2014 Accounting Conference FAS 91/FIN 45 Update

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1 2014 Accounting Conference FAS 91/FIN 45 Update Kim Brunner, Assistant Controller & Director - Financial and Management Reporting May 14, 2014 FAS 91/FIN 45 Update Agenda FAS 91 GAAP Requirements FAS 91 Farm Credit Process FAS 91 Association Summary Information FIN 45 GAAP Requirements FIN 45 Farm Credit Impacts FIN 45 Reporting Questions? 2 1

2 FASB ASC provides guidance on the recognition, measurement, derecognition, and disclosure of nonrefundable fees, origination costs, and acquisition costs associated with lending activities and loan purchases. Loan origination fees and direct loan origination costs should be deferred and recognized over the life of the loan as an adjustment of interest income (yield) Glossary Terms: Direct Loan Origination Costs Direct loan origination costs represent costs associated with originating a loan. Direct loan origination costs of a completed loan shall include only the following: a. Incremental direct costs of loan origination incurred in transactions with independent third parties for that loan b. Certain costs directly related to specified activities performed by the lender for that loan. Those activities include all of the following: 1. Evaluating the prospective borrower's financial condition 2. Evaluating and recording guarantees, collateral, and other security arrangements 3. Negotiating loan terms 4. Preparing and processing loan documents 5. Closing the transaction. The costs directly related to those activities shall include only that portion of the employees' total compensation and payroll-related fringe benefits directly related to time spent performing those activities for that loan and other costs related to those activities that would not have been incurred but for that loan. See Section for examples of items. 4 2

3 Glossary Terms (continued): Incremental Direct Costs Costs to originate a loan that have both of the following characteristics: a. Result directly from and are essential to the lending transaction b. Would not have been incurred by the lender had that lending transaction not occurred. Commitment Fees Fees charged for entering into an agreement that obligates the entity to make or acquire a loan or to satisfy an obligation of the other party under a specified condition. Commitment fees include fees for letters of credit and obligations to purchase a loan or group of loans and pass-through certificates Glossary Terms (continued): Loan Origination Fees Origination fees consist of all of the following: a. Fees that are being charged to the borrower as prepaid interest or to reduce the loan's nominal interest rate, such as interest buy-downs (explicit yield adjustments) b. Fees to reimburse the lender for origination activities c. Other fees charged to the borrower that relate directly to making the loan (for example, fees that are paid to the lender as compensation for granting a complex loan or agreeing to lend quickly) d. Fees that are not conditional on a loan being granted by the lender that receives the fee but are, in substance, implicit yield adjustments because a loan is granted at rates or terms that would not have otherwise been considered absent the fee (for example, certain syndication fees addressed in paragraph ) e. Fees charged to the borrower in connection with the process of originating, refinancing, or restructuring a loan. This term includes, but is not limited to, points, management, arrangement, placement, application, underwriting, and other fees pursuant to a lending or leasing transaction and also includes syndication and participation fees to the extent they are associated with the portion of the loan retained by the lender. 6 3

4 Other Direct Loan Origination Costs Examples of other direct loan origination costs that may be deferred as such under the definition of that term for loans that are granted include all of the following: 1. Reimbursement of costs for air travel, hotel accommodations, automobile mileage, and similar costs incurred by personnel relating to the specified activities 2. Costs of itemized long-distance telephone calls related to loan underwriting 3. Reimbursement for mileage and tolls to personnel involved in on-site reviews of collateral before the loan is granted Payroll-related fringe benefits include any costs incurred for employees as part of the total compensation and benefits program. Examples of such benefits include all of the following: 1. Payroll taxes 2. Dental and medical insurance 3. Group life insurance 4. Retirement plans (k) plans 6. Stock compensation plans, such as stock options and stock appreciation rights 7. Overtime meal allowances The portion of total compensation of executive employees that relates directly to the time spent approving successful loans prior to funding may be deferred as direct loan origination costs under the definition of that term. For example, the amount of compensation allocable to time spent by members of a loan approval committee is a component of direct loan origination costs Paragraph specifies that equipment costs (for example, a lender's data processing equipment dedicated to originating loans), depreciation, and maintenance must be charged to expense as incurred. Those costs do not meet the criteria for deferral as direct loan origination costs under the definition of that term as they would have been incurred whether or not a loan was originated. 7 Direct Loan Origination Costs - Specified Activities The following are examples of specified activities contemplated as direct loan origination costs under the definition of that term: 1. Loan counseling, such as discussing alternative borrowing arrangements with borrowers, and negotiating terms 2. Application processing 3. Appraisal 4. Initial credit analysis 5. Initial credit investigation 6. Quality control review performed during the underwriting period 7. Direct approval processing 8. Loan evaluation and approval committees (all activities involved in origination decisions) 9. Loan closing. 8 4

5 Fees 05-2 Nonrefundable fees have many different names in practice, such as origination fees, points, placement fees, commitment fees, application fees, management fees, restructuring fees, and syndication fees, but, for FAS 91 purposes, they are referred to as loan origination fees, commitment fees, or syndication fees The scope of FAS 91 does not apply to loan origination or commitment fees that are refundable; however, FAS 91 does apply when such fees subsequently become nonrefundable. 9 Refinanced Loans (excluding situations of a troubled debt restructuring): If the refinancing resulted in terms at least as favorable to the lender as the terms for comparable loans to other customers with similar collection risks who are not refinancing/restructuring a loan, then existing unamortized fees/costs should be recognized in interest income when the new loan is granted. Criteria that may determine if the terms are at least favorable are: Effective yield is equal to or greater than the effective yield for other such loans Modifications of the debt instrument are more than minor identified when: The PV of the cash flows under the terms of the new loan is at least 10% different from the PV of the remaining cash flows under the terms of the original loan Other facts and circumstances considered by the lender if the 10% threshold is not met If the criteria outlined above are not met, the unamortized fees/costs on the original loan should be carried forward as part of the net investment in the new loan 10 5

6 Troubled Debt Restructurings: Fees received in connection with a modification of terms of a troubled debt restructuring as defined in Subtopic shall be applied as a reduction of the recorded investment in the loan. All related costs, including direct loan origination costs, shall be charged to expense as incurred. 11 FAS 91 Update Farm Credit Process Associations Defer material fees (optional) Reclass impact only on current period activity (fees not individually deferred) Gets us closer to the spirit of netting costs/expenses into interest income AgriBank District Post adjusting entry at District level utilizing all Association level data (not just reclass) 12 6

7 FAS 91 Update Farm Credit Process Association Reporting Association Responsibilities: Determine which material loan fees will be deferred Determine the standard costs to be used by loan type AgriBank Responsibilities: Summarize loan fees which are subject to deferral Perform calculation for FAS 91 reclass entry If over 100% - then no entry is needed (FAS 91 fees are already netted with interest income) If under 100% - then % is applied to fees and salary expense 13 FAS 91 Update Association Summary Information Avg Costs - by Type of Loan Min Max Avg 2013 Standard Cost Mortgage Standard Cost OTS $ 410 $ 1,443 $ 971 $ 710 Mortgage Standard Cost Non OTS $ 885 $ 3,159 $ 1,482 $ 1,350 Conversion Standard Cost $ 33 $ 529 $ 282 $ 480 Commercial Standard Cost Renewals OTS $ 44 $ 286 $ 143 $ 338 Commercial Standard Cost Non OTS $ 285 $ 1,344 $ 668 $ 294 Fees Deferred $ (1,376) $ 14,974,967 $ 2,674,947 Cost to Fees Deferral Ratio 52.1% % 164.3% 14 7

8 FIN 45 Update GAAP Requirements Scope of GAAP FASB ASC 460, Guarantees, establishes the accounting and disclosure requirements to be met by a guarantor for certain guarantees issued and outstanding. Commercial letters of credit and other loan commitments, which are commonly thought of as guarantees of funding, are not included in the scope of FASB ASC 460 (as stated in FASB ASC (a)): Commercial letters of credit and other loan commitments, which are commonly thought of as guarantees of funding, are not included in the scope of this Topic because those instruments do not guarantee payment of a money obligation and do not provide for payment in the event of default by the account party. 15 FIN 45 Update GAAP Requirements Scope of GAAP ASC : Except as provided in paragraph , the provisions of this Topic apply to the following types of guarantee contracts: a. Contracts that contingently require a guarantor to make payments (as described in the following paragraph) to a guaranteed party based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party. b. Contracts that contingently require a guarantor to make payments (as described in the following paragraph) to a guaranteed party based on another entity s failure to perform under an obligating agreement (performance guarantees). c. Indemnification agreements (contracts) that contingently require an indemnifying party (guarantor) to make payments to an indemnified party (guaranteed party) based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party. d. Indirect guarantees of the indebtedness of others, even though the payment to the guaranteed party may not be based on changes in an underlying that is related to an asset, a liability, or an equity security of the guaranteed party. 16 8

9 FIN 45 Update GAAP Requirements Scope of GAAP FASB ASC states that a financial standby letter of credit is an example of a guarantee contract under the scope of FASB ASC 460. A financial standby letter of credit is defined by the FASB ASC glossary as an irrevocable undertaking (typically by a financial institution) to guarantee payment of a specified financial obligation. 17 FIN 45 Update GAAP Requirements Accounting Requirements ASC : The issuance of a guarantee obligates the guarantor (the issuer) in two respects: a. The guarantor undertakes an obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur (the noncontingent aspect). b. The guarantor undertakes a contingent obligation to make future payments if those triggering events or conditions occur (the contingent aspect). 18 9

10 FIN 45 Update GAAP Requirements Accounting Requirements - Inception ASC : At the inception of a guarantee, a guarantor shall recognize in its statement of financial position a liability for that guarantee. This Subsection does not prescribe a specific account for the guarantor s offsetting entry when it recognizes a liability at the inception of a guarantee. That offsetting entry depends on the circumstances in which the guarantee was issued. AgriBank District records as a debit to provision for credit losses and credits an other liability. ASC : Initial measurement of a guarantee liability is at the fair value of the guarantee at its inception. 19 FIN 45 Update GAAP Requirements Accounting Requirements Subsequent Measurement ASC : 35-1 This Subsection does not describe in detail how the guarantor s liability for its obligations under the guarantee would be measured after its initial recognition. The liability that the guarantor initially recognized under paragraph would typically be reduced (by a credit to earnings) as the guarantor is released from risk under the guarantee Depending on the nature of the guarantee, the guarantor s release from risk has typically been recognized over the term of the guarantee using one of the following three methods: a. Only upon either expiration or settlement of the guarantee b. By a systematic and rational amortization method c. As the fair value of the guarantee changes. AgriBank District reverses the liability and records in the ALLL when the financial letter of credit commitment is funded into a loan (no impact on the income statement due to offsetting provision entries). The fair value of the liability must be evaluated on an ongoing basis until the commitment is funded (could increase or decrease)

11 FIN 45 Update Farm Credit Impacts Materiality Assessment for Standby Letters of Credit PwC Audit Questions Related to FIN 45: Have you had any losses in 2013 related to standby letters of credit? Are any standby letters of credit considered in your allowance? Are you continuing to assess your Association s FIN 45 liability on an ongoing basis? Are individual customer ratings included as part of your FIN 45 analysis? Please reconfirm that you have not experienced any losses relating to standby letters of credit in 2013, and do not currently expect any losses. 21 FIN 45 Update Reporting Model Financial Statement Disclosures NOTE 3: LOANS AND ALLOWANCE FOR LOAN LOSSES Allowance for Loan Losses [Next three paragraphs applicable only to associations with losses on letters of credit] The Provision for (reversal of ) credit losses in the Consolidated Statements of Income includes a provision for loan losses as presented in the previous chart as well as a provision for credit losses on letters of credit. We issue standby letters of credit, which include performance and financial guarantees, for customers in connection with contracts between our customers and third parties. Standby letters of credit are agreements where we are obligated to make payment to a third party on behalf of a customer in the event the customer fails to meet their contractual obligations. During the year ended December 31, 2012, $ thousand/million of provision expense was recorded to establish a reserve on letters of credit. No additional provision for credit losses was required during the year ended December 31, The accrued credit losses are recorded in Other liabilities in the Consolidated Statements of Condition. During the year ended December 31, 2013 a portion of the established liability was funded. As a result of the funding, an allowance for loan loss of $ thousand/million has been established through a provision for loan losses while a reversal of credit losses of $ thousand/million simultaneously occurred. The accrued credit losses related to letters of credit were $ thousand/million and $ thousand/million as of December 31, 2013 and 2012, respectively. No credit losses of this nature were accrued as of December 31,

12 FIN 45 Update Reporting Model Financial Statement Disclosures NOTE 12: CONTINGENCIES AND COMMITMENTS We have commitments to extend credit and letters of credit to satisfy the financing needs of our borrowers. These financial instruments involve, to varying degrees, elements of credit risk not recognized in the financial statements. Commitments to extend credit are agreements to lend to a borrower as long as there is not a violation of any condition established in the loan contract. Standby letters of credit are agreements to pay a beneficiary if there is a default on a contractual arrangement. Commercial letters of credit are agreements to pay a beneficiary under specific conditions. At December 31, 2013, we had commitments to extend credit and unexercised commitments related to standby letters of credit [if applicable] of $ thousand/million. Additionally, we had $ thousand/million of issued standby letters of credit as of December 31, 2013, [Include for losses on letters of credit: of which $ thousand/million was included in Other liabilities in the Consolidated Statements of Condition at December 31, 2013]. Refer to Note 13 for additional discussion regarding standby letters of credit included in the Consolidated Statements of Condition. At December 31, 2013, we had commercial letters of credit of $ thousand/million. Commitments to extend credit and letters of credit generally have fixed expiration dates or other termination clauses and we may require payment of a fee. If commitments to extend credit and letters of credit remain unfulfilled or have not expired, they may have credit risk not recognized in the financial statements. Many of the commitments to extend credit and letters of credit will expire without being fully drawn upon. Therefore, the total commitments do not necessarily represent future cash requirements. Certain letters of credit may have recourse provisions that would enable us to recover from third parties amounts paid under guarantees, thereby limiting our maximum potential exposure. The credit risk involved in issuing these financial instruments is essentially the same as that involved in extending loans to borrowers and we apply the same credit policies. [Remove letter of credit references if association has no letters of credit.] 23 FAS 91 / FIN 45 Update Any other questions? 24 12

13 For additional questions or comments, please contact: Your Financial Reporting Analyst Abby Wegner at or Kim Brunner at or DISTRIBUTION: AGRIBANK DISTRICT 25 13