The hairsplitting points of Emerging Issues Task Force (EITF) 03-1 remain murky, and market participants gathered at the American Securitization Forum Sunset Seminar in New York were hoping for a brief reprieve. The rule, as originally released, is slated to take effect later this week, but there have been new developments.
Earlier this month, the Financial Accounting Standards Board (FASB) proposed to postpone the implementation of the effective date for paragraph 16 of EITF 03-1, which addresses most debt securities that are underwater solely because of an increase in interest rates. Two FASB Staff Position (FSP) were released seeking comment on the issue. Comments for the FSP proposing to defer portions of EITF 03-1 are due by Sept. 29, and comments on the proposed FSP providing clarifying guidance for parts of EITF 03-1 are due Oct. 29.
With the proposed rule, the FASB will establish rules governing the timing of recording losses on underwater bonds, while also restricting the ability to sell those bonds without recording a loss on other securities in the portfolio. The new rules would only affect those securities that are held available for sale (AFS).
“If a bond is carried as available for sale, and the fair value is less than the amortized cost, management must assert that it has the intent and ability to hold that security until the date that the market value is expected to at least equal the then current amortized cost,” said Marty Rosenblatt of Deloitte & Touche during a panel discussion at the ASF meeting.
The FASB has yet to offer any guidance on how the hypothetical date would be calculated. “A model could be created based on historical volatility of interest rates,” Rosenblatt added.
The FASB’s novel concept of a “minor impairment” also has many in the industry scratching their heads. Under the rule, as currently proposed, management would not be required to make any claims regarding a security that suffers only minor impairment. However, it is not clear what qualifies as minor. A quantitative definition could solve the problem, and the SEC has specifically asked for comments on whether the FASB should specify a numerical threshold such as 5% or less. “Five percent will not satisfy many investors holding securities of longer duration where price variance can easily exceed 5% when general interest rates increase or sector spreads widen,” Rosenblatt said.
Another question appearing in the second proposed FSP is: at what point will sales of impaired bonds call into question, or “taint,” the assertions made by management with respect to their intent to hold other underwater securities in the portfolio? The proposed FSP will allow for certain sales, provided they are in response to unexpected and significant changes in conditions.
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