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FASB Statement 157:Fair Value Issues Impacting Financial Services Webcast

Wednesday, February 27th, 2008

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Welcome…

Mark ScolesFinancial Institutions

Accounting Principles Partner

Matt LuttingerFinancial ServicesAssurance Partner

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Recent developments regarding fair value measurements

• Identify some of the issues clients will face implementing FASB Statement 157

• Provide industry expertise to your clients on issues relevant to their business

Objectives

• Brief Overview of FASB Statement 157

• Common FASB Statement 157 Questions

Agenda

By the end of this session …

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Overview of key concepts

• Exit price vs. entry price

• Orderly transaction assumes pre-measurement date exposure to market

• Market participants vs. "willing parties"

• Emphasizes market-based measurement, not an entity specific measurement

• Price in principal (or most advantageous) market from seller's perspective

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Group check 1

Is application of FAS 157 at the implementation date primarily prospective or retrospective (adjust beginning retained earnings)?

Prospective

Retrospective

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Debrief

Is application of FASB Statement 157 at the implementation date primarily prospective or retrospective (adjust beginning retained earnings)?

Prospective, except for very limited financial instruments such as those traded in an active market where an entity applied a block discount

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Recent developments regarding fair value measurements

• Identify some of the issues clients will face implementing FASB Statement 157

• Provide industry expertise to your clients on issues relevant to their business

Objectives

• Brief Overview of FASB Statement 157

• Common FASB Statement 157 Questions

Agenda

By the end of this session …

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Common questions

Where do you start?Q

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Common questions

Where do you start?

• Identify assets and liabilities measured at fair value

• Identify assets and liabilities disclosed at fair value

• Determine principal (or most advantageous) market

• Prioritize use of market based inputs

• Determine hierarchy of inputs

• Classify within the hierarchy

Q

A

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Group check 2

In valuing securities does FASB Statement 157 require use of the bid price or the ask price by retail customers?

Bid price

Ask price

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Debrief

In valuing securities does FASB Statement 157 require use of the bid price or the ask price by retail customers?

Bid price

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Common questions

If a third party pricing service provides classification within the hierarchy what needs to be done?

Q

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Common questions

If a third party pricing service provides classification within the hierarchy what needs to be done?

• Client is responsible for disclosures in their financial statements

• Client needs to determine processes and controls of pricing service

• PCAOB Staff Audit Practice Alert 2

Q

A

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Group check 3

What is the primary purpose of the fair value hierarchy?

To provide disclosures that indicate the reliability of fair value measurements

To prioritize the use of observable inputs over unobservable inputs in fair value measurements

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Debrief

What is the primary purpose of the fair value hierarchy?

To prioritize the use of observable inputs over unobservable inputs in fair value measurements

Don't get caught up in thinking that the hierarchy only relates to disclosures

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Common questions

What investment securities would be Level 1?Q

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Common questions

What investment securities would be Level 1?

• Identical security traded on an active market

– Exchange traded securities

• Stocks, bonds, futures or options traded on an exchange

– Actively traded bonds

• Active market has sufficient frequency and volume of transactions to provide pricing

Q

A

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Group check 4

If an entity owns a number of securities that are traded on an active market, but uses matrix pricing as a practical expedient in measuring fair value, what level would the securities be within the hierarchy?

Level 1

Level 2

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Debrief

If an entity owns a number of securities that are traded on an active market, but uses matrix pricing as a practical expedient in measuring fair value, what level would the securities be within the hierarchy?

Level 2

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Common questions

What are some examples of investment securities that would be Level 2?

Q

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Common questions

What are some examples of investment securities that would be Level 2?

• Restricted stock of a public company

• Debt securities traded on an active market, but matrix pricing is used

• Debt securities traded on a market that is not active (few transactions and/or prices not current)

• Similar debt securities traded on a market that is not active

• Many derivatives – inputs would be Level 1

Q

A

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Common questions (cont)

What are some examples of investment securities that would be Level 2?

• Restricted stock of a public company subject to Level 2

– Example: Common stock of a public company that is restricted under Rule 144

• Restricted stock of a public company subject to Level 1

– Example: Common stock of a public company that is subject to an underwriter's lock-up agreement

Q

A

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Common questions (cont)

What are some examples of investment securities that would be Level 2?

• Similar investment securities are actively traded

– Example: No active market for US Treasury security with 37 months to maturity, but active market for those with 36 and 39 months to maturity

• Similar investment securities are traded on a market that is not active

– Subjective judgment as to similarity of security and level of activity of similar security could render Level 3

Q

A

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Common questions

What are some examples of investment securities that would be Level 3?

Q

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Common questions

What are some examples of investment securities that would be Level 3?

• Somewhat similar investment securities are traded on a market that is not active

– Amount of adjustment because only somewhat similar would render Level 3

– Amount of adjustment because the market is inactive would render Level 3

• No similar investment securities are traded

Q

A

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Group check 5

In the absence of a quoted price of an entity’s own debt and quoted prices for similar debt, can the entity look to the amount they would require from a market participant in order to issue that liability at the measurement date?

Yes

No

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Debrief

In the absence of a quoted price of an entity’s own debt and quoted prices for similar debt, can the entity look to the amount they would require from a market participant in order to issue that liability at the measurement date?

Yes

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Common questions

What about mortgage loans?Q

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Common questions

What about mortgage loans?

• Determine principal market to sell the loans

Whole loan market or securitization market?

Q

A

Q

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Common questions

What about mortgage loans?

• Determine principal market to sell the loans

Whole loan market or securitization market?

• Whole loan market

• Adjust securitization market only if there is no whole loan market

Q

A

Q

A

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Common questions

What about an investment in a portfolio company?Q

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Common questions

What about an investment in a portfolio company?

• Determine principal market to sell the investment

• Consider whether a secondary market exists

• If no market is identified consider the inputs that a hypothetical market participant would use to price the investment

– Market approach – multiple of earnings, EBITDA

– Income approach – discounted cash flows, option-pricing model

Q

A

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Common questions

What about limited partner investments in funds?Q

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Common questions

What about limited partner investments in funds?

• Determine principal market to sell the investment

• Consider whether a secondary market exists

• If no market is identified consider the inputs that a hypothetical market participant would use to price the limited partner investment

– Are restrictions an attribute of the security or the holder?

– Consider transfer restrictions and redemption provisions

Q

A

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Common questions

What about a limited partner investment in a private equity fund?

Q

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Common questions

What about a limited partner investment in a private equity fund?

• Is there a secondary market, even if not at all active?• Information about transactions in a secondary market

would be considered• What can be said about transactions in secondary

markets?– Are transaction prices at NAV, at a discount to NAV,

or at a premium to NAV?– What factors about the limited partnership

investment influence the amount of premium or discount from NAV?

Q

A

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Common questions

What about a limited partner investment in a hedge fund?Q

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Common questions

What about a limited partner investment in a hedge fund?

• Is there a secondary market, even if not at all active?

– Information about transactions in a secondary market would be considered

• If no market is identified consider the inputs that a hypothetical market participant would use to price the limited partner investment

– Are redemptions subject to a lock-up period? Is it an attribute of the security or the holder?

– Are redemptions and subscriptions at NAV? How frequent?

Q

A

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Group check 6

Does the fair value measurements of a liability reflect the reporting entity's own credit risk?

Yes

No

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Debrief

Does the fair value measurements of a liability reflect the reporting entity's own credit risk?

Yes

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