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The FASB Approves Proposed Changes to Hedge Accounting

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Hedge Accounting Bulletin #3 The FASB Approves Proposed Changes to Hedge Accounting Early adoption will be available for interim periods upon final standard issuance and mandatory adoption is effective January 1, 2019 On June 7, 2017, all seven FASB board members confirmed their intention to vote to approve the proposed changes to the hedge accounting guidance in ASC 815. Formal voting is expected to occur via written ballot within the next few weeks and final guidance is expected to be issued in August. The mandatory effective date of adoption for public business entities will be fiscal years beginning after December 15, 2018 with early adoption permitted as early as upon issuance of the final guidance, which is a change from the previously expected early issuance date of fiscal years beginning after December 15, 2017. The new standard will better align economic results of an entity's risk management activities with its financial reporting and make targeted improvements to simplify hedge accounting. This bulletin provides an overview of the proposed changes to Accounting Standards Codification (ASC) 815, Derivatives and Hedging that are relevant to financial institutions. Each of the changes has a positive impact on the application of hedge accounting. Individual strategies are impacted differently. The strategies outlined above are typically used by financial institutions under the current standard. As expected, the majority of the improvements will make fair value hedging easier to apply and result in less volatility in the financial statements, which should further help entities achieve their economic objectives. We expect hedgers of fixed-rate liabilities to utilize partial term hedging to better hedge their financing portfolio risk. Similarly, we expect pooling of fixed-rate assets 1 to be applied by most financial institutions immediately, whether it is utilized to pool fixed-rate loans or investment securities in a hedging relationship. The following illustration demonstrates one of the new hedging strategies under the proposed hedging standard that most liability sensitive financial institutions will benefit from. Hedging Pools of Fixed Rate Loans 1 Financial institutions will also have the ability to transfer debt securities from held-to-maturity into available-for-sale classification upon transition, in order to take advantage of the last layer designation. 1. Originate fixed rate loans to create a hedgeable portfolio a. Loans do not need to have the same maturity or coupon b. Loans may be prepayable 2. Determine size and duration of risk exposure and compare to average retention period of loans 3. Designate the last layer of a closed portfolio of fixed-rate loans (i.e. $40mm portion that is not expected to prepay of a $100mm portfolio) 4. Execute a plain-vanilla swap with the same notional as the last layer and a duration that address the risk exposure 5. Any partial or full prepayments that occur up to the undesignated portion of the closed pool will be ignored for hedge accounting purposes 6. Stop hedge accounting once prepayments exceed undesignated portion of the closed pool and encroach into the designated last layer amount

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