GASB No. 53 – Accounting For
Derivative Instruments
FGFOA Conference, Orlando FL,
Mark A. White, CPA, Partner, Purvis
Gray & Company LLP
Jim Towne, Senior VP, DerivActiv
Precision
Experience
Assurance
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Statement 53
Accounting and
Financial Reporting
for Derivative
Instruments
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Attribution and Acknowledgment
We would like to acknowledge and thank both
David Bean of GASB and Stephen Gauthier of
GFOA for sharing some of their presentation
materials on this subject with us. Much of the
material contained in this presentation comes
from information that they have provided, we
hope to do it some justice!
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What Will We Talk About Today?
There are many different types of derivatives that
exist in the markets today
Impossible to cover all possibilities today
Will cover basics of the statement
Will go into more detail on Interest Swaps
Interest Rate Swaps are the most common
derivative used by local governments and are a
major piece of the statement
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Prior Guidance
Supersedes Technical Bulletin No. 2003-1,
Disclosure Requirements for Derivatives Not
Reported at Fair Value on SONA
Amends Statement No. 7, Advance Refundings
Resulting in Defeasance of Debt, paragraph 11
Amends Statement No, 23, Accounting and
Financial Reporting for Refundings of Debt
Reported by Proprietary Activities
Various other less used areas
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One Page Summary of No. 53
Derivatives generally fit into two general
categories;
Hedging derivative if effectiveness test is met
Record at FMV and defer the gain or loss
Investment derivative if effectiveness test is not met
Record at FMV and recognize investment gain or loss
 OUCH!!
Thus most of the statement deals with meeting
hedge effectiveness—the prize!
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What is a Derivative Instrument for
Financial Reporting Purposes?
 A financial instrument or contract that has all of the
following characteristics:










Precision
One or more reference rates (underlying) and one or more
notional amounts or payment provisions
LIBOR, SIFMA
Currency or other units specified in the derivative
Currency units, shares, pounds, MMBTUs
Leverage
Little or no initial cash investment
Net settlement
Terms require or permit settlement net
Not required to take delivery of commodity
Can be settled with another derivative (swaption)
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How Does a Derivative Differ From a
Traditional Financial Instrument?
Investment instruments—generally do not
meet the second characteristic (initial
investment is not leveraged)
Debt instruments—generally do not meet the
third characteristic (not net settled)
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Excluded Instruments
Normal purchases and normal sales contracts
Commodity—for example, gas or electricity used
in an activity
Government intends to and has practice of taking
delivery or selling the commodity
Quantity is consistent with volume used
Traditional insurance contracts
Non exchange-traded climate contracts,
liquidated damages, etc.
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Hedging Derivative Instruments
The derivative instrument is associated with a
hedgeable item
Consistency of notional amounts
Derivative instrument will be reported in same fund as
hedgable item
Term or time period consistency
The hedging derivative is effective in significantly
reducing the identified financial risk using No. 53
methods
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Common Derivative Instruments
Interest Rate Swaps
Futures contracts--NYMEX
Options—exchange-traded and others
Swaptions
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Features of Futures Contracts
Exchange-traded-NYMEX, etc.
Standard terms—notional amount, reference
rate/underlying, settlement dates
At the market
Entered into a no cost; however, accounts are
adjusted daily
Margin—collateral is required
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Terminating Events
Hedge accounting to cease upon terminating
event;
Hedging derivative is no longer effective by
applying No. 53 criteria
Hedging derivative is terminated
Bond refunding (interest rate swap)
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Terminating Events
Balance in deferral account should be reported in
flow of resources statement within investment
revenue - no more hedge accounting
If refunding or advance refunding of hedged debt,
the balance in the deferral account is considered
carrying value of old debt for gain or loss on
refunding
If debt is remarketed—no gain/loss deferral must
go to investment gain/loss
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How To Implement
Two ways to calculate effectiveness;
End of first year of adoption (FYE 9/30/10)
Life to date of derivative through end of first year
of adoption (5/14/04 through 9/30/10)
Must have information available from inception
Annual test, can use any of the approved methods
If you test as of 9/30/10 and are deemed
effective; employ hedge accounting
Record derivative at FMV and defer the gain loss
at 9/30/10 values
Re-test annually
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How To Implement
 If 9/30/10 effectiveness fails;
 Test effectiveness as of 9/30/09, if effective;
 Record at FMV and defer gain/loss as of 9/30/09
 Bring deferred gain/loss into Investment Income in 2010
 Test effectiveness as of 9/30/09, if ineffective;
 Record at FMV and restate equity as of 9/30/09
 Current year change in FMV—investment gain/loss
 What about retesting next year if ineffective this year?
 Too bad forever, unless terms of instrument substantially modified
 Record at fund level or entity wide?
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Practical Considerations
If Interest Rate Swap effectiveness fails;
DSC coverage problems in utility funds?
Pledge of NET Revenues
Resolution definitions
Technical default
Additional bonds test
FAS 71 bail out?
Would not be a problem for governmental debt where
gross revenues are pledged and Swap not recorded at
fund level
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Methods of Evaluating Effectiveness
Consistent Critical Terms
Notional amount same as principal amount
Issued at FMV of zero
Formula for net settlements don’t change over the
term of the instrument
Same reference rates
Both or neither can have cap or floor
Same time interval of reference rate
Same maturity dates
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Methods of Evaluating Effectiveness
Synthetic Instrument Method
Didn’t pass the CCT test, must now measure how
much difference there is
Test of if the variable cash flows substantially offset, -the synthetic fixed rate is substantially fixed
Does the difference in variable cash flows move the
fixed rate more than 10%?
No—Effective
Yes– Ineffective
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Methods of Evaluating Effectiveness
Dollar Offset Method
Compares the changes in expected cash flows or fair
values of the hedging derivative to the same for the
hedgable item
Can be applied YTD or LTD
Has to fall within 80 to 125% in absolute terms
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Methods of Evaluating Effectiveness
Regression Analysis
Other quantitative methods
These methods are too detailed to go into today,
they are in the statement and implementation
guide and Jim Towne can answer any question
you might have on them after the presentation
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Components of an Interest Swap
Time: Beginning and end
Reference rate
Notional amount
Payment frequency
Receive variable and pay fixed to counterparty
Receive fixed and pay variable to counterparty
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Swap-Cash Flow Hedge
Fixed payment 5.0%
State or local
government
Swap counterparty
Variable-rate
coupon
payments; SIFMA
Variable payment received: 67% of 1month LIBOR
Variable-rate
bond holders
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Consistent Critical Terms Method
Fail Due to Benchmark
Interest Rate Contract
Variable Rate Demand Bonds
Swap Value at Inception
0
Swap Fixed Leg
Fixed for Life of Swap
Notional Amount
$
10,000,000
Bond Principal
(no amortization)
Termination Date
12/1/2030
Variable Index
70% of 1 Month LIBOR
Frequency of Reset
Weekly
Swap Payment Dates
Precision
1st Bus. Day of ea. Mo.
Experience
$
10,000,000
(no amortization)
Maturity Date
12/1/2030
Bechmark Interest Rate
SIFMA
Frequency of Reset
Wekly
Bond Coupon Payment Dates
1st Bus. Day of ea. Mo.
Assurance
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Consistent Critical Terms Method
Pass
Interest Rate Contract
Variable Rate Demand Bonds
Swap Value at Inception
0
Swap Fixed Leg
Fixed for Life of Swap
Notional Amount
$
10,000,000
Bond Principal
(no amortization)
Termination Date
12/1/2030
Variable Index
SIFMA
Frequency of Reset
Weekly
Swap Payment Dates
Precision
1st Bus. Day of ea. Mo.
Experience
$
10,000,000
(no amortization)
Maturity Date
12/1/2030
Bechmark Interest Rate
SIFMA
Frequency of Reset
Wekly
Bond Coupon Payment Dates
1st Bus. Day of ea. Mo.
Assurance
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Synthetic Instrument Method
(Cash Flow Hedges Only-No Hybrids
of Fair Value Hedges)
Swap Notional Amount
$ 10,000,000
Swap Fixed Rate
Pay Fixed - Receive Variable From Counterparty
4%
SWAP Index
70% 1 Mo. LIBOR
FYE
9/30/2010
Fixed Swap
Variable Swap
Net
Variable
Pmnt. To
Receipt From
Derivative
Bond
Total
Synthetic
Counterparty
Counterparty
(Pmnt) Receipt
Interest
Payments
Rate
$ (400,000)
$
100,000
$
(300,000)
$ (95,000)
$
(395,000)
3.95%
Analysis of Synthetic Instrument Test
Synthetic Rate
3.95%
Swap Fixed Rate
4.00%
Percentage Ratio
98.75%
Is Ratio Between 90% and 111%?
Precision
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Pass
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Synthetic Instrument Method
(Cash Flow Hedges Only-No Hybrids
of Fair Value Hedges)
Swap Notional Amount
$
10,000,000
Swap Fixed Rate
4%
SWAP Index
70% 1 Mo. LIBOR
FYE
9/30/2010
Pay Fixed - Receive Variable From Counterparty
$
Fixed Swap
Variable Swap
Net
Variable
Pmnt. To
Receipt From
Derivative
Bond
Total
Synthetic
Counterparty
Counterparty
(Pmnt) Receipt
Interest
Payments
Rate
(400,000)
$
45,000
$
(355,000)
$
(95,000)
$
(450,000)
4.50%
Analysis of Synthetic Instrument Test
Synthetic Rate
4.50%
Swap Fixed Rate
4.00%
Percentage Ratio
112.50%
Is Ratio Between 90% and 111%?
Precision
Experience
Fail
Assurance
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Dollar Offset Method
FYE
FYE
Change In
9/30/2009
9/30/2010
FMV
Fair Value of Derivative
$ (1,000,524)
$(1,254,755)
$ (254,231)
Fair Value of Item Being Hedged
$
$(1,044,589)
$ (242,144)
Dollar Offset
104.992%
Does Dollar Offset Fall Within the 80% to 125% Band?
Precision
(802,445)
Experience
Pass
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Dollar Offset Method
FYE
FYE
Change In
9/30/2009
9/30/2010
FMV
Fair Value of Derivative
$ (1,000,524)
$(1,254,755)
$
(254,231)
Fair Value of Item Being Hedged
$ (802,445)
$ (955,447)
$
(153,002)
Dollar Offset
166.162%
Does Dollar Offset Fall Within the 80% to 125% Band?
Precision
Experience
Fail
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Disclosures
 Summary Information;
 Segregate between Hedging and Investment Derivatives
 Within each category, present by type
 Notional amounts
 FMV and change in FMV
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Disclosures
Hedging Derivatives;
Objectives
Terms-notional amounts, reference rates, maturities
Risks-credit risk, interest risk, basis risk, termination
risk, rollover risk, market access risk, foreign currency
risk,
Investment Derivatives
Risks above
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GASB No. 53 – Accounting For
Derivative Instruments
FGFOA Conference, Orlando FL,
Mark A. White, CPA, Partner Purvis Gray &
Company LLP,
888-378-2463
Jim Towne, Senior VP, DerivActiv,
952-746-6049
Precision
Experience
Assurance
32