LENEXA, Kan.-When U.S. Central FCU surprised everyone last month - including NCUA - with a massive $1.1-billion loss for its recently completed fourth quarter it was precipitated by the implementation of a controversial and often confusing accounting term called other-than-temporary impaired, or OTTI.
The central bank for credit unions, which had been watching the unrealized losses on its huge investment portfolio swell to a staggering $10 billion at year-end was finally forced by its auditors to take a charge for OTTI of $1.2 billion for the quarter, resulting in the actual loss.
But how much of that $1.2 billion is actually loss, and how much of it will eventually be recovered?
Under the often confusing rules of fair value accounting, neither U.S. Central's management, its accountants or the regulators actually know what amount of that $1.2 billion will result in actual loss. But according to generally accepted accounting principles, or GAAP, losses on securities become "realized" and an entity must record OTTI when it is determined the securities will not pay back some portion of the principal. Even when realized losses occur, it does not necessarily mean that the securities have been sold.
They could, in fact, regain part of the realized loss as securities reach maturity.
In fact, some of that $1.2 billion OTTI charge by U.S. Central is almost certain to be recovered, and thus the losses reversed. U.S. Central executives acknowledge at least $420 million of that amount will be charged off permanently. But what of the other $800 million? How much, if any of that, will be recovered? And will U.S. Central ultimately have to take OTTI charges on other of its $8 billion worth of unrealized losses?
GAAP rules state there are two categories of realized losses, other than temporary impairment and permanent. Losses are considered permanent when it becomes apparent that the issuer of the security will be unable to pay back the remaining principal owed to the investor.
This is where the judgment of management and the auditors comes in. But the judgment is unclear in today's unprecedented period in the financial markets. So, like U.S. Central, management at WesCorp FCU, Members United Corporate FCU, Corporate One FCU, and several other corporates holding large amounts of unrealized losses on their books, are struggling to decide what should be reported as OTTI.
