 |
 |
Note that by way of the change in accounting designation, the firm has kept its Fair Value stabilized against changes in interest rates for all of these changes. The only thing that has changed is how the accounting measures reflect the value of these positions.
Suppose now that the firm has premium loans in its held to maturity portfolio. These loans are subject to FAS-91, so that changes in the amortization of premium are reflected directly in retained earnings. Falling rates will cause a loss in premium as prepayment forecasts increase. The position of the firm is as follows:
($millions)
Position |
Fair Value |
AOCI |
Retained Earnings |
Loans--HTM |
$2.0 |
- |
-$0.3 |
Loans--AFS |
$1.0 |
$1.0 |
|
Debt |
-$2.0 |
- |
- |
Derivatives |
-$1.0 |
-$1.0 |
- |
Net |
0 |
0 |
- |
The fluctuation in FAS-91 premium amortization can create significant volatility in the net income of the firm. To offset this risk, the firm can replace some of its assets with TBA mortgages. The firm would not seek hedge accounting on these assets so that changes in their value would be reflected directly in net income and retained earnings. At this point the firm could be represented as follows:
($millions)
Position |
Fair Value |
AOCI |
Retained Earnings |
Loans--HTM |
$1.7 |
- |
-$0.3 |
Loans--AFS |
$1.0 |
$1.0 |
|
TBAs--trading |
$0.3 |
|
$0.3 |
Debt |
-$2.0 |
- |
- |
Derivatives |
-$1.0 |
-$1.0 |
- |
Net |
0 |
0 |
0 |
