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



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 recognised in net income (NI) and the amount related to all other factors (noncredit loss) recognised in other comprehensive income (OCI) under certain instances. Thus, the FSP provides banks with additional discretion in recognising the amount of unrealised losses in NI. Using quarterly accounting data on US bank holding companies from the first quarter of 2010 to the first quarter of 2013, I examine whether banks’ decisions regarding OTTI bifurcation are associated with financial reporting and regulatory capital incentives. I predict and find that the distance of earnings from their desired targets and regulatory capital impact the percentage of OTTI recognised in OCI. I predict and find that banks manage OTTI recognised in NI downward to meet quarterly financial reporting benchmarks. Further evidence suggests that the Big Four auditors mitigate the ability of banks to avoid missing earnings benchmarks using OTTI bifurcation. In addition, I show that banks with histories of income smoothing through loan loss provision and realised security gains and losses assign a greater share of OTTI to OCI. Finally, I find that banks with a higher discretionary portion of OTTI recognised in OCI increase their lending over the subsequent quarter.

This seminar is organised by the Erasmus Accounting Research Group.