusion of only temporary impairment
and not OTTI.
•
Banks should not infer that debt securities with declines of less than one year are not other-
than-temporarily impaired or that declines of greater than one year are automatically other-
than-temporarily impaired. An other-than-temporary decline could occur within a very short
time, or a decline in excess of a year might still be temporary.
•
A market price recovery that cannot reasonably be expected to occur within an acceptable
forecast period should not be included in the assessment of recoverability.
Question 6
May impairment of a debt security be deemed other-than-temporary even if the bank has not
made a decision to sell the debt security?
Staff Response
Yes. ASC 320-10-35-33 states that an investor should recognize an impairment loss when the
impairment is deemed other-than-temporary even if a decision to sell the debt security has not
been made.
INVESTMENT SECURITIES
1B. Other-Than-Temporary Impairment
Bank Accounting Advisory Series
15
August 2018
Facts
A bank holds an AFS equity security whose fair value is less than amortized cost. Bank
management has determined, based on facts and circumstances, that the decline in fair value is
other-than-temporary.
Question 7
How should the bank record OTTI for the equity security?
Staff Response
The bank recognizes a loss in earnings equal to the entire difference between the security’s cost
basis and its fair value at the balance sheet date. The fair value of the equity security becomes the
new amortized cost basis, and net income is not adjusted for subsequent recoveries in fair value
of the instrument.
PBEs and non-PBEs
Under ASU 2016-01, equity securities will no longer be classified as either trading or
available-for-sale. Equity securities must be measured at fair value, with changes in fair value
recognized through net income. Therefore, an evaluation of OTTI is not applicable.
Facts
Using the same facts as for question 7, assume the asset is a debt security rather than an
equity security.
Question 8
How should the bank record OTTI for the debt security?
Staff Response
It depends. If the bank intends to sell the debt security or if it is more likely than not the bank
will be required to sell the debt security before recovery of its amortized cost basis, the bank
should recognize a loss in earnings for the entire difference between the debt security’s
amortized cost basis and its fair value at the balance sheet date.
If the bank does not intend to sell the debt security and it is not likely that the bank will be
required to sell the debt security before recovery of its amortized cost basis, the bank shall
separate the decline in value into the following two components:
•
The amount representing the credit loss (also referred to as the credit component).
•
The amount related to all other factors (also referred to as the noncredit component).
INVESTMENT SECURITIES
1B. Other-Than-Temporary Impairment
Bank Accounting Advisory Series
16
August 2018
The amount of OTTI related to the credit component shall be recognized in earnings. The
amount of the OTTI related to the noncredit component shall be recognized in AOCI, net of
applicable taxes.
The previous amortized cost basis less the OTTI impairment recognized in earnings shall
become the new amortized cost basis of the investment. Subsequent recoveries in fair value of
the debt security will not be immediately reflected in net income. The amortized cost basis of the
impaired debt security, however, will be adjusted for accretion and amortization as described in
question 15 included in this topic.
Question 9
How should a bank calculate the credit component of the OTTI for a debt security?
Staff Response
ASC 320-10-35-33D states that one way to estimate the credit component of the OTTI would be
to consider the impairment methodology described in ASC 310-10-35. In general,
ASC 310-10-35 measures impairment as the excess of the asset’s recorded balance over the
present value of expected future cash flows discounted at the asset’s effective interest rate. Other
methodologies may be used if they represent reasonable measurements of credit impairment.
Facts
ASC 325-40 does not apply to beneficial interests in securitized financial assets that have
both of the following characteristics: (1) are of high credit quality and (2) cannot be contractually
prepaid or settled so that the investor does not recover substantially all of the recorded
investment.
Question 10
What is meant by securitized financial assets that are of “high credit quality”?
Staff Response
ASC 325-40 provides examples of the securities that are of “high credit quality,” such as
securities that are guaranteed by the U.S. government, its agencies, or other creditworthy
guarantors, and loans or securities that are collateralized to ensure that the possibility of credit
loss is remote. As such, it appears the standard intended assets to be deemed of “high quality”
only when the likelihood of loss was remote. The SEC staff has interpreted securities of “high
credit quality” to be those rated AA or above.
Question 11
Is there a different OTTI measurement for beneficial interests in securitized financial assets that
meet the scope of ASC 325-40 and thus are “not of high credit quality” and can be contractually
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