May 1, 2004
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Loan Commitments Scope Out Reset to C13
March 22, 2002
Loan Commitments Scope Out Reset to C13
March 22, 2002
Derivatives accounting's impact on loan commitments too burdensome?
March 6, 2002
Derivatives accounting's impact on loan commitments too burdensome?
March 6, 2002
Updates on FAS 133 Issues Before the FASB Board in November/December
December 17, 2001
Derivatives Accounting (FAS 133/IAS 39)
New Guidance on Loans and Revisions to C15 (Bookouts) Cleared
December 19, 2001

Changes in determining how loans will be scoped in bring guidance closer to the statement itself, as more issues achieve closure.

At its meeting on December 19, the Board agreed to the staff's recommendation to change its final guidance on the application of FAS 133 to loans (and other credit arrangements): i.e., when they should be defined as derivatives for accounting purposes. The Board thus decided to override C13,"When a Loan Commitment is Included in the Scope of Statement 133," with broader guidance utilizing FAS 133's characteristic-based definition of a derivative (in particular, the net-settlement criteria found in paragraph 9b).

Under this approach, loans and other off-balance sheet credit arrangements that meet the statement's definition of a derivative would be scoped in. However, the key to this approach is to be found in the language the staff has drafted to help apply the FAS 133 definition of a derivative to such loans/credit arrangements. This language, which we understand will set a relatively high hurdle for loans to meet the 9b test, is to be posted on the FASB site soon, and subjected to a 35-day comment period. [There may be two issues: one to clarify the market mechanism need to qualify for 9b (net settlement) and a second to address the application of the derivative definition in accounting of the loan.]

Clarification on the question of MAC clauses (not to be considered) and asymmetrical accounting for borrower and lender (allowing borrowers to continue to account for loans deemed derivatives for banks as loans) as discussed below will also be included in the guidance posted to the FASB website. Notice will be given that the resulting guidance will be conditioned on amendments to Statements 65 and 91, which covered prior loan accounting.

Desperate for closure, the board stresses that this is essentially the final answer on the subject, and it will primarily consider comments that help improve the application of the derivative definition test. Note that this change sets a further precedent for seeking changes to existing, pre-cleared guidance that go back to the conceptual foundation of the statement itself.

Another issue of large concern to the electricity industry was the Board's discussion of further revisions to C15, "Normal Purchases and Sales Exception for Option-Type Contracts and Forward Contracts in Electricity." In October, the staff revised C15 to clarify the unique nature of capacity contracts in the electrical industry and define criteria under which contracts with certain option features and bookouts can qualify for the normal purchases and sales exception. The Board has given the final go- ahead, approving staff revisions which means C15 will be posted in its final form very soon. We are unclear as to what extent, if at all, these revisions will differ from the October 10 draft, but interested parties will want to scrutinize the words carefully.


Loan commitments and FAS 133
Prior to today's meeting, this issue had been addressed, in part, with C13, "When a Loan Commitment is Included in the Scope of Statement 133," which was posted as tentative guidance on the FASB website in January 2001. C13 provided that (1) loan commitments that relate to the origination or acquisition of mortgage loans that will be held for resale under Statement 65 must be accounted for as derivatives under Statement 133 by both the borrower and lender; (2) loan commitments that relate to the origination or acquisition of mortgage loans that will be held of investment continue to be accounted for under Statement 65 and (3) commitments that relate to the originations of non-mortgage loans continue to be accounted for under Statement 91.

However, C13 dealt mainly with mortgage loans, which would have required FASB to consider extending the guidance in C13 to non-mortgage loans held for resale.

As an alternative, the staff had recommended the Board switch gears and use the Statement's broader guidance on defining derivatives to determine when loans are scoped in, which the Board accepted.

A third and fourth alternative were also presented but not widely considered. The first of these would have imposed the need for both parties of a contract to have access to a market mechanism, in order for the contract to meet the paragraph 9b net settlement criteria. Going down this route would require a similar decision by the board on this "both counterparty" requirement for all 9b tests. The second of these alternatives suggested the Board simply carve out a specific subset of loans from FAS 133.

In discussing this question, one of the board members noted how divisive this issues was in the financial services industry, with constituents coming down almost equally on both sides (see I-bank vs. C-bank debate). This prevented easy consideration of a carve out, or any guidance, that drifted away from FAS 133's conceptual fundamentals.

The guidance in C13 (formerly E13) was already drifting away from the core FAS 133 concepts, but this reflected the Board's mistaken view that most all loan commitments were clearly not derivatives. However, C13 arose out of discussions at the DIG (see Item 11-4 discussions here and here) where DIG members pointed out market mechanisms that could emerge to facilitate net settlement in loans and how loans with option features were included in Statement 119 disclosure guidelines.

Moreover, C13 was potentially holding back the planned move to a fair value model for all financial instruments--a project discussed later at the meeting. As one of the new board members, Katherine Schipper, pointed out, going with the alternative to C13 not only provides an opportunity to fix a flawed approach to loan scope outs, but it brings GAAP further in the direction of the fair value model toward which the FASB is moving. Though, other board members, and the staff, said it was not clear whether more or fewer loans would be likely to be scoped in under the agreed upon C13 alternative.

Having reached on consensus on the first question concerning loans, the Board turned to the second and third questions framed by the staff.

Question 2 dealt with the effect of a subjective material change clause (Ma clause that may be invoked by the issuer based oive evaluation of the adverse change-on whethoped into FAS 133. Though not explicitly stated, this question was posed in order to prevent the insertion of MAC clauses into credit arrangements merely to trigger a scope exception.

The alternative guidance proposed by the staff dealt with the degree of control the issuer has over the MAC trigger:

Alternative 1 states that the existence of a subjective MAC clause always causeso be excluded from the scope of the staff's proposed guidance.

Alternative 2 would have the loan excluded only if it is remote that the issuer would invoke the MAC clause.

Alternative 3 would ignore the MAC altogether and not use it as a consideration in excluding the contract.

The board had no objections to the staff recommendation to ignore the MAC clause (alternative 3).

The third question arising from the loan discussion asked if asymmetrical accounting would be allowed for loans falling under the scope of FAS 133. In other words, a market mechanism might exist for the issuer (lender), but not the holder (borrower), which would make the contract a derivative from the former's perspective but not the latter's.

As a pure practical matter, the Board concluded that asymmetrical accounting would be allowed on an exception basis where the holder (borrower) does not account for the contract as a derivative--even where it meets the test for the issuer (lender). Otherwise, borrowers would have to phone their lenders and ask how they were accounting for the loan in order to arrive at proper accounting.


Other items
In what might be labeled year-end clean up, the Board cleared to Issues of relatively minor importance. J19, "Application of the Normal Purchases and Normal Sales Exception on Initial Adoption to Certain Compound Derivatives" is a transition issue and has become a moot point now that most people have adopted FAS 133 and proceeded through the initial transition phase. Following procedure the Board cleared this issue, just to bring finality to the subject.

The second, B34, "Period-Certain Plus Life-Contingent Variable-Payout Annuity Contracts with a Guaranteed Minimum Level of Period Payments," dealt with an unresolved question in B25.

The staff response in B34 was that:

the embedded derivative related only to the period-certain guaranteed minimum periodic payments would be required to be separated under paragraph 12, whereas the embedded derivative related to the life-contingent guaranteed minimum periodic payments would not be separated under paragraph 12. Separate accounting for the embedded derivative related only to the period-certain guaranteed minimum periodic payments would be required even if the period-certain plus life-contingent annuity, in its entirety, meets the definition of an insurance contract under paragraph 8 of Statement 97 and has no withdrawal features.


This conclusion is based on the premise that the guaranteed floor payment is not clearly and closely related to the host contract (a variable-payout annuity contract) and, thus, must be bifurcated. This is consistent with the guidance in Statement 133 Implementation Issue No. B8, Identification of the Host Contract in a Nontraditional Variable Annuity Contract." However, the life-contingent portion of the variable-annuity that has no withdrawal features would not be subject to the requirements of Statement 133 because the contract meets the paragraph 10(c) exception. Thus, no separate accounting is required under paragraph 12 for the embedded derivative related to the guarantee that each life-contingent periodic payment will not be less than a specified minimum.


The Board affirmed this response, clearing B34. However, in the discussion the Board members noted that the rationale used in applying paragraph 10c to allow the insurance exemption was more the result of death than the insurance definition in Statement 97, which should have been recognized in the discussion of B25. For this reason, board members asked that the rationale language be taken out and that the staff keep B34 separate from B25 to highlight the rationale nuances.

 


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