January 30, 2009 NDS 2009-06 Revised for FASB Codification July 1, 2009 New Developments Summary Other-than-temporary impairment of beneficial interests and debt securities FASB Staff Position EITF 99-20-1 Summary Recently issued FASB Staff Position (FSP) EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20” (FASB Accounting Standards Codification™ (ASC or Codification) 325, Investments – Other, 40, “Beneficial Interests in Securitized Financial Assets”), is designed to achieve a more consistent determination of whether other-than-temporary impairment exists for some beneficial interests. The FSP amends EITF Issue 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets” (ASC 325-40), by aligning its impairment guidance more closely with that in FASB Statement 115, Accounting for Certain Investments in Debt and Equity Securities (ASC 320, Investments – Debt and Equity Securities, 10-35-31). The FSP is effective for interim and annual reporting periods ending after December 15, 2008 and should be applied prospectively. Retrospective application to a prior reporting period is prohibited. Contents A. B. C. D. Background............................................................................................................................................. 1 Basis for amendments ............................................................................................................................ 2 Amendments featured in FSP EITF 99-20-1 .......................................................................................... 3 Effective date and transition ................................................................................................................... 4 A. Background Prior to the issuance of FASB Staff Position (FSP) EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20” (FASB Accounting Standards Codification™ (ASC or Codification) 325, Investments – Other, 40, “Beneficial Interests in Securitized Financial Assets”), U.S. GAAP provided two methods to evaluate whether the impairment of a beneficial interest was other-than-temporary. One method is described in EITF Issue 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets” (ASC 325-40), and the other in FASB Statement 115, Accounting for Certain New Developments Summary 2 Investments in Debt and Equity Securities (ASC 320, Investments – Debt and Equity Securities, 10-3531). For beneficial interests within the scope of ASC 325-40, an entity was required to compare market participants’ assumptions about future cash flows with its own previous cash flow assumptions to assess other-than-temporary impairment. For beneficial interests outside the scope of ASC 325-40, an entity was required to apply ASC 320-10-35-31. Under ASC 320-10-35-31, the entity evaluated impairment using management’s reasonable judgment of whether it was probable that the holder would be unable to collect all amounts due, rather than relying on market participants’ assumptions. Constituents raised a question with the FASB regarding the application of the aforementioned ASC 32540 impairment model. Entities would evaluate securities or beneficial interests with a higher credit quality at the time the interest was acquired using the guidance in ASC 320-10-35-31. But if the credit quality of the same or a similar interest subsequently deteriorated and was then purchased, an entity would use the guidance in ASC 325-40 to assess impairment. Therefore, it was possible to apply two different impairment models, one requiring the use of market participants’ assumptions and the other requiring the use of management’s judgment to the same or similar securities. The recent credit crisis has brought to light several other issues with the application of ASC 325-40 as the markets for many debt securities ceased to function and prices for such securities fell dramatically. As a result, the FASB received comments from constituents raising concerns that entities could not rely on management’s judgment to assess the probability of collecting previously projected cash flows in evaluating whether securities under ASC 325-40 were other-than-temporarily impaired. Further, several constituents expressed concern that applying the impairment evaluation guidance in ASC 325-40 in a dislocated market would automatically result in a conclusion that an other-than-temporary impairment had occurred, despite evidence indicating that the underlying assets could still fully perform. It is difficult to discern market participants’ expectations regarding credit and liquidity issues as the prices for many securities under the scope of ASC 325-40 are depressed and indicate unusually high yields. Some entities are concerned that the absence of conclusive information on the components of the yield (liquidity and credit spreads) may lead them to erroneously conclude that market participants’ expectations regarding the ability to collect future cash flows indicate other-than-temporary impairment. B. Basis for amendments In undertaking this project to amend ASC 325-40, the FASB sought to promote consistent determination of whether a beneficial interest is other-than-temporarily impaired, and to emphasize to its constituents the objective of assessing an other-than-temporary impairment as well as the disclosure requirements in ASC 320-10 and other relevant guidance. The FASB concluded that the objective of an other-thantemporary impairment analysis is to determine whether it is probable that a holder will realize a portion of the unrealized loss on an impaired interest. Under U.S. GAAP, an unrealized loss associated with an impaired interest may eventually be realized if it is probable that either (1) the holder will not collect the entire contractual or estimated cash flow from that interest, or (2) the holder lacks the intent and ability to hold the interest until it is expected to recover. The FASB considered the following existing authoritative accounting literature related to other-thantemporary impairment in determining how to amend ASC 325-40: • SEC Staff Accounting Bulletin (SAB) Topic 5M (ASC 320-10-S99-1), which states the following: − A holder’s lack of intent and ability to hold an impaired security for a period of time sufficient to allow for recovery of fair value may trigger the realization of an unrealized loss. New Developments Summary − Declining market prices require management to consider all available evidence in evaluating the realizable value of an investment. − A holder should consider the current financial condition and near-term prospects of an issuer in evaluating whether an investment is impaired and, unless evidence supports a realizable value greater than or equal to the carrying amount, whether a realized loss should be recorded. • FSP FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (ASC 320-10-35-33 through 35-34), states that an impairment loss should be recognized when an impairment is deemed to be other-than-temporary, even if the holder is not committed to selling the security. • AICPA Accounting Principles Board Opinion 18, The Equity Method of Accounting for Investments in Common Stock (ASC 323, Investments – Equity Method and Joint Ventures, 10-35-31), states that continued operating losses of an investee may indicate that an other-than-temporary impairment has occurred and that a loss should be recognized. • AICPA Statement on Auditing Standards 92, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities, states that the determination of whether an impairment is other-thantemporary requires estimating the outcome of future events and gives examples of several factors that might indicate other-than-temporary impairment. 3 C. Amendments featured in FSP EITF 99-20-1 The FASB amended ASC 325-40-35-4 by removing the requirement that entities evaluate the current information, events, and projected cash flows that a market participant would use in determining the fair value of a beneficial interest and stating that the holder of a debt security should assess whether it is probable that a change would occur, whether favorable or adverse, in the estimated cash flows of the interest from the amounts previously projected. If the holder deems that such a change is probable, then it should recalculate the accretable yield on the evaluation date, pursuant to the existing guidance in ASC 325-40-35-4. The entity should determine whether an other-than-temporary impairment exists if it is probable that an adverse change in estimated cash flows has occurred. The FASB added ASC 325-40-35-10A to emphasize that it is inappropriate for an entity to conclude that an instrument is not other-than-temporarily impaired only because it has received all scheduled payments to date, or that an instrument is other-than-temporarily impaired solely due to a decline in fair value. This new paragraph also refers to the language in SAB Topic 5M that states a holder must look to the period over which a security’s cost exceeded its fair value, as well as the extent of the excess, in assessing whether a decline in fair value is other-than-temporary. The FASB also added ASC 320-10-35-33G which highlights information that holders should consider when developing an estimate of future cash flows. This information includes • Remaining payment terms • Prepayment speeds • Financial condition of the issuer(s) • Expected defaults • Value of underlying collateral Additionally, ASC 320-10-35-33I states that the holder of an interest should consider whether New Developments Summary • Credit enhancements and guarantees are associated with the security • Any subordinated interests are capable of absorbing losses on the underlying loans • The remaining payment terms due from the underlying securities are significantly different than in prior periods • Currently performing loans will continue to perform if payments are required to increase in the future (including “balloon” payments) • Collateral might affect the expected performance of the security 4 The FSP amends ASC 325-40-35-13 to refer to the guidance in ASC 320-10-S99-1 that states an otherthan-temporary impairment would exist if the interest holder lacks the intent and ability to hold the interest to recovery. The FASB added paragraph 28 to EITF Issue 99-20 (not included in Codification), which refers to ASC 320-10-35-33 when it states that a loss should be realized when impairment is considered other-thantemporary, even if the holder is not committed to selling the instrument. Finally, the FSP amends FASB Statement 157, Fair Value Measurements (ASC 820, Fair Value Measurements and Disclosure), to clarify that the discount rate adjustment technique described in ASC 820 is not appropriate for applying the impairment guidance in ASC 325-40. D. Effective date and transition The FSP is effective for interim and annual reporting periods ending after December 15, 2008 and should be applied prospectively. Retrospective application to a prior reporting period is prohibited. If an other-than-temporary impairment results from the application of ASC 320-10-35-31 or ASC 325-40, the entity should recognize the entire difference between the instrument’s cost and its fair value at the balance sheet date of the reporting period in which the assessment is made. © 2009 Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP bulletin provides information and comments on current accounting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in the bulletin. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this bulletin. For additional information on topics covered in this bulletin, contact your Grant Thornton LLP adviser.