1
Travis W. Harms, CFA, CPA/ABV May, 2010 AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital www.mercercapital.com
2
»  Overview of ASC 820 Presentation
Outline
»  Emerging Guidance: Updates and ApplicaCon §  Non-­‐AcCve Markets / Non-­‐Orderly TransacCons §  LiabiliCes §  PorLolio ValuaCon »  Fair Value Disclosure Example »  ValuaCon and ReporCng Best PracCces AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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3
OVERVIEW
ASC 820 Fair Value
Measurements and Disclosures
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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4
ASC 820
(Formerly
SFAS 157)
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital »  Defines fair value for financial reporCng »  Establishes a framework to measure fair value under GAAP »  Expands disclosures on fair value measurements www.mercercapital.com
5
The
Fair Value
Objective
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital The FASB believes that, in order to be useful, accounCng informaCon should be both relevant and reliable Reliability
Relevance
Historical Cost
Fair Value
www.mercercapital.com
6
The
Fair Value
Definition
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transacCon between market parCcipants at the measurement date. www.mercercapital.com
7
Measurement AAribute The
Hypothetical
Fair Value
Transaction
§  Considers price received to exit an exisCng posiCon (sell asset or transfer liability) MoCvaCon §  Not a forced transacCon PerspecCve §  That of the “market parCcipant” that holds the asset AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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Market
Participants Market ParCcipants are buyers or sellers in the principal or most advantageous market who are: »  Independent of the reporCng enCty »  Knowledgeable about the asset and the transacCon »  Able to transact »  Willing to transact AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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9
The
Importance
of the
Market
Participant
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital Fair value of an asset shall be determined based on the assumpCons that market parCcipants would use in pricing the asset www.mercercapital.com
10
Observable Inputs The
Fair Value
Hierarchy
Based on market data obtained from sources independent of the reporCng enCty Unobservable Inputs Reflect reporCng enCty’s own assumpCons about the assumpCons market parCcipants would use AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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Level 1 Fair
»  Direct Value
(unadjusted) quoted price from an acCve market for idenCcal assets Hierarchy:
Level 2 Input Quality
»  Quoted prices for similar assets »  Other observable inputs (interest rates, yield curves, etc.) Level 3 »  Unobservable inputs not derived from the market AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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»  Cash flow forecasts for private companies Common
Level 3
Inputs
»  Default probabiliCes and loss severiCes for private placement debt or asset-­‐
backed securiCes »  Growth expectaCons (revenue, earnings, etc.) »  Required returns on illiquid investments »  AnCcipated holding periods for illiquid investments AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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»  For all assets measured under ASC 820: Disclosure
Requirements
§  The level within the fair value hierarchy in which fair value measurements in their enCrety fall §  The valuaCon techniques used to measure fair value »  For measurements using significant Level 3 inputs: §  Beginning balance §  Total gains or losses (both realized and unrealized) §  Purchase and sales of assets §  Transfers in and/or out of Level 3 AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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14
EMERGING GUIDANCE
Updates & Applications
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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15
EMERGING GUIDANCE
Non-Active Markets
Non-Orderly Transactions
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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Fair Value
Guidance
Prompted
by the
Market
Meltdown
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital »  Measuring and Disclosing the Fair Value of Financial Instruments in Markets that are No Longer Ac;ve Issued by the IASB Expert Advisory Panel, October 2008 »  Determining Fair Value When the Volume and Level of Ac;vity for the Asset or Liability Have Significantly Decreased and Iden;fying Transac;ons That Are Not Orderly ASC 80-­‐10-­‐35-­‐51A through 35-­‐51H (formerly FASB Staff PosiCon No. FAS 157-­‐4) www.mercercapital.com
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ASC
820-10-35-51A
through
35-51H
»  Emphasizes that, regardless of volume, objecCve is sCll to determine FV at the measurement date under current market condi;ons »  Clarifies that an orderly transacCon assumes sufficient exposure to the market prior to the measurement date for usual and customary markeCng acCviCes »  FV is a market-­‐based measurement, not an enCty-­‐specific measurement AN
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ASC
820-10-35-51A
through
35-51H
»  If volume has decreased significantly, use judgment in adjusCng observed transacCon prices »  Consider whether observed transacCons are orderly AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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ASC 820-10-35-51A through 35-51H
AN
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»  Factors to evaluate with respect to a decrease in market volume: ASC
820-10-35-51A
through
35-51H
§  Few recent transacCons §  Price quotes not based on current informaCon §  Price quotes vary substanCally §  ReducCon of historical correlaCons §  Significant increase in implied liquidity premiums, etc. compared to reporCng enCty’s esCmate of expected cash flows §  Widening bid-­‐ask spreads §  Curtailment of primary market for similar instruments §  Lihle informaCon released publicly AN
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Indicators that a transacCon was not orderly: ASC
820-10-35-51A
through
35-51H
§  Not adequate exposure to the market for usual and customary markeCng acCviCes §  Seller marketed the asset or liability to a single market parCcipant §  Seller in or near bankruptcy, or under other regulatory or legal requirements to sell §  TransacCon price an outlier compared to other recent transacCons for the same or similar asset or liability AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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ASC 820-10-35-51A through 35-51H
IllustraCve FV yield determinaCon for RMBS (ASC 820-­‐10-­‐55-­‐59A through 55-­‐59I) »  Build-­‐up (discount rate adjustment) technique indicates yield of 12% »  FV measurement also considered indicaCve (nonbinding) quotes implying yields of 15% to 17% DISCOUNT RATE ADJUSTMENT
Benchmark Risk-Free Rate
At the measurement date
3.00%
Original Credit Spread
Based on pricing at issusance
2.50%
Est. Spread Widening Since Origination
Based on performance of relevant index
7.00%
Basis Adjustment for Index
Observed in most recent transaction
-3.50%
Liquidity Risk Premium
Measured Relative to Index Liquidity
3.00%
INDICATED YIELD
12.00%
»  Concluded FV yield was 13% AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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EMERGING GUIDANCE
Application to Liabilities
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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»  Principal assumpCons: Fair Value:
Liabilities
§  Transfer of liability to a market parCcipant (not sehlement with counterparty) §  No change in nonperformance risk before and aker contemplated transfer »  Emerging guidance recognizes: §  Contractual and legal restricCons prevent transfer of many liabiliCes §  Some liabiliCes are traded in the marketplace as assets AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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»  Fair value consideraCons: Fair Value:
Liabilities
§  Reflect market parCcipant assumpCons at measurement date §  Maximize use of relevant observable inputs and minimize use of unobservable inputs §  Guidance related to decreased volume or acCvity and non-­‐orderly transacCons is also relevant AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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»  Fair value measurement of liabiliCes: Fair Value:
Liabilities
§  Quoted price in an acCve market for idenCcal liability (Level 1 input) §  If Level 1 input is not available: »  Quoted price of idenCcal (or similar) liability traded as an asset, with potenCal adjustments »  Income approach (present value technique) or market approach (amount required to transfer or enter into idenCcal liability) §  No separate adjustment for restricCons on transfer of liability AN
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Fair Value:
Liabilities
»  PotenCal adjustments to quoted prices of idenCcal (or similar) liability traded as an asset to account for: §  Differences in characterisCcs of the quoted (liability trading as an) asset and subject liability §  Differences in units of account between quoted asset and subject liability »  For example, quoted prices of assets reflect third-­‐party enhancements not provided by the issuer of the liability AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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EMERGING GUIDANCE
Portfolio Valuation
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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29
Fair Value:
Portfolio
Valuation
»  Fair Value Measurements of Investments in Certain En;;es That Calculate Net Asset Value per Share (or Its Equivalent) §  ASC 820-­‐10-­‐15-­‐4 through 15-­‐5 §  ASC 820-­‐10-­‐35-­‐59 through 35-­‐62 §  ASC 820-­‐10-­‐50-­‐6A AN
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»  An investment has readily determinable fair value if (ASC 820 Glossary): Fair Value:
Portfolio
Valuation
§  Relevant sales prices or bid-­‐ask quotes are publicly reported by a major U.S. securiCes exchange (domesCc equity security) §  Foreign market in which it trades is comparable in breadth and scope to major U.S. securiCes exchanges (foreign equity security) §  Fair value per share is determined and published, and used as a basis for current transacCons (for investments in mutual funds) AN
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»  Investment Company ahributes (946-­‐10-­‐15-­‐2): Fair Value:
Portfolio
Valuation
§
Primary business is invesCng in assets for current income, appreciaCon, or both §
Ownership represented by units of investment to which proporConate share of net assets can be ahributed §
Funds of owners are pooled to facilitate access to professional investment management §
Is the primary reporCng enCty »
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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32
Fair Value:
Portfolio
Valuation
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital »  ASC 820-­‐10-­‐35-­‐59 provides for a pracCcal expedient for fair value measurement of ownership interests in an investment vehicle if: §  The ownership interests do not have readily determinable fair value §  The vehicle possesses all of the ahributes of an investment company, or the industry pracCce relevant to the vehicle is consistent with the reporCng pracCces required of investment companies www.mercercapital.com
33
Fair Value:
Portfolio
Valuation
»  As a pracCcal expedient, the fair value of an interest in an investment vehicle may be esCmated using net asset value per share reported by the company, provided: §  CalculaCon of the reported net asset value is consistent with fair value measurement principles (pursuant to ASC 946 Financial Services – Investment Companies) §  Net asset value per share was obtained at the measurement date »  Adjustments to reported net asset value may be appropriate if the preceding condiCons are not met AN
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Fair Value:
Portfolio
Valuation
»  The pracCcal expedient is not available if it is probable that an interest in the investment company will be sold for a price that is different from reported net asset value »  A sale is probable if: §  Management decides on a plan to sell the interest §  Process of searching for buyers has begun §  The interest is available for immediate sale §  Significant changes to the plan are unlikely and the plan will not be withdrawn AN
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»  Required disclosures for interests in investment companies: Fair Value:
Portfolio
Valuation
§  Fair value of interests by major category, including descripCon of corresponding investment strategies §  For irredeemable interests, expected liquidaCon period of underlying assets §  Unfunded commitments related to interests §  RedempCon terms and condiCons §  Circumstances that may constrain redempCon features (e.g. gates) §  Other restricCons on sale of interests §  Fair value of interests whose sale is deemed probable §  Intent to sell interests, if any AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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36
Financial Institution
Disclosure Survey
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
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37
Financial
Institution
Disclosures
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital »  Sample Disclosure »  Revenue Impact of Level 3 Assets »  Balance Sheet Exposure www.mercercapital.com
38
Sample Disclosure (Morgan Stanley)
Assets
Cash and securities deposited w/ clearing orgs
Financial instruments owned:
U.S. Gov't & Agency Securities
Other Sovereign Debt Obligations
Corporate and Other Debt
Corporate Equities
Derivative Contracts
Investments
Physical Commodities
Total financial instruments owned
Securites Received as Collateral
Intangible Assets
Liabilities
Commercial paper and other short-term borrowings
Deposits
Financial instruments sold, not yet purchased:
U.S. Gov't & Agency Securities
Other Sovereign Debt Obligations
Corporate and Other Debt
Corporate Equities
Derivative Contracts
Total financial instruments sold, not yet purchased
Obligation to return securities received as collateral
Other secured financings
Long-term borrowings
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital Level 1
$0
Level 2
$0
Level 3
$0
35,064
21,080
0
49,732
2,310
743
0
108,929
12,778
0
27,115
4,362
70,000
7,700
102,466
930
5,329
217,902
855
0
36
3
20,454
536
14,549
7,613
0
43,191
23
137
0
0
791
4,943
0
24
20,480
16,747
0
18,125
3,383
58,735
12,778
0
0
23
1,497
7,107
4,472
67,847
80,946
855
6,570
30,745
0
0
719
4
6,203
6,926
23
1,532
6,865
Netting Adj
$0
0
0
0
0
(70,244)
0
0
(70,244)
0
0
0
0
0
0
0
0
(39,224)
(39,224)
0
0
0
Balance @
12/31/2009
$0
62,215
25,445
90,454
57,968
49,081
9,286
5,329
299,778
13,656
137
791
4,967
20,503
18,244
7,826
22,601
38,209
107,383
13,656
8,102
37,610
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39
Sample Disclosure (Morgan Stanley)
Level 3 Assets
Financial instruments owned:
U.S. Gov't & Agency Securities
Other Sovereign Debt Obligations
Corporate and Other Debt
Corporate Equities
Derivative Contracts
Investments
Securiites Received as Collateral
Intangible Assets
Level 3 Liabilities
Deposits
Other Sovereign Debt Obligations
Financial Instruments Sold, Net Yet Purchased:
Corporate and Other Debt
Corporate Equities
Obligation to return securities received as collateral
Other secured financings
Long-term borrowings
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital Beginning
Balance
Gain /
(Loss)
Transfers
$127
1
34,918
976
23,382
9,698
30
184
($2)
(3)
(434)
121
(4,316)
(1,418)
0
(44)
0
0
(2)
0
3,808
27
30
6,148
5,473
(47)
(6)
0
396
(450)
($33)
4
(3,539)
130
(9,764)
(749)
0
0
22
10
(760)
61
0
(463)
675
Purchases
Ending
Balance
Fiscal 2009
Unrealized
Gain /
(Loss)
($56)
1
(10,491)
(691)
(956)
82
(7)
(3)
$36
3
20,454
536
8,346
7,613
23
137
$0
0
(289)
(227)
(3,037)
(1,317)
0
(44)
0
(10)
24
0
(2)
0
(2,376)
(90)
(7)
(3,757)
267
719
4
23
1,532
6,865
(238)
(1)
0
(50)
(450)
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40
Revenue Impact of Level 3 Assets
Level 3 Gain / (Loss) Exposure
For Fiscal 2009
Gain/(Loss) on Net Level 3 Assets as % of Pro
Forma Net Revenue
0.0%
-2.4%
-5.0%
-10.0%
-8.4%
-8.9%
-15.0%
-20.0%
-21.0%
-25.0%
GS
C
MS
JPM
Gains and Losses as % of Pro Forma Net Revenue
AN
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41
Balance Sheet Exposure
Level 3 Asset Exposure
As of Fiscal Year-end 2009
12.0%
10.2%
As % of Total Assets
10.0%
8.0%
6.0%
6.0%
4.7%
4.8%
4.6%
4.1%
3.9%
4.0%
4.5%
2.0%
0.0%
GS
C
MS
2008
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital JPM
2009
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42
Balance Sheet Exposure
Level 3 Liability Exposure
As of Fiscal Year-end 2009
3.0%
2.5%
As % of Total Liabilities
2.5%
1.9%
2.0%
1.5%
1.5%
1.4%
1.3%
1.1%
0.9%
1.0%
0.7%
0.5%
0.0%
GS
C
MS
2008
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital JPM
2009
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43
Balance Sheet Exposure
Level 3 Gross Exposure
As of Fiscal Year-end 2009
200.0%
180.0%
171.5%
160.0%
As % of Total Equity
140.0%
120.0%
100.0%
80.0%
101.2%
87.8%
77.9%
78.6%
64.7% 68.1%
54.9%
60.0%
40.0%
20.0%
0.0%
GS
C
MS
2008
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital JPM
2009
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44
Valuation and Reporting
Best Practices
AN
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45
Perspective
Our approach to risk management is rooted in accountability, escalaCon and communicaCon. A large part of this discipline is reflected in the marking process, which assigns current values to financial assets and liabiliCes. We believe that rigorous fair value accounCng for financial instruments is fundamental to prudent management because it facilitates a clear view of risk. It allows us to manage market risk limits, monitor exposure to credit risk and manage our liquidity requirements. For Goldman Sachs, the daily marking of posiCons to their fair value was a key contributor to our decision to reduce risk relaCvely early in markets and in posiCons that were deterioraCng. This process can be difficult, and someCmes painful, but we believe it is a discipline that should define financial insCtuCons. We fair value our posiCons, not only because we are required to, but because we wouldn’t know how to assess or manage risk if market prices were not reflected on our books. TesCmony by Lloyd C. Blankfein to the Financial Crisis Inquiry Commission, January 13, 2010 AN
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46
What Are
Common
“Level 3”
Assets?
»  Mortgage and asset-­‐backed securiCes »  Private placement corporate debt »  Equity investments in private companies »  Forward contracts, commitments, and guarantees »  Other derivaCve contracts AN
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»  Investment banks Who Owns
“Level 3”
Assets?
»  Broker/dealers »  Business development companies »  Mutual funds (open and closed) »  OperaCng companies »  AlternaCve asset managers §  Hedge funds §  Venture capital and private equity funds §  Funds of funds AN
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Available Implementation Guidance
»  Global Investment Performance Standards (GIPS) »  Best PracCces for Hedge Fund Managers and Investors from the President’s Working Group on Financial Markets »  AlternaCve Investment Management AssociaCon Guide to Sound PracCces for Hedge Fund ValuaCon »  Sound PracCces for Hedge Fund Managers from the Managed Funds AssociaCon »  SEC Sample Leher Sent to Public Companies on MD&A Disclosure Regarding the ApplicaCon of SFAS 157 »  Leading-­‐PracCce Disclosures for Selected Exposures Issued by the Senior Supervisors Group »  Private Equity Industry Guidelines Group (PEIGG) »  InternaConal Private Equity and Venture Capital ValuaCon Guidelines »  Private Equity Principles from the InsCtuConal Limited Partner AssociaCon AN
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49
GIPS Valuation Principles (Chapter II)
Required Provisions
Recommended Provisions
Frequency of Valuation
PE investments must be valued annually.
Basis of Valuation
The fair value basis is required for periods beginning on
The fair value basis is recommended.
or after January 1, 2011.
Changes in Valuation Method
Disclose valuation policies and methodologies used in
the most recent period. PE investments must disclose
material changes to valuation policies and/or
methodologies ending on or after January 1, 2011.
Use of Valuation Hierarchy
Disclose if the valuation hierarchy differs materially from
The specified valuation hierarchy should be followed
the recommended hierarchy for periods beginning on or
(see following slide for detail).
after January 1, 2011.
Valuation Inputs
Disclose the use of subjective unobservable inputs in
valuing investments for periods beginning on or after
January 1, 2011.
Disclose the use of subjective unobservable inputs in
valuaing investments for periods prior to January 1,
2011.
Independent Valuation Review
Not required.
Obtain valuations from a qualified independent third
party.
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital PE investments should be valued quarterly.
Disclose material changes to valuation policies and/or
methodologies.
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50
GIPS
Valuation
Hierarchy
(Inputs)
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital 1.
ObjecCve, observable, unadjusted quoted market prices for idenCcal investments in acCve markets on the measurement date. 2.
ObjecCve, observable quoted market prices for similar investments in acCve markets. 3.
Quoted prices for idenCcal or similar investments in markets that are not acCve. 4.
Market-­‐based inputs, other than quoted prices, that are observable for the investment. 5.
SubjecCve unobservable inputs for the investment where markets are not acCve at the measurement date. Use these inputs only to the extent observable inputs and prices are not available or appropriate. Unobservable inputs reflect assumpCons about the assumpCons market parCcipants would use in valuing an investment. www.mercercapital.com
51
Best Practices
for Valuing
Illiquid
Portfolio
Assets
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital »  Recognize that valuaCon mahers (it will really maher when something has gone awry) »  Document valuaCon procedures to follow (and follow them) »  Designate a member of senior management to be responsible for oversight of the valuaCon process »  Create contemporaneous and consistent documentaCon of valuaCon conclusions and raConale www.mercercapital.com
52
Best Practices
for Valuing
Illiquid
Portfolio
Assets
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital »  Solicit relevant input (from the professionals responsible for the investment, auditors, and third-­‐party experts) »  Check your math! »  Disclose the process and conclusions (potenCal investors take comfort in transparency) www.mercercapital.com
53
Travis W. Harms, CFA, CPA/ABV Contact
Information
AN
ANALYSTS GUIDE TO ASC 820 © 2010 Mercer Capital
© 2010 Mercer Capital 901.322.9760 harmst@mercercapital.com MERCER CAPITAL
Clark Tower 5100 Poplar Avenue, Suite 2600 Memphis, Tennessee 38137 www.mercercapital.com www.mercercapital.com
Mercer Capital’s Financial Reporting
Valuation Services
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Mercer Capital Financial ReporCng ValuaCon Services
Mercer Capital Financial ReporCng ValuaCon Clients » Purchase Price AllocaCon Services » Impairment TesCng Services » Equity-­‐Based CompensaCon ValuaCon Services » PorLolio ValuaCon Services » Publicly Traded and Large Private Companies » Financial InsCtuCons » Start-­‐Up Companies » Private Equity/Other Investment Funds Mercer Capital provides a comprehensive suite of valuaCon services to assist financial managers with financial reporCng requirements. In an environment of increasingly complex fair value reporCng standards and burgeoning regulatory scruCny, Mercer Capital helps clients resolve fair value reporCng issues successfully. Mercer Capital fair value opinions are consistently accepted by the Big Four audit firms and other reviewing enCCes. Our professionals hold the Accredited in Business ValuaCon (ABV) designaCon from the AICPA and the Accredited Senior Appraiser (ASA) designaCon from the American Society of Appraisers. Contact a Mercer Capital professional at 901.685.2120 for more specific informaCon related to industry focus in financial reporCng related valuaCon and consulCng services. AN
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