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Investment securities: 5 things you need to know · PwC's accounting podcast

• 0:00
  SPEAKER_01: Thought leadership from PWC.
• 0:07
  SPEAKER_00: Welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_00: I'm Heather Horn.
• 0:12
  SPEAKER_00: Thanks so much for joining us today for the next month in our Tuesday series, in which we're shaking things up a bit and bringing in one of our all-star podcast guests to take over the series, picking the topics for the month, and joining me on all the episodes.
• 0:28
  SPEAKER_00: My guest for August is Brett Dooley, Deputy Chief Accountant in PWC's national office, who leads our financial instruments team.
• 0:36
  SPEAKER_00: So we know that August is a busy month with vacations and preparing for back to school, and perhaps not the month that you really are dying to dive in deep into technical accounting matters.
• 0:49
  SPEAKER_00: So Brett had a proposition and a commitment for you.
• 0:53
  SPEAKER_00: Each of his episodes this month will hit a current accounting hot topic and bring you five things you need to know in under 25 minutes.
• 1:02
  SPEAKER_00: Stay tuned to see how he does on that commitment.
• 1:06
  SPEAKER_02: Whether it's a core part of your business or risk management model, like in a financial services company, or more of a separate treasury or investing function, we see these investment security questions being dealt with by a really wide range of companies.
• 1:21
  SPEAKER_00: That was Brett kicking us off.
• 1:24
  SPEAKER_00: Today's episode focuses on the accounting for investments.
• 1:28
  SPEAKER_00: And we all know investments like Hell to Maturity Securities have gotten a lot of headlines lately.
• 1:34
  SPEAKER_00: So Brett shares the latest insights on HTM securities and other investment securities topics, which raise questions from a wide range of companies beyond financial institutions.
• 1:46
  SPEAKER_00: He also hits tips on debt securities available for sales securities, foreign currency bonds, and the measurement alternative for equity securities.
• 1:54
  SPEAKER_00: So all great information and spoiler alert, we come very, very close to squeezing this all in to 25 minutes.
• 2:03
  SPEAKER_00: So stay tuned to hear what he has to say.
• 2:11
  SPEAKER_00: So, Brett, thanks so much for joining me today.
• 2:14
  SPEAKER_00: And this is our first topic in our August series.
• 2:16
  SPEAKER_00: And I'm so excited about the theme because we sort of went back to the beginning of the podcast when we used to do this five things you need to know about whatever topic.
• 2:25
  SPEAKER_00: And today's topic is investment securities, which I know there's a big focus on.
• 2:31
  SPEAKER_00: But maybe before we get into the topic, can you just share how you came up with this idea to do the five things and what we're planning for the series?
• 2:39
  SPEAKER_02: Yeah, I'm I'm excited to kick off the series too.
• 2:41
  SPEAKER_02: And I've I figured it's August, it's hot, people are on vacation, um, and we should try to keep it light.
• 2:49
  SPEAKER_02: That being said, we are talking about financial instruments type topics, and so it's hard to keep those really fun.
• 2:55
  SPEAKER_02: So I figured at least we can keep it short and to the point.
• 2:58
  SPEAKER_02: So I think of this as five minutes each on five reminders today on the topic of investment securities, and we'll see how how well we do with with keeping it.
• 3:07
  SPEAKER_02: The timing.
• 3:08
  SPEAKER_00: Yes.
• 3:09
  SPEAKER_02: You know, but also like whether it's a core part of your business or risk management model, like in a financial services company, or more uh of a separate treasury or investing function, we see these investment security questions uh being dealt with by a really wide range of companies.
• 3:25
  SPEAKER_02: So maybe today our listeners will learn something totally new, um, or maybe they'll just get a quick reminder of some aspects of what our clients are thinking about or or should be thinking about in the current environment.
• 3:35
  SPEAKER_00: Well, and I think Brett, before we get into the topic, it's uh funny.
• 3:38
  SPEAKER_00: I was actually talking a couple weeks ago to someone who said they dealt with investment securities, but not from the banking side.
• 3:46
  SPEAKER_00: And I think it's just such a good reminder that this is a huge issue.
• 3:49
  SPEAKER_00: There's you know two sides here, and so this is definitely not just a financial services topic.
• 3:54
  SPEAKER_00: Trevor Burrus, Jr.
• 3:54
  SPEAKER_02: Right.
• 3:55
  SPEAKER_02: And and but in financial services, it's also very top of mind with some of the recent bank fail failures, suddenly held maturity securities like are being talked about in the popular press, and my parents are asking me what I know about that, and so uh maybe we'll learn some things there as we go along.
• 4:12
  SPEAKER_00: So here we go.
• 4:12
  SPEAKER_00: Now we're gonna start our 25-minute clock.
• 4:14
  SPEAKER_00: So what's first on your list of reminders?
• 4:17
  SPEAKER_02: My first reminder is you may have a debt security but not know it.
• 4:23
  SPEAKER_02: Um and when we talk about debt securities, it sounds simple.
• 4:27
  SPEAKER_02: Um, you think you have a bond, a fixed income instrument, um, and often it it is simple, but it's often not that easy.
• 4:35
  SPEAKER_02: Um, the scope of the literature here, it's ASC320, will include um more than just legal form debt instruments.
• 4:44
  SPEAKER_02: Um and generally um there is a definition in the accounting literature, an accounting definition of a security.
• 4:50
  SPEAKER_02: It's slightly different um than a legal definition of a security.
• 4:54
  SPEAKER_02: So I don't want to overcomplicate this discussion, but I think it's important to start with knowing that uh just having a debt security, a legal form debt security, may not be your right starting point.
• 5:06
  SPEAKER_02: You need to start uh in the literature.
• 5:08
  SPEAKER_00: All right.
• 5:09
  SPEAKER_00: So start in the literature, but what are some of the complexities should we should be focused on?
• 5:13
  SPEAKER_02: Maybe I'll I'll focus on three questions that that often come up.
• 5:17
  SPEAKER_02: Um first is on preferred stock.
• 5:20
  SPEAKER_02: Oftentimes, uh, you know, the the business talks, I I bought preferred equity, and you hear the word equity and you think I'm gonna be an equity model, but it may not be that simple because preferred stock that's mandatorily redeemable or is redeemable at the investor's option is accounted for as a debt security.
• 5:38
  SPEAKER_02: So this can be complicated sometimes when dealing with contingent redemption options.
• 5:42
  SPEAKER_02: And we ask ourselves first, who controls that contingency?
• 5:46
  SPEAKER_02: Because if the investor controls it, it would qualify as a debt security.
• 5:50
  SPEAKER_02: The other thing we remind people is that passage of time is not a contingency.
• 5:56
  SPEAKER_02: So if you have an instrument that becomes putable at the investor's option at a certain point of time, that is accounted for as a debt security uh throughout its throughout its life.
• 6:07
  SPEAKER_02: However, if the option is outside of the investor's control, we see this with a redemption option that allows the investor to put upon the issuer going public doing an IPO, that would not be considered a debt security because that's considered to be a contingent event outside of the control of the investor.
• 6:27
  SPEAKER_00: So, Brett, this is sort of the flip side of the liability versus equity analysis that the issuer is doing for these securities?
• 6:34
  SPEAKER_02: It is, but it's not symmetrical.
• 6:36
  SPEAKER_00: Okay, that was why I asked the question, because it didn't sound symmetrical.
• 6:40
  SPEAKER_00: So what are if we're thinking then, so obviously these contracts can get very complicated economically very quickly, and you don't want to just be focused on this preferred equity title.
• 6:52
  SPEAKER_00: So what are what should you be looking at then?
• 6:55
  SPEAKER_02: Well you need to look at the provisions in the contract itself.
• 6:58
  SPEAKER_02: So when if someone starts with preferred equity, you need to understand these redemption options and understand uh where they fit within the model I just laid out.
• 7:06
  SPEAKER_00: All right.
• 7:06
  SPEAKER_00: So then what are some of the other things that you have people focus on?
• 7:10
  SPEAKER_02: Yeah, another area that and that trips people up is where um it's actually in a different part of the literature in our in the transfers guidance.
• 7:18
  SPEAKER_02: Um it's ASC 860 for the for the accounting savvy.
• 7:22
  SPEAKER_02: But financial assets that that can be contractually prepaid or settled in a way that you don't get all substantially all of your investment could be accounted for as a debt security.
• 7:33
  SPEAKER_02: So that sounds confusing, but think of it in the world of a securitization vehicle where a securitization trust owns some assets, let's say it owns variable rate assets, floating rate assets, and issues fixed-rate debt securities.
• 7:48
  SPEAKER_02: There are interest rate scenarios, if that's all it has, where the interest rates could go so low that those fixed-rate security investors don't get all of their contractually promised money back.
• 8:01
  SPEAKER_02: Generally, securitization trusts are set up with interest rate swaps or other derivatives or are structured in a way that that wouldn't happen in most scenarios.
• 8:12
  SPEAKER_02: But the accounting literature doesn't have a probability test to it.
• 8:16
  SPEAKER_02: It's are there any scenarios where you could uh not get your full contractual cash flows back?
• 8:22
  SPEAKER_02: And so you need to think about all possible scenarios.
• 8:25
  SPEAKER_02: And oftentimes we see in these securization vehicles that they fail this test.
• 8:30
  SPEAKER_02: And so whether they're issued in the legal form debt security or legal form loan, they often are counted for as debt securities.
• 8:39
  SPEAKER_00: Uh so definitely understanding the terms of the contract is a good reminder on that one.
• 8:44
  SPEAKER_00: So then, Brett, you mentioned held maturity securities at the very beginning of uh the podcast.
• 8:50
  SPEAKER_00: And I know that's a place where we can get questions because there is an election you can make where if you have a held maturity security, you can account for it at amortized cost, not fair value.
• 9:03
  SPEAKER_00: And so decreases in fair value would not be necessarily reflected on the balance sheet, or they wouldn't be, they'd just be in the disclosure.
• 9:10
  SPEAKER_00: So, how do we think about that?
• 9:13
  SPEAKER_02: Yeah, that's a good summary and a pretty easy summary on a topic that has gotten a lot of attention lately.
• 9:19
  SPEAKER_02: So, my second reminder here is that there's more to held to maturity than just holding on.
• 9:25
  SPEAKER_02: First of all, upon designation or upon purchase, a company needs to have a definitive intent to hold all the way to maturity.
• 9:33
  SPEAKER_02: That sounds like it could be simple, just declaring an intent, but it can be more complicated because sometimes these debt securities have a very long contractual life.
• 9:42
  SPEAKER_02: And so you're you're actually making a forecast and declaring an intent for a long period of time.
• 9:47
  SPEAKER_02: And especially now, I think there's a lot of scrutiny put on this designation and the documentation analysis supporting it.
• 9:55
  SPEAKER_02: So, questions might you might ask, how are you gonna demonstrate that you have the ability and intent to hold them all the way to maturity?
• 10:02
  SPEAKER_02: Have you considered different interest rate scenarios?
• 10:05
  SPEAKER_02: Have you considered different um economic conditions?
• 10:09
  SPEAKER_02: Have you considered different liquidity scenarios and where you may need cash?
• 10:13
  SPEAKER_02: And can you really assert that you're gonna hold these all the way to maturity, even in light of all of those different scenarios that may come to fruition uh during the life of that security?
• 10:25
  SPEAKER_02: And second reminder here is that the intent is declared at inception, but you have to continue to reassess it every period.
• 10:34
  SPEAKER_02: You have to continue to think about have your business plans changed as economic conditions changed, what has changed that could that could uh change that intent.
• 10:44
  SPEAKER_02: And then third, I remind people that there are actually a few scenarios where held to maturity security can be disposed of early without consequences.
• 10:53
  SPEAKER_02: Um they're spelled out in the literature, and frankly, we don't see them often in in practice.
• 10:58
  SPEAKER_02: So I'm not going to go through them here, but they are things like a significant downgrade in um in credit quality or a significant business combination or disposition, very significant regulatory capital changes, those may qualify as an event that you could actually choose to sell a held maturity security.
• 11:19
  SPEAKER_02: But among that list is not interest rate changes.
• 11:22
  SPEAKER_02: So uh or or changes in expected liquidity needs.
• 11:26
  SPEAKER_02: So what we find ourselves now is some companies have very long-dated fixed-rate securities that they that they bought and they're sitting in held maturity with very large, unrealized losses uh on those securities because of the interest rate uh increases that we've seen over the past year.
• 11:42
  SPEAKER_02: And they may want to turn over that portfolio in order in order to increase their overall investment yield, but it's just not allowable exception uh to be able to sell or transfer those securities.
• 11:53
  SPEAKER_00: So, Brad, I guess two things I take from that.
• 11:56
  SPEAKER_00: A lot of judgment involved that you need to be considering up front before you make this designation.
• 12:03
  SPEAKER_00: But then also it's almost like if you are looking at any type of security with any duration, you want to make sure, you know, there's more to this analysis.
• 12:12
  SPEAKER_00: So if it's three months versus well, you wouldn't do this with three months, maybe, but if it's a year versus 30 years, there's maybe a different bar you want to be using.
• 12:21
  SPEAKER_00: But I like how what are you seeing people really focus on as you're thinking about this?
• 12:27
  SPEAKER_02: Yeah, I mean, I think it comes down to a very holistic um approach and analysis when you're when you're looking at that.
• 12:34
  SPEAKER_02: We talked about different interest rate scenarios, different business needs, and making sure that when you take your whole portfolio, not just these held maturity securities, but also your AFS securities, your trading securities, make sure that that whole picture and your whole portfolio makes sense.
• 12:50
  SPEAKER_02: Because HTM, the held maturity, is intended to be a very restricted designation.
• 12:54
  SPEAKER_02: So we advise clients to think very carefully about whether to use this at all, um, and then also the extent to which they use it.
• 13:03
  SPEAKER_00: So to the point that someone did make the decision to make this designation, but then they they do have to um there and then they conclude that they no longer have the intent and ability to hold, or in fact, they actually dispose of it, then sort of what are the implications of that?
• 13:21
  SPEAKER_02: Right.
• 13:21
  SPEAKER_02: So the as soon as you don't longer have the intent to hold maturity, the accounting is that you should reclassify that to available for sale and do all the the uh accounting for available for sale, you mark it to fair value uh with changes in OCI.
• 13:36
  SPEAKER_02: But the important thing here is you need to consider the tainting, what we call, of the remaining held to maturity portfolio and future assertions.
• 13:43
  SPEAKER_02: So if you do either sell or decide that you no longer intend to hold without qualifying for one of the exceptions in the literature, it calls a number of things into question.
• 13:53
  SPEAKER_02: First, it could call into question your previous assertions.
• 13:56
  SPEAKER_02: Did you really have the right analysis in the first place to put it into held to maturity?
• 14:02
  SPEAKER_02: And second, it may call into question the classification of other held to maturity.
• 14:07
  SPEAKER_02: So you changed these, but why not your whole portfolio?
• 14:10
  SPEAKER_02: Uh we call this a tainting event, which again happens fairly rarely in practice, but it's something that we always are concerned about and talk about.
• 14:18
  SPEAKER_00: Well, yeah, and I think this is why you really need to think before you do the designation.
• 14:23
  SPEAKER_00: The other place we see tainting is normal purchases and normal sales for commodities, and it's the same thing.
• 14:29
  SPEAKER_00: You really want to make sure you're going to qualify for that throughout the duration of the contract, or you don't want to make the designation.
• 14:35
  SPEAKER_00: So it's it's very similar.
• 14:36
  SPEAKER_00: It may not be a helpful analogy to many of our listeners, but if you're in the commodity space, it could be helpful.
• 14:42
  SPEAKER_00: So let's go on then to you mentioned available for sale and that you have to sort of switch models.
• 14:50
  SPEAKER_00: And so if we are in available for sale and we're seeing losses, which we may be right now, um, we're actually seeing those on the balance sheet, but those changes in fair value are going through OCI.
• 15:01
  SPEAKER_00: So how are you thinking about that?
• 15:04
  SPEAKER_02: Um my reminder here, our third one, is that unrealized losses on AFS securities don't always just sit in OCI.
• 15:12
  SPEAKER_02: So, like we talked about, given how rates have moved uh in the past year, a lot of fixed-rate debt securities are in an unrealized loss position.
• 15:20
  SPEAKER_02: They're underwater, as we call it.
• 15:22
  SPEAKER_02: Um for available sale bonds in a loss position, companies need to determine whether that unrealized loss should remain in OCI or should actually flow through and be reclassified to earnings.
• 15:34
  SPEAKER_02: So the the key consideration here is determining whether you have an intent to sell a security, or it's more likely than not that you'll be required to sell the security before recovering to its amortized cost basis.
• 15:48
  SPEAKER_02: Um if either of those is true, you either have the intent to sell or you may be required to sell.
• 15:54
  SPEAKER_02: It's more than likely you'll be required to sell.
• 15:57
  SPEAKER_02: Um, then you should impair the security all the way down to its fair value with any amounts in OCI being recorded uh in income.
• 16:06
  SPEAKER_02: If those aren't aren't true, so you don't have the intent to sell, and it's not more likely than not that you're gonna be required to sell.
• 16:13
  SPEAKER_02: It's a mouthful, but we I think we get the concept.
• 16:15
  SPEAKER_02: You know, a company may determine that an unrealized loss amount is as a result of credit factors.
• 16:21
  SPEAKER_02: It's not just interest rates affecting this.
• 16:24
  SPEAKER_02: If it is determined that all or a portion of that loss is related to credit, you know, counterparty credit worthiness, then allowance for credit losses should be established through income for the portion of that loss that relates to credit.
• 16:36
  SPEAKER_02: Again, the the interest rate component of that loss should remain in OCI.
• 16:42
  SPEAKER_00: Well, and I think this is one of the areas that in particular for um, I'll say non-financial services companies dealing with this, where maybe they're not as focused on credit and interest rates and otherwise, this is one of the places where it can get very complicated just doing the measurement.
• 16:57
  SPEAKER_00: And so you don't want to miss this.
• 16:59
  SPEAKER_00: You want to make sure you're really focused on that.
• 17:01
  SPEAKER_00: But what are some of the common questions you're seeing because we're seeing so much interest rate movement, and if it links back to credit, that's great, or if it's just focused on interest rates, that's good too.
• 17:13
  SPEAKER_02: Yeah.
• 17:14
  SPEAKER_02: Maybe I'll give two common questions we're seeing.
• 17:16
  SPEAKER_02: One, I'll pick up on the credit point you raised.
• 17:19
  SPEAKER_02: How to determine whether that unrealized loss is related to credit or non-credit related.
• 17:24
  SPEAKER_02: And there's some factors in the literature that that help you with this.
• 17:27
  SPEAKER_02: Um, you know, the extent to which fair value is less than amortized cost, you know, the issuer's financial condition, their credit ratings uh maybe, other adverse factors happening in the issuer's industry.
• 17:39
  SPEAKER_02: But interestingly, like here, length of time should not be a factor.
• 17:43
  SPEAKER_02: If something's been underwater for a long time, it can be underwater for a long time just due to interest rates.
• 17:48
  SPEAKER_02: So it it's not just enough to say it's been underwater for a long period.
• 17:53
  SPEAKER_02: The second um thing I would note here is questions come up about how to do this whole analysis if if you've outsourced the management of that portfolio to a third-party investment manager.
• 18:06
  SPEAKER_02: Um, the easy answer is, well, I'm not declaring any intent because they're they're doing it for me, but you can probably guess that's it's not gonna be that simple.
• 18:15
  SPEAKER_02: So the assessment has to be the same, whether the company itself is making those decisions or if they've hired a third party to make those decisions.
• 18:22
  SPEAKER_02: The company still has to assert whether they have the intent to sell a security or are, you know, could be required to sell the security when determining a write down is necessary.
• 18:32
  SPEAKER_02: So that's gonna require some communication with the investment manager who may be making those decisions on behalf of the company to settle up on what the intent is for uh individual security.
• 18:43
  SPEAKER_02: But the other message here is it's it's not automatically impaired just because you're using a third-party manager.
• 18:49
  SPEAKER_02: You're gonna have to do the work and have some discussions with how those securities are being managed.
• 18:53
  SPEAKER_00: Yes, and having dealt with this when I was an audit partner, I will personally state that you would think it would be easier because there's a third-party manager involved.
• 19:02
  SPEAKER_00: And if anything, I think sometimes it can be more complicated.
• 19:05
  SPEAKER_00: And so it's definitely management still needs to be to make sure they're they're doing this analysis and they're able to make this assertions.
• 19:13
  SPEAKER_00: And I guess the other thing here, Brett, for all of these is that's a good reminder.
• 19:17
  SPEAKER_00: You can't just kind of carry forward your accounting each period, but you have to really be looking at it.
• 19:23
  SPEAKER_00: But with that said, that's not one of your counted reminders.
• 19:26
  SPEAKER_00: So what's your your fourth one?
• 19:28
  SPEAKER_02: We're on number four now.
• 19:29
  SPEAKER_02: Um so my fourth reminder, I'm gonna stay with debt securities, uh, and it is that life isn't fair for foreign currency bonds.
• 19:37
  SPEAKER_00: Or in general.
• 19:38
  SPEAKER_00: But maybe that's beyond our 25 minutes.
• 19:43
  SPEAKER_00: So yeah.
• 19:45
  SPEAKER_02: So um, you know, for I think for people who don't spend a lot of time with foreign currency accounting, it can be sort of confusing.
• 19:51
  SPEAKER_02: And and one thing that we often anchor ourselves to is that monetary assets and liabilities are translated at spot rates every every period, with changes in those spot rates going through income.
• 20:02
  SPEAKER_02: Uh, and sometimes it will be that easy.
• 20:04
  SPEAKER_02: So here we give credit to held maturity securities.
• 20:07
  SPEAKER_02: Um, they are considered monetary assets and they follow that model where changes in spot rate are recognized as gains and losses in income just as you'd expect.
• 20:17
  SPEAKER_02: But it gets more complicated for trading securities.
• 20:20
  SPEAKER_02: Those are the ones that are marked to fair value through earnings every period.
• 20:24
  SPEAKER_02: And they're actually considered to be non-monetary assets.
• 20:27
  SPEAKER_02: But because they are um all changes in fair value are going through earnings, you know, changes in value due to foreign exchange rate changes, are they're just part of that overall mark that's gonna flow through earnings.
• 20:39
  SPEAKER_02: And so then we hit available for sales securities, right?
• 20:42
  SPEAKER_02: Um and they're interestingly also considered non-monetary.
• 20:46
  SPEAKER_02: So there's a special rule that says for changes in fair value due to changes in the FX rate, it goes along to OCI just with other changes in value.
• 20:57
  SPEAKER_02: So FX changes shouldn't be factored into the credit loss uh analysis we just discussed.
• 21:03
  SPEAKER_02: You know, when computing expected cash flows, you use the historical rate when that was in effect when you bought it.
• 21:10
  SPEAKER_02: And those FX gains and losses reported in OCI are only reclassified to income either upon maturity of the security, sale of the security, or if there's impairment.
• 21:20
  SPEAKER_00: So in some ways, this is simplifying the analysis, right?
• 21:24
  SPEAKER_00: Because you don't have to sort of tease apart what's foreign currency and what's interest rate, and you just have it all in OCI until one of these events occurs.
• 21:32
  SPEAKER_02: That's right.
• 21:33
  SPEAKER_00: All right.
• 21:34
  SPEAKER_00: So now number five.
• 21:36
  SPEAKER_00: And so if I'm counting right, we've had four for debt securities, and equity securities is only getting one reminder.
• 21:42
  SPEAKER_00: So what but it better be a big one.
• 21:44
  SPEAKER_02: It's an important one.
• 21:45
  SPEAKER_02: Uh my my reminder here is that the measurement alternative is often not an easy shortcut.
• 21:51
  SPEAKER_00: Good reminder.
• 21:52
  SPEAKER_00: So I think here I'll chime in and remind listeners that the basic model for equity securities, and I hope all of Our listeners are aware of this, is to mark to fair value with changes reported in income.
• 22:04
  SPEAKER_00: And that's basically the same as accounting for trading debt securities.
• 22:08
  SPEAKER_00: But there is an option, I'll use the word option for private equity securities that you can elect this measurement alternative, which would essentially mark the most recent observable price, and then you hold it there until there's another one.
• 22:22
  SPEAKER_00: And you know, I think the intent with this, although I'll defer to Brett, is really because maybe you're not seeing observable prices every day.
• 22:29
  SPEAKER_00: And so this is intended in some ways to simplify.
• 22:33
  SPEAKER_00: However, it can be challenging because there's a concept in the measurement alternative that can be elected on an optional basis if you don't have readily determinable fair value.
• 22:44
  SPEAKER_00: But with that, maybe I'll hand it to you, Brett, to really explain what we're we're saying there.
• 22:49
  SPEAKER_02: Yeah.
• 22:49
  SPEAKER_02: And I think you're right.
• 22:51
  SPEAKER_02: People often think of this measurement alternative as like a shortcut or an easy way to get to fair value because they think, well, I'm not going to have to come up with some model to estimate fair value for something that is, by definition, not publicly traded.
• 23:05
  SPEAKER_02: Right.
• 23:05
  SPEAKER_02: But I think often those expectations of this being easy are wrong.
• 23:09
  SPEAKER_02: And I'll give I'll give quick th three quick reasons for it.
• 23:12
  SPEAKER_02: Okay.
• 23:13
  SPEAKER_02: Um first, it can often be difficult in practice to determine when the remeasurement of securities are required because you're trying to find these observable transactions.
• 23:23
  SPEAKER_02: So the guidance says that companies should make a reasonable effort to identify observable price changes, but you don't need to expend undue cost and effort.
• 23:33
  SPEAKER_02: So what does that mean?
• 23:35
  SPEAKER_00: Yeah, what is undue?
• 23:36
  SPEAKER_02: We think companies should establish policies and controls for how it's going to monitor for observable transactions.
• 23:42
  SPEAKER_02: Some of them are easy.
• 23:43
  SPEAKER_02: Think of when you're invested in common stock of a private company and they do a new round financing and they issue more common stock.
• 23:52
  SPEAKER_02: You may participate in that round of financing.
• 23:56
  SPEAKER_02: Those prices may be very observable to you.
• 23:58
  SPEAKER_02: So generally that's going to be an observable transaction.
• 24:02
  SPEAKER_02: And then you'll have to determine if what whatever they issued new is the same or similar to what you hold.
• 24:09
  SPEAKER_02: Sometimes you have an arm's length transaction between two investors selling the same security.
• 24:14
  SPEAKER_02: That can be tricky because if you know about it, you know the terms and you know the prices, that would be an observable transaction.
• 24:21
  SPEAKER_02: But often in this world, if if two other investors, you know, sell buy their securities, you may not know the details of that transaction.
• 24:30
  SPEAKER_02: Um just because you have no business reason to know it.
• 24:33
  SPEAKER_02: Um sometimes we come into this where a single investor sells a portion of their holdings, and so they know what that price was.
• 24:42
  SPEAKER_02: They clearly have an observable transaction, and that will require them then to mark up the remaining uh securities that they hold because they had an observable transaction.
• 24:52
  SPEAKER_00: Or markdown.
• 24:53
  SPEAKER_02: Or markdown.
• 24:54
  SPEAKER_02: I'm gonna get to impairment because you always have to be marking down.
• 24:57
  SPEAKER_00: Yeah, so go on, sorry.
• 24:59
  SPEAKER_02: Um second, the second um complexity here is the standard requires remeasurement when there's a transaction not just in the identical security, but also a similar security.
• 25:08
  SPEAKER_02: And so we see a lot of judgments about what does similar mean.
• 25:12
  SPEAKER_02: And and you can imagine there's there's first not a lot of guidance here, and so there's a lot of judgment in here.
• 25:18
  SPEAKER_02: Generally, we encourage companies to think about the rights and obligations of their security and the rights and obligations of that security that where you see an observable transaction, and think about how differences in those rights and obligations would impact the value of a security.
• 25:34
  SPEAKER_02: And if that's a if they're significantly different, maybe you don't have an observable transaction because it's not considered similar.
• 25:40
  SPEAKER_02: But if those rights and obligations would expect to affect the value in very similar ways, then it may be considered similar.
• 25:48
  SPEAKER_02: I think this is often we see this uh and it's complicated when when you own a series of preferred stock and they issue a different series of preferred stock because when as we talked about before, those the rights and obligations, the terms of those um preferred shares can often be very tricky.
• 26:06
  SPEAKER_02: The third reminder you just had talked about is the impairment model, and it can also be time consuming to apply.
• 26:13
  SPEAKER_02: So the impairment model starts with the qualitative indicators, and then if you meet one of those qualitative indicators, then you need to do a quantitative um assessment of fair value and write it down if fair value is below your carrying amount.
• 26:28
  SPEAKER_00: So before you go on, let me just confirm here.
• 26:30
  SPEAKER_00: So you're seeing unlike uh I'll say writing up an asset, which you wait for these observable or otherwise, this you need to be sort of doing every quarter, at least checking for these qualitative factors.
• 26:44
  SPEAKER_00: Is that fair?
• 26:44
  SPEAKER_02: That's right.
• 26:45
  SPEAKER_02: That's right.
• 26:45
  SPEAKER_02: And sometimes these qualitative factors in some instances are very broad.
• 26:49
  SPEAKER_02: For instance, one of the qualitative factors is a significant adverse change in the general market conditions of the industry.
• 26:56
  SPEAKER_00: Oh, right.
• 26:57
  SPEAKER_02: And so that that that's very broad, that can happen.
• 27:00
  SPEAKER_02: And that once you hit that trigger, now you need to go through and assess fair value.
• 27:04
  SPEAKER_02: So if your whole objective in applying the measurement alternative in the first place was to not have to do a bunch of complicated calculations and estimates of fair value, you're still gonna have to do that once you hit these qualitative um impairment indicators.
• 27:20
  SPEAKER_00: All right.
• 27:20
  SPEAKER_00: And I think that goes back then to the reminder that this you need to be looking at all of these securities every quarter, maybe for different things, but you can't just kind of uh put them on the balance sheet and leave them there until you dispose of them.
• 27:33
  SPEAKER_00: So so definitely a lot for companies to think about, Brett.
• 27:37
  SPEAKER_00: And I think we hit at least close to our 25 minutes, but two last questions.
• 27:42
  SPEAKER_00: So, first, where should people go for more information?
• 27:45
  SPEAKER_02: Uh in our loans and investment guide, that'd be a good spot.
• 27:48
  SPEAKER_02: Look at chapters two, three, and eight.
• 27:51
  SPEAKER_02: Um, we cover the accounting for equity investments, for debt securities, and also impairment of AFS securities.
• 27:57
  SPEAKER_00: All right.
• 27:58
  SPEAKER_00: And then I know when you were putting together uh the these points, you actually tried to tie them all back to song titles, which would have been very fun, but I noticed we didn't actually do that.
• 28:11
  SPEAKER_00: So, first of all, what would they have been?
• 28:13
  SPEAKER_00: And then second of all, why didn't we?
• 28:15
  SPEAKER_00: Because I mean, what what better way to hook the audience?
• 28:17
  SPEAKER_02: I I know it I thought it was fun.
• 28:19
  SPEAKER_02: I I love music, and I was thinking back to like my younger days of making remember making mixtapes?
• 28:24
  SPEAKER_02: Yes, exactly.
• 28:25
  SPEAKER_02: Yeah.
• 28:26
  SPEAKER_02: So it was fun.
• 28:26
  SPEAKER_02: So so I started out on a roll.
• 28:28
  SPEAKER_02: Like for the debt securities, I had if you're a debt security and you know it, clap your hands.
• 28:33
  SPEAKER_00: There you go.
• 28:34
  SPEAKER_00: What more can you ask for?
• 28:35
  SPEAKER_02: Or then I was thinking held to maturity, you got Hold Me Now by the Thompson twins.
• 28:40
  SPEAKER_02: That would be good.
• 28:40
  SPEAKER_00: Another great one.
• 28:41
  SPEAKER_02: Measurement alternative, Take It Easy by the Eagles, right?
• 28:44
  SPEAKER_00: So we're although you did say that wasn't that easy, but still a good one.
• 28:48
  SPEAKER_00: I did, yeah.
• 28:48
  SPEAKER_02: But but then I hit what I don't know if it was our third or fourth, remeasurement of foreign currency bonds.
• 28:54
  SPEAKER_02: Like I was just stuck.
• 28:56
  SPEAKER_02: So I had to bail the whole thing.
• 28:58
  SPEAKER_02: Now, when I say that, I'm sure I'm gonna get a bunch of texts and pings from friends with a bunch of great ideas for how you could do, you know, remeasurement of foreign currency bonds in a song title.
• 29:08
  SPEAKER_00: But all right, well, if we get those, we'll have to amend and and and add those.
• 29:11
  SPEAKER_00: But anyway, very good note to end on there.
• 29:14
  SPEAKER_00: I can't wait to see what we hear in the rest of this series.
• 29:17
  SPEAKER_00: But thanks so much for joining me today.
• 29:18
  SPEAKER_01: Thanks, Heather.
• 29:20
  SPEAKER_00: That's our show for today.
• 29:22
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• 29:28
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• 29:32
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• 29:42
  SPEAKER_00: From thought leadership at PWC, I'm Heather Horn.
• 29:46
  SPEAKER_00: Thanks for tuning in.
• 29:53
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