The issuance of Accounting Standards Update (ASU) 2016-01 significantly moved the needle for fair value disclosures. The volatility of the 2022-2023 interest-rate environment has put these disclosures in focus, especially for bank credit portfolios.
It has been just over seven years since the Financial Accounting Standards Board (FASB) issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” With this ASU, the FASB raised the bar for public business entities (PBEs) with an important change in how fair values are determined for the fair value of financial instruments disclosure. These disclosures include financial instruments not carried at fair value, such as loan portfolios and borrowings.
Since implementation, this change has not received significant attention from financial statement users. However, seven rate increases in 2022 and three additional hikes in 2023 have brought significant attention as the Federal Funds Rate increased significantly from 0.25% to 5.25%, causing volatility in forward curves, interest projections, costs of funds, and overall required rates of return on loans that serve as key inputs for the financial services industry fair value estimates. The speed and frequency of these increases put considerable stress on the fair value of loan and bond portfolios, particularly those with longer duration or imbedded interest-rate risk.
While management teams monitoring portfolio risks have engaged in strategies where this risk could be managed, the financial services industry was rattled by a string of bank failures starting in March 2023. Much has been written in the following months regarding the whys and hows of what caused those failures, and as a result, emphasis and scrutiny over fair value disclosures as a means of measuring and quantifying risk and exposure in today’s environment have increased. Analysts are focused on understanding whether risk is present within other institutions due to the current rate environment.