FIRMA National Conference New Orleans 2009

1. FAS 157 Michael Daly VP Risk Management and Quality Control Union Bank of California FIRMA National Conference New Orleans 2009

2. What’s New?

3. Introducing FAS 157 • The Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards No. 157 provides direction for financial statements prepared in accordance with General Accepted Accounting Principles (GAAP). • The new Financial Accounting Standard is mandatory for financial statements prepared in accordance with GAAP Principles for fiscal years beginning after November 15, 2007.

4. Introducing FAS 157 • A principles based standard that provides limited implementation guidance. • Proper disclosure will enable financial statement users to assess the assumption used in asset valuation.

6. The Concepts

7. Simplified The Concepts

8. The Concepts Fair Value Observable Inputs Unobservable Inputs Pricing Methodologies

9. Key Concepts Exit Price Market Based Principal and Most Advantageous Markets Nonperformance Risk

10. LIQUIDITY Conceptual Culprit

11. “LIQUIDITY IS AN ILLUSION. It is always there when you don’t need it and rarely there when you do.” Michael Milken

12. Fair Value Fair Value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

13. The Inputs • OBSERVABLE INPUTS = Inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the reporting entity.

14. The Inputs • UNOBSERVABLE INPUTS = Inputs that reflect the reporting entities own assumptions about the market, that participants would use in pricing the asset or liability based on the best information available.

15. The Fair Value Input Hierarchy • LEVEL 1 – quoted prices (unadjusted) in active markets for identical assets. • LEVEL 2 – observable for the asset or liability, either directly or indirectly. • LEVEL 3 – unobservable and contain assumptions.

16. Pricing Methodologies • Close of Market • Reference Data • Evaluation (dealer quotes, bond market activity, and other relevant information) • Bid, Mean and Ask (generally a price adjustment to a bid price based on maturity, credit standing and trade frequencies)

19. Exit Price Or Market Value - versus - Market Entry Value Or “Hypothetical Transaction” Value

20. Market Based • Market inputs for evaluation include: - benchmark yields - reported trades - broker/dealer quotes - benchmark securities - etc.

21. Market Based • The standard is very subjective for non-traded financial assets and liabilities. • In 2007, less than 1% of USD denominated debt trades on an average day – In 2008, as a result of the sub-prime crisis even less.

22. FAS 157 • Prior to FAS 157, transaction price or entry price was assumed to represent fair value at initial recognition. • Today the exit price objective applies regardless of reporting entities intent and/or ability to sell the asset or transfer the liability.

23. FAS 157 • Disclosure of pricing sources (often what lurks beneath the vendor feed?) • Tier I – “quoted prices (unadjusted) in active markets for identical markets” • Tier II – “observable for the asset or liability, either directly or indirectly” [similar assets or markets] • Tier III – “unobservable”

24. Principal and Most Advantageous Markets • PRINCIPAL MARKET = the market with the greatest volume and level of activity • MOST ADVANTAGEOUS MARKET = the market in which the entity would recognize the highest value, after considering transaction costs.

25. Non Performance Risk • NONPERFORMANCE RISK = the risk that the obligation will not be fulfilled

26. The Re-think of Long Held Valuation Assumptions • What about Hedge Funds? • Generally calculated a “net asset value” • Like mutual fund – but: • More complexity of investments • More uncertainty in pricing of investments • Less reliability in valuation received. • Less liquid • ….and …. Unregulated.

27. The Re-think of Long Held Valuation Assumptions • What about Investment Advisor Influence? • Receiving prices directly from investment advisors • Multiple investment advisors pricing the same asset at different prices • Client disclosure of all price sources?

28. The Re-think of Long Held Valuation Assumptions What will be the effect on Forecasted earnings and communicating those results? Will there be a reduction in the number of transactions in certain asset classes?

29. Communicating the Components of Valuation and Performance

30. The “Bucketing Approach” Consideration of types or groups of securities to determine the pricing methodology, evaluated pricing applications and models, and other inputs that may have been used by pricing and reference data vendors.

31. Let’s Review

32. FAS 157 • Buyer Beware to Buyer Aware • Disclosure • FASB (Financial Accounting Standards Board) • FAS 157 – new standard – new rules • Fair value retains “exchange price notion” • “exit price” – “not the price paid to acquire asset or liability”

33. FAS 157 • Disclosure of pricing sources (often what lurks beneath the vendor feed?) • Tier I – “quoted prices (unadjusted) in active markets for identical markets” • Tier II – “observable for the asset or liability, either directly or indirectly” [similar assets or markets] • Tier III – “unobservable”

34. A New Mantra

35. Understand the Concepts Communicate Valuation Methodologies Be Helpful and Accurate and Don’t Opine When Unclear - Escalate CYA