FSP FAS 115-2 and FAS 124-2

On April 9, 2009, FASB issued additional guidance on recognition and measurement of impairment losses which allowed a more uniform assessment of impairment compared to the previous guidance and improving disclosure and presentation of other-than-temporary-impairments (OTTI). The market conditions in the financial crisis led to situtiations for some securities where the market value didn’t reflect the amount of cash to be collected. Also, the requirements for recognition and measurement of impairment losses for loans were not the same as those for debt securities.

FSP FAS 115-2 and FAS 124-2 highlights factors to be considered for determining whether a debt security is OTTI:

A. Does it have the intent to sell the security or

B. Is it more likely than not be required to sell a security before it recovers the amortized cost basis

If the fair value of the security is below amortized cost and the answer to A or B is yes, the security is impaired. However, if the answer is no to both questions, the entity can still determine whether a credit loss exists, which is the case if the following question is answered with yes

C. Does the entity not expect to recover the entire amortized cost basis of the security (credit loss)

This credit loss is recorded in earnings, while any remaining mark-to-market loss is recorded in equity.

To determine whether the entire cost basis can be recovered, the present value needs to be estimated by summing up the expected discounted cash flows to get to the present value and comparing this present value with the amortized cost basis.

The FSP outlines some examples that should be considered for estimating the amount and the period over which the recovery is expected to happen

a. The length of time and the extent to which the fair value has been less than the

amortized cost basis

b. Adverse conditions specifically related to the security, an industry, or a geographic

area (for example, changes in the financial condition of the issuer of the security, or

in the case of an asset-backed debt security, in the financial condition of the

underlying loan obligors, including changes in technology or the discontinuance of a

segment of the business that may affect the future earnings potential of the issuer or

underlying loan obligors of the security or changes in the quality of the credit

enhancement)

c. The historical and implied volatility of the fair value of the security

d. The payment structure of the debt security (for example, nontraditional loan terms as

described in FSP SOP 94-6-1, Terms of Loan Products That May Give Rise to a

Concentration of Credit Risk) and the likelihood of the issuer being able to make

payments that increase in the future

e. Failure of the issuer of the security to make scheduled interest or principal payments

f. Any changes to the rating of the security by a rating agency

g. Recoveries or additional declines in fair value subsequent to the balance sheet date.

If it is determined that there is an OTTI, the amount of the total impairment related to credit losses is recognized in earnings, while the total amount related to all other factors is recognized in other other comprehensive income.

The FSP leads to new disclosures related to the OTTI, as well as more detailed disaggregation for major security categories. The frequency for certain existing disclosures is extended to include interim periods as opposed to just annual periods. The entity must also adjust the opening balance of retained earnings to recognize the cumulative effect of first time adoption of this FSP.

Early adoption was allowed for periods ending after March 15, 2009, with numerous companies deciding to early adopt. The effective date of FSP FAS 115-2 and FAS 124-2 was put to interim and annual reporting periods ending after June 15, 2009.