Below is the proposal from the FASB meeting. My view:
** The change is less meaningful to earnings and income than some people may think. After all, we have taken the pain all these months, so now most banks are looking forward to writing these assets back up! And the rule looks like it applies to only L3 assets.
** Some people in DC describe this as a revolution, but our friend Josh Rosner calls it rightly evolution. Another colleague, Alton Cogert at Strategic Asset Alliance, says that the rule will help insurers avoid both M2M loss and Other Than Temporary Impairment (“OTTI”):
“Under specific direction from Congress, FASB has modified both GAAP accounting’s approach to measuring fair value as well as OTTI. As always, the devil is in the details and these are still proposals, subject to finalization. But the trend is clear on two basic fronts:
1 – You can separate declines in value due to the credit of an issuer or bond from all other impacts. And, only write down through income the amount subject to credit specific to the issuer or bond.
2 – Fair value is not the last quoted price, if the market isn’t operating in a ‘usual and customary’ manner and there are not multiple bidders. In those situations, you’ve got a distressed value and you can use more analytic approaches to valuation.”
The FASB PROPOSAL
Step 1: Determine whether there are factors present that indicate that the market for the
asset is not active at the measurement date. Factors include:
a. Few recent transactions (based on volume and level of activity in the market).
Thus, there is not sufficient frequency and volume to provide pricing
information on an ongoing basis.
b. Price quotations are not based on current information.
c. Price quotations vary substantially either over time or among market makers
(for example, some brokered markets).
d. Indices that previously were highly correlated with the fair values of the asset
are demonstrably uncorrelated with recent fair values.
e. Abnormal (or significant increases in) liquidity risk premiums or implied yields
for quoted prices when compared to reasonable estimates of credit and other
nonperformance risk for the asset class.
f. Significant widening of the bid-ask spread.
g. Little information is released publicly (for example, a principal-to-principal
If after evaluating all the factors the sum of the evidence indicates that the market is not
active, the reporting entity shall apply step 2.
Step 2: Evaluate the quoted price (that is, a recent transaction or broker price quotation)
to determine whether the quoted price is not associated with a distressed transaction. The
reporting entity shall presume that the quoted price is associated with a distressed
transaction unless the reporting entity has evidence that indicates that both of the
following factors are present for a given quoted price:
a. There was a period prior to the measurement date to allow for marketing activities
that are usual and customary for transactions involving such assets or liabilities
(for example, there was not a regulatory requirement to sell).
b. There were multiple bidders for the asset.
11. If the reporting entity has evidence that both of the factors are present for a given quoted
price, then that quoted price is presumed not to be associated with a distressed
transaction. In that case, the quoted price may be a relevant observable input that shall be
considered in estimating fair value. However, the reporting entity should consider
whether any other factors or conditions warrant making an adjustment to the quoted price
(see paragraph 29). For example, if a quoted price that is not associated with a distressed
transaction is not current or is a consequence of a trade with an insignificant volume
relative to the total market for that asset, the reporting entity should consider whether that
quoted price is a relevant observable input (that is, whether the quoted price requires
12. If the reporting entity does not have evidence that both of these factors are present for a
given quoted price (including because there is insufficient information on which to base a
conclusion), then the reporting entity shall consider the quoted price to be associated with
a distressed transaction and shall use a valuation technique other than one that uses the
quoted price without significant adjustment (that is, a significant adjustment is required,
resulting in a Level 3 measurement). For example, the reporting entity could use an
income approach (that is, a present value technique) to estimate fair value. However, the
fair value resulting from the present value technique shall not be derived solely from
inputs based on the quoted price associated with a distressed transaction. The inputs
should be reflective of an orderly (that is, not distressed or forced) transaction between
market participants at the measurement date. An orderly transaction would reflect all
risks inherent in the asset, including a reasonable profit margin for bearing uncertainty
that would be considered by market participants (that is, willing buyers and willing
sellers) in pricing the asset in a non-distressed transaction.
TRANSITION AND EFFECTIVE DATE
13. The staff proposes prospective transition. Changes in fair value resulting from the
application of the FSP are considered changes in estimate and affect results in the period
of adoption. The staff believes there are two effective date alternatives:
a. Effective for interim and annual periods ending after March 15, 2009.
b. Effective for interim and annual periods ending after June 15, 2009. Early
adoption would be permitted.
14. The staff recommends that a final FSP be effective for interim and annual periods ending
after March 15, 2009.
15. The staff recommends a comment period of 15 days ending April 1 so that the Board can
finalize the proposed FSP at its Board meeting on April 2.