Any company that holds debt securities that have been hampered by current market conditions will benefit from the changes, says Jeffrey Ellis, a managing director at Huron Consulting. However, he adds, investors’ views of banks’ capital – which have been the most affected by OTTI charges related to fair value – may not change. That’s because most investors seem instead to be zeroing in on another metric, tangible common equity (book value minus intangible assets, goodwill, and preferred equity.)
Critics of the current OTTI rules believe banks in particular have unduly had to take damaging hits to their earnings to account for their impaired assets, such as mortgage-backed securities, which they have no immediate intentions to offload and which they expect will bring in cash down the road when the financial markets improve. The current rules don’t take into account an asset’s expected cash flows, a concern that some FASB members share.
Some of the language in FASB’s OTTI proposal might spawn confusion. Under the current rule FAS 115, Accounting for Certain Investments in Debt and Equity Securities, when determining whether an OTTI exists, companies are expected to predict when an impaired asset will recover in value and forecast that they intend and can hold onto it during that time period – a judgment call that can easily be second-guessed by auditors. FASB has now flipped the positive wording into a negative, which could be misconstrued as creating a new loophole, some think. The FASB proposal says, “management would be required to assert that (a) it does not have the intent to sell the security and (b) it is more likely than not that it will not have to sell the security before recovery of its cost basis.”
Hanson, a member of FASB’s Emerging Issues Task Force, says he first read this to mean companies that do intend to offload an asset could say they do not and not take any impairment charge until they sell it, presumably when its market recovers. This interpretation would likely result in a sharp decrease in OTTI charges — an interpretation the proposal’s supporters on the board may not intend. Depending on the feedback it gets in comment letters, the board will likely change the proposal to make its intentions clearer, according to Hanson.
If approved, the OTTI guidance would become effective for interim and annual periods ending after March 15, 2009. FASB has issued the proposal for a 15-day comment period, ending April 1, an unusually short time frame to consider all the feedback the board will receive. The board will vote on its proposals, including the new guidance for FAS 157, on April 2. Late last year, the last time the board proposed changes to OTTI guidance, it received nearly 300 letters.