Standards Update: Familiar Faces

1. Standards Update: Familiar Faces Paul Oseland, CPA Supervising Examiner – SRM Accounting Specialist

2. Disclaimer The opinions expressed in this presentation are intended for informational purposes and are not formal opinions of, nor binding on, the Board of Governors of the Federal Reserve System or the Federal Reserve Bank of Kansas City.

3. Implementation Relief (For Some) On October 16th the FASB approved delayed implementation for certain entities for the new Hedging, Leases, CECL, and Insurance standards. Expect new Accounting Standards Updates (ASUs) in the near future.

4. This is Not a Recording The “Big Five” roll on… • Revenue Recognition (ASU 2014-09) • Implementation date: 2018 for PBEs and 2019 for non-PBEs • Financial Instruments – Recognition and Measurement (ASU 2016-01) • Implementation date: 2018 for PBEs and 2019 for non-PBEs • Leases (ASU 2016-02) • Implementation date: 2019 for PBEs and 2021 for non-PBEs • Hedging (ASU 2017-12) • Implementation date: 2019 for PBEs and 2021 for non-PBEs • CECL (ASU 2016-13) • Implementation date: 2020 for non-SRC SEC filers and 2023 for all others

5. Revenue Recognition • Establishes a 5-step, principles-based framework • Revenue is to be recognized as performance obligations are performed • Most traditional banking revenue streams are out of scope • Fee income is in scope, but generally results in same treatment as old GAAP • Changes accounting for seller financed sales of OREO • Eliminates prescriptive criteria and methods for sales treatment and gain recognition • Collectability must be probable • Buyer must be committed to perform

6. Financial Instruments – Recognition and Measurement • Changes accounting for equity investments not accounted for under the equity method or otherwise consolidated • Fed and FHLB stock is scoped out • Equity investments are reported at fair value with changes in value reflected in current earnings • Could result in volatility in bank earnings • Equity investments without readily determinable fair values measured at cost minus impairment, plus or minus observable changes in orderly transactions for the identical or similar investments of the same issuer • May affect bankers bank stock and VISA B shares • PBEs must disclose Fair Value of loans at “exit price”

7. Leases • Recognize a Right of Use (ROU) asset measured at the present value of lease payments • Option to exempt leases of one year or less • Operationally complex and may require new systems • ROU on the balance sheet will impact capital ratio calculations • May trigger Reg. H limits on investment in premises • SR 19-7 – Statement on the Implications of the New Lease Standard on Regulation H • Approval not needed at implementation, but is required following adoption

8. Hedging • Simplifies the application of the hedging model and standardizes financial statement reporting • No longer required to separately measure and report hedge ineffectiveness • Facilitates component and partial term hedges • Adds “last of layer” method to hedge closed pools of prepayable assets • Optional one-time transfer of certain HTM securities without tainting the portfolio • “Phase 2”will consider more holistic changes to hedging guidance

9. Borrower Financial Statements Consider how these standards will affect your customers • Revenue Recognition may change the timing of borrower’s earnings • Leasing may significantly impact borrower’s balance sheet • May need to modify loan covenants and policies • Hedging may be more attractive to borrowers, especially in agriculture and energy industries Educate your loan officers!

10. Reference Rate Reform • The future of LIBOR is uncertain and its publication cannot be guaranteed to continue after 2021. • The Alternative Reference Rates Committee (ARRC) selected the Secured Overnight Financing Rate (SOFR) as the recommended alternative to LIBOR • LIBOR is referenced in a wide range of financial contracts, including: • Derivatives (e.g., interest rate swaps) • Commercial loans (e.g., syndicated loans) • Consumer loans (e.g., adjustable rate mortgages) • Debt issuances (e.g., floating rate bonds and notes) • Securitized assets (e.g., mortgage-backed securities, asset-backed securities)

11. LIBOR Transition • LIBOR is currently linked to over $350 trillion of financial products in five currencies • Primarily OTC and Exchange-Traded derivatives • LIBOR reflects the cost of unsecured bank-to-bank borrowing • Published daily for five currencies and seven tenors (from overnight to 12-months) • What happens when LIBOR is gone and contracts don’t have fallback language?

12. FASB’s Response to Reference Rate Reform • Exposure draft issued September 5, 2019 proposed optional expedients and exceptions to address impact on: • Hedge accounting • Debt modifications • Optional relief can be elected at any point after the final guidance is issued and applied on a go-forward basis • Final standard expected early in 2020 • Guidance will expire after 12/31/2022

13. FASB’s Response to Reference Rate Reform Relief is available for contracts that satisfy the following “filters”: • Reference LIBOR or another reference rate that is expected to be discontinued due to reference rate reform • Have modifications that directly change, or have the potential to change, the amount and timing of contractual cash flows related to the replacement rate • Included: interest rate index, reset dates, payment dates • Excluded: notional amount, maturity date, counterparty credit spread

14. FASB’s Response to Reference Rate Reform

15. FASB Projects • Since last November the FASB has issued ten Accounting Standards Updates • Six are modifications/improvements to “Big Five” standards • Most items on the “technical agenda” are narrow in scope • Accounting for asset acquisitions, business combinations, and consolidation • Accounting for income taxes • New chairman when Russell Golden’s term expires on June 30, 2020

16. FASB – Broad Scope Projects Distinguishing Liabilities from Equity (Including Convertible Debt) • Exposure draft issued July 31, 2019 (comment period closed October 14th) • Convertible Instruments - reduce the number of accounting models for convertible debt instruments and convertible preferred stock. • Limiting the accounting models will result in fewer embedded conversion features being separately recognized from the host contract as compared with current GAAP. • Derivatives Scope Exception for Contracts in an Entity’s Own Equity - reduce form-over-substance-based accounting conclusions. • Strict application of the derivatives scope exception guidance results in accounting for some contracts as derivatives while economically similar contracts are accounted for as equity.

17. FASB – Broad Scope Projects Identifiable Intangible Assets and Subsequent Accounting For Goodwill • Invitation to comment issued July 9, 2019 (comment period closed October 7th) • Public roundtable discussion to be held on November 15, 2019 • Should Goodwill be tested for impairment, amortized, or both? • If amortized, for how long? • Should the Goodwill impairment test be changed? • Should PCC alternatives (ASU 2014-17) for customer-related intangibles and noncompete agreements be extended to all entities? • Are additional disclosures warranted?

18. Questions?