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CUNA Regulatory Comment Call

July 21, 2004

EXECUTIVE SUMMARY

• The Financial Accounting Standards Board (FASB) has issued proposed guidance (Statement of Financial Accounting Standards) to improve the current guidance for measuring fair (market) value. The Exposure Draft, Fair Value Measurements, seeks to establish a framework for measuring fair value that would apply broadly to financial and nonfinancial assets and liabilities. The aim of the proposed guidance is to improve the consistency, comparability, and reliability of fair value measurements. The proposed guidance is intended to bring together existing fair value-measurement guidance in a range of existing FASB guidance. After standardization, the fair value measurement guidance will be available in one document that supercedes current rules. In other words, the guidance would serve as a "handbook" as to how to calculate fair value.
• The proposed Statement would require expanded disclosures about the use of fair value to remeasure assets and liabilities recognized in the statement of financial position, including information about the fair value amounts, how those fair value amounts were determined, and the effect of remeasurements on earnings (including unrealized gains and losses). FASB believes that this should provide information that is useful to users of financial statements in assessing the effects of those measurements used in financial reporting.
• The issue of when to use fair value measurements — and especially how to record the resulting amounts — is extremely controversial. It is especially controversial among banks and other organizations concerned about volatility in earnings statements from a period-to-period gauging of financial instruments and nonfinancial assets and liabilities.
• FASB is committed to achieving its long-term objective of measuring all financial instruments at fair value. This Statement achieves FASB’s near-term objective of developing a Statement that clarifies the fair value measurement objective and its application in generally accepted accounting principles (GAAP). This Statement does not establish requirements for when to measure assets and liabilities at fair value. FASB expects to consider that issue on a project-by-project basis in individual pronouncements. FASB’s longer-term objective is to improve its conceptual framework, developing conceptual guidance for its use in establishing requirements for when to measure fair value that will focus on the qualitative characteristics of relevance and reliability and related trade-offs. FASB expects to address those conceptual issues in a subsequent phase of this project.
• This proposed Statement is important to FASB’s Business Combinations project, which has fair value measurement requirements. The objective of the Business Combinations project is to develop interpretive guidance on the accounting for combinations between two or more mutual enterprises (including credit unions). In 2001, FASB issued a new merger rule that eliminates the pooling-of-interests method of accounting for business combinations (simple combination of the balance sheets of the merging entities), the approach used in the majority of credit union mergers. Instead, the new rule requires the use of the purchase method of accounting. Under the purchase method, the acquiring credit union would have to determine and reflect on its financial statements the fair value of the acquired credit union’s balance sheet (including goodwill and intangible assets). Proposed business combinations guidance is expected out for public comment in the fourth quarter of 2004; and a roundtable will be held in the first quarter of 2005. In the third quarter of 2004, the FASB staff will post to its website a staff draft of a version of FASB Statement 141, Business Combinations, (revised) marked to show how it would be amended to reflect the tentative decisions reached by the Board in the purchase method procedures as of January 1, 2006. More information on FASB’s Business Combinations project is available on CUNA’s website at the following Internet address:
  http://www.cuna.org/reg_advocacy/member/hot_topic/fasb_mergersproject.html
• The proposed Statement would be effective for financial statements issued for fiscal years beginning after June 15, 2005 and interim periods within those fiscal years.
• FASB plans to conduct a public roundtable discussion on September 21, 2004 to receive additional feedback and advice before finalizing the fair value measurement guidance.
• Comments are due to FASB by September 7, 2004. Please send your comments to CUNA by August 27, 2004. Please feel free to fax your responses to CUNA at 202-638-7052; e-mail them to Associate General Counsel Mary Dunn at mdunn@cuna.com or to Senior Regulatory Counsel Catherine Orr at corr@cuna.com; or mail them to Mary or Catherine in c/o CUNA's Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, 6th Floor - South Building, Washington, DC 20004-2601. You may also contact us if you would like a copy of the FASB Exposure Draft or you may access it on the FASB website at the following address:
  http://www.fasb.org/draft/ed_fair_value_measurements.pdf

DESCRIPTION OF THE PROPOSED STATEMENT

Definition of "Fair Value"

• The proposed Statement defines "fair value" as "the price at which an asset or liability could be exchanged in a current transaction between knowledgeable, unrelated willing parties."
• The objective of a fair value measurement is to estimate an exchange price for the asset or liability measured in the absence of an actual transaction for that asset or liability.

Valuation Techniques

• The proposed Statement would require that in the absence of quoted prices for identical or similar assets or liabilities, fair value must be estimated using multiple valuation techniques consistent with the market approach, income approach, and cost approach whenever the information necessary to apply those techniques is available without undue cost and effort. In all cases, the valuation techniques used for those estimates would emphasize relevant market inputs, including those derived from active markets.

• The market approach requires observable prices and other information generated by actual transactions involving identical, similar, or otherwise comparable assets or liabilities. The estimate of fair value is based on the value indicated by those transactions.
• The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The estimate of fair value is based on the value indicated by marketplace expectations about those future amounts.
• For an asset, the cost approach considers the amount that currently would be required to replace its service capacity. The estimate of fair value considers the coast to acquire a substitute asset of comparable utility, adjusted for obsolescence.



• According to the proposed Statement, valuation techniques used to estimate fair value shall emphasize market inputs, including those derived from active markets, whether using the market approach, income approach, or cost approach.

Fair Value Hierarchy

• The proposed Statement would establish a framework or hierarchy that groups into three broad categories (levels) the inputs that should be used for all estimates of fair value, considering the relative reliability of the estimates. In general, the more market inputs, the more reliable the estimate. Accordingly, the fair value hierarchy gives the highest priority to market inputs that reflect quoted prices in active markets and the lowest priority to inputs that reflect an organization’s own internal estimates and assumptions. The three levels, in order of highest to lowest priority, are as follows:

• Level 1 Estimates
  Fair value shall be estimated using quoted prices for identical assets or liabilities in active reference markets whenever that information is available.
• Level 2 estimates
  If quoted prices for identical assets or liabilities in active markets are not available, fair value shall be estimated using quoted prices for similar assets or liabilities in active markets, adjusted as appropriate for differences, whenever that information is available. The price effect of the differences must be objectively determinable.
• Level 3 estimates
  If quoted prices for identical or similar assets or liabilities in active markets are not available, or if differences between similar assets or liabilities are not objectively determinable, fair value shall be estimated using multiple valuation techniques consistent with the market approach, income approach, and cost approach whenever the information necessary to apply those techniques is available without undue cost and effort.

Disclosures

• At initial recognition (including in a business combination) many assets and liabilities are measured in the statement of financial position at amounts that approximate fair value. The proposed Statement would require disclosures in situations in which fair value is used to remeasure those assets and liabilities in subsequent periods.
• An entity would have to disclose the following information about the use of fair value to remeasure assets and liabilities recognized in the statement of financial position for each interim and annual period for which a statement of financial position is presented:

• For assets and liabilities that are measured at fair value on a recurring (ongoing) basis during the period: (1) the fair value amounts at the end of the period, in total and as a percentage of total assets and liabilities; (2) how those fair value amounts were determined (valuation techniques used); (3) the effect of the remeasurements on earnings for the period (unrealized gains or losses) relating to those assets and liabilities still held at the reporting date.
• For assets and liabilities that are remeasured at fair value on a nonrecurring (periodic) basis during the period (for example, impaired asets): (1) the reason for the remeasurements; (2) the fair value amounts; (3) how those fair value amounts were determined (valuation techniques used); (4) the effect of the remeasurements on earnings for the period relating to those assets and liabilities still held at the reporting date.



• The objective of the disclosures is to provide, in one place, information about the extent to which fair value is remeasure assets and liabilities, incorporating the similar information disclosed under other pronouncements.

Definition of Fair Value

1. Will credit unions be able to consistently apply the fair value measurement objective using the guidance provided by this proposed statement together with other applicable valuation standards and generally accepted valuation practices?
   
   Yes ______ No ______
   
   If not, what additional guidance is needed?
   
   

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Valuation Techniques

2. This proposed Statement would clarify and incorporate the guidance contained in FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements, for using present value techniques to estimate fair value (Appendix A). That FASB Concepts Statement is available on the FASB website at http://www.fasb.org/pdf/con7.pdf. Is that guidance sufficient?
   
   Yes ______ No ______
   
   If not, what additional guidance is needed?
   
   

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Active Markets

3. This proposed Statement would clarify the valuation techniques used to estimate fair value should emphasize market inputs, including those derived from active markets. In this proposed Statement, active markets are those in which quoted prices are readily and regularly available; readily available means that pricing information is currently accessible and regularly available means that transactions occur with sufficient frequency to provide pricing information on an ongoing basis. Is that guidance sufficient?
   
   Yes ______ No ______
   
   If not, what additional guidance is needed?
   
   

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Valuation Premise

4. This proposed Statement would provide general guidance for selecting the valuation premise that should be used for estimates of fair value. Appendix B illustrates the application of that guidance (Example 3). Is that guidance sufficient?
   
   Yes ______ No ______
   
   If not, what additional guidance is needed?
   
   

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Fair Value Hierarchy

5. This proposed Statement would establish a hierarchy for selecting the inputs that should be used in valuation techniques used to estimate fair value. Those inputs differ depending on whether assets and liabilities are identical, similar, or otherwise comparable. Appendix B provides general guidance for making those assessments (Example 4). Is that guidance sufficient?
   
   Yes ______ No ______
   
   If not, what additional guidance is needed?
   
   

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Level 1 Reference Market

6. In this proposed Statement, the Level 1 reference market is the active market to which an entity has immediate access or, if the entity has immediate access to multiple active markets, the most advantageous market. Appendix B provides general guidance for selecting the appropriate reference market (Example 5). Is that guidance sufficient?
   
   Yes ______ No ______
   
   If not, what additional guidance is needed?
   
   

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Level 3 Estimates

7. This proposed Statement would require that in the absence of quoted prices for identical or similar assets or liabilities in active markets, fair value be estimated using multiple valuation techniques consistent with the market approach, income approach, and cost approach whenever the information necessary to apply those techniques is available without undue cost and effort (Level 3 estimates). Appendix B provides general guidance for applying multiple valuation techniques (Examples 6-8). Is that guidance sufficient?
   
   Yes ______ No ______
   
   If not, what additional guidance is needed?
   
   

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Fair Value Disclosures

8. This proposed Statement would require expanded disclosures about the use of fair value to remeasure assets and liabilities recognized in the statement of financial position. Appendix B illustrates those disclosures. The proposed Statement also would encourage disclosures about other similar remeasurements that, like fair value, represent current amounts. FASB concluded that those disclosures would improve the quality of information provided to users of financial statements. Do you agree?
   
   Yes ______ No ______
   
   If not, why not?
   
   

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Effective Date

9. FASB believes that the effective date provides sufficient time for entities to make the changes necessary to implement this proposed Statement. Do you agree?
   
   Yes ______ No ______
   
   If not, please explain the types of changes that would be required and indicate the additional time that would be needed to make those changes.
   
   

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Other Issues

10. This proposed Statement represents the completion of the initial phase of this fair value project. In subsequent phases, FASB expects to address other issues, including issues relating to the relevance and reliability of fair value measurements and the unit of account that should be used for those measurements. Are there any other issues should the Board address?
    
    Yes ______ No ______
    
    If so, what are those issues and how should FASB prioritize those issues?
    
    

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11. Other comments?

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