A Career & More. Click here to explore opportunities with TBG today!

OTTI Considerations in a Volatile Market

The financial markets have seen significant volatility in the past few weeks and months. On June 15th, the Federal Reserve increased rates by 75 basis-points, the largest increase in over two decades. Additionally, the Fed has also hinted that additional increases may still be needed. This has resulted in an increase in the concern over inflation.

As we begin to focus on quarters and year-ends for several of our clients, we believe that this will have an impact on a few areas including:

  • Investment portfolios
  • Loans
  • Deposits

Bond markets have been negatively impacted with all the volatility, with many investors leaving low-rate bonds and moving to other investments or cash searching for returns. From a loans and deposits perspective, with the uncertainty in the financial markets, many investors may turn to cash versus being exposed to risk. As a result, deposit growth may continue. Loan rates have hit the highest rates since 2008. This may have a negative impact on loan volume, as less people may find it more difficult to purchase a home.

While all the above items leave a lot of uncertainty in the marketplace, these factors are still unknown. However, as we approach the end of the year for some financial institutions and the close of another quarter, the volatility will result in the need for additional procedures surrounding your investment portfolio.

With the decline in bond portfolios, it is important for financial institutions to begin to review their portfolio for potential impairment of their debt securities. Below are a couple of reminders on what is expected to be performed with regards to your portfolios during each quarter and year-end.

  • Impairment must be assessed on individual investment securities in accordance with your financial institution’s policy. Financial institutions are not able to aggregate their investment types (i.e., municipalities, government agencies, etc.) portfolio when evaluating for impairment.
  • Financial institutions will need to consider if they intend to sell the investment. It is important for the financial institution to consider if it will be required to sell prior to recovery of the investment to cost. Consideration should be placed on capital ratios, liquidity, and other factors impacting the financial institution.
  • If a financial institution determines that it is more likely than not to be required to sell the security before the recovery to cost, then an OTTI has occurred.
  • In accordance with ASC 320-10-35-33F:
    • In assessing whether the entire amortized cost basis of the security will be recovered, an entity shall compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis of the security, the entire amortized cost basis of the security will not be recovered (that is, a credit loss exists), and an other-than-temporary impairment shall be considered to have occurred.

When OTTI is identified and it is determined that a financial institution will have to sell the investment prior to recovery of the cost, the OTTI is recognized in earnings equal to the difference between the cost and fair value at the date of the interim period. Subsequently, for investments where an OTTI charge was recognized, the difference between the new amortized cost basis (cost after impairment) and the cash flows expected to be collected shall be accreted into interest income. An entity shall continue to estimate the present value of cash flows expected to be collected over the life of the debt security.

For our attest clients, please contact a member of your engagement team to discuss expected items that will be needed as part of the procedures to be performed as part of the upcoming interim or year-end period.

For our internal audit clients, do not hesitate to contact a member of your engagement team to discuss how we will be able to assist you surrounding the overall analysis to be performed as outlined above.

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.