An Examination of Other-than-Temporary Impairments: Evidence from FSP FAS 115-2 and FAS 124-2

• In Event: Research in Financial Accounting

Abstract

This study investigates amendments to the other-than-temporary impairment (OTTI) measurement and recognition guidance for debt securities in the Financial Accounting Standards Board (FASB) Staff Position FAS 115-2 and FAS 124-2 (“the FSP”) issued by the FASB. The FSP permits the impairment charge for debt securities to be split into the credit loss amount recognized in net income (NI) and the amount related to all other factors (noncredit loss) recognized in other comprehensive income (OCI) under certain instances. Thus, the FSP provides banks with additional discretion in recognizing the amount of unrealized losses in NI. Using quarterly accounting data on US bank holding companies from the first quarter of 2010 to the fourth quarter of 2013, I examine whether banks’ decisions regarding OTTI bifurcation are associated with financial reporting and regulatory capital incentives. First, I predict and find that the distance of earnings from their desired targets and regulatory capital impact the percentage of OTTI recognized in OCI. Further evidence suggests that banks with histories of income smoothing through loan loss provision and realized security gains and losses assign a greater share of OTTI to OCI. Then, I predict and find that banks manage OTTI recognized in NI downward to meet quarterly financial reporting benchmarks. In addition, I show that banks with a higher discretionary portion of OTTI recognized in OCI increase their lending over the subsequent quarter. Finally, I find that banks with a higher discretionary portion of OTTI recognized in OCI engage in less loss selling.

Author

• Tuba Toksoz, Koc university