Financial Institutions Executive Briefing
April 16, 2013
The Financial Institutions Executive Briefing offers updates on financial reporting, governance, and risk management topics from Crowe Horwath LLP. In each issue of this electronic newsletter, you will find abstracts of recent standard-setting activities and regulatory developments affecting financial institutions.
From the Federal Financial Institution Regulators
Leveraged Lending Guidance Updated and Published
On March 22, 2013, the Federal Reserve System (Fed), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) published in the Federal Register updated supervisory guidance on leveraged lending. The guidance, which replaces previous guidance issued in April 2011, covers transactions characterized by a borrower with a degree of financial leverage that significantly exceeds industry norms. It focuses attention on key areas such as high-level principles related to safe-and-sound leveraged lending activities, including the following:
- Underwriting considerations
- Assessing and documenting enterprise value
- Risk management expectations for credits awaiting distribution
- Stress-testing expectations
- Pipeline portfolio management
- Risk management expectations for exposures held by the institution
Although the guidance applies to all financial institutions supervised by the agencies, community banks are expected to be largely unaffected because few have substantial involvement in leveraged lending.
Banks Urged by OCC to Manage Operational and Compliance Risks
In a speech at the Institute for International Bankers Annual Washington Conference on March 4, 2013, Comptroller of the Currency Thomas Curry said innovations add to consumer convenience, and to remain competitive banks respond by offering cutting-edge products. However, some innovations introduce operational risk and compliance risk.
In the speech, Curry discussed the risk that arises from the failure to maintain effective Bank Secrecy Act (BSA) and anti-money-laundering (AML) compliance programs. He said it is a challenge for banks and regulators to stay ahead of the curve. Curry also identified other trends that warrant attention by lenders and regulators, such as international activities and third-party relationships such as with payment processors.
Curry also talked about BSA/AML compliance issues in March 7, 2013, testimony before the Senate Committee on Banking, Housing, and Urban Affairs. Curry provided information on OCC efforts to make sure that federal banks and thrifts have programs in place to deny money launderers and other criminal elements access to the banking system. Curry testified that, in the wake of the financial crisis, too many banks inappropriately cut staffing and spending for BSA and AML compliance as austerity measures and that OCC examiners are now working to ensure that these institutions add the necessary resources they need to maintain solid BSA/AML programs.
Fourth-Quarter Report on Mortgage Performance Released by OCC
On March 27, 2013, the OCC released “OCC Mortgage Metrics Report” for the fourth quarter of 2012. The report, covering about 57 percent of all first-lien residential mortgages in the U.S., shows that the overall quality of first-lien mortgages serviced by large national and federal savings banks improved from the prior quarter and from the same period a year ago. It reports that 89.4 percent of mortgages were current and performing at the end of the quarter, compared to 88.6 percent the prior quarter and 88.0 percent a year earlier. Following are other significant findings in the report:
- Seriously delinquent mortgages – 60 days or more past due or held by bankrupt borrowers whose payments are 30 days or more past due – remained at 4.4 percent for the third consecutive quarter.
- The number of loans in the process of foreclosure at the end of 2012 fell below one million for the first time since the end of June 2009.
- During the fourth quarter of 2012, servicers initiated the lowest number of new foreclosures since the OCC began reporting mortgage performance in the first quarter of 2008.
- The number of completed foreclosures decreased 7.7 percent from the previous quarter and decreased 8.9 percent from a year earlier.
- Servicers continued to emphasize alternatives to foreclosures, implementing 367,169 home retention actions compared with 169,064 home forfeiture actions.
- Servicers have modified more than 2.8 million mortgages from the beginning of 2008 through the end of the third quarter of 2012. At the end of the fourth quarter of 2012, 47.7 percent of those modifications were current or paid off.
Study on CRE Concentration Guidance Published by OCC and Fed
On April 3, 2013, the OCC and the Fed released a white paper, “An Analysis of the Impact of the Commercial Real Estate Concentration Guidance,” which analyzes aspects of the 2006 interagency guidance, “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices.” That interagency guidance established supervisory criteria for banks that exceeded 100 percent of capital in construction lending and 300 percent of capital in total commercial real estate (CRE) lending. According to the white paper, banks with high concentrations of construction and total CRE lending that exceeded supervisory criteria failed at higher rates than banks with lower concentrations. Other significant findings include:
- Thirteen percent of banks that exceeded only the 100 percent construction lending criterion failed during the economic downturn from 2008 through 2011.
- Twenty-three percent of banks that exceeded both the construction and total CRE lending criteria failed from 2008 through 2011, compared with 0.5 percent of banks that exceeded neither criteria.
- An estimated 80 percent of losses to the FDIC insurance fund from 2007 to 2011 can be attributed to banks that exceeded the 100 percent construction lending criterion.
FDIC Banker Teleconference Series Announced
The FDIC announced in an April 9, 2013, Financial Institution Letter that the staff of the FDIC’s Division of Depositor and Consumer Protection will host several banker teleconferences during 2013. The teleconferences are intended to maintain open lines of communications and to update bankers on important regulatory and emerging issues in the compliance and consumer protection areas. The first three calls, scheduled for May 2, May 15, and June 6, will focus on significant mortgage-related final rules issued by the Consumer Financial Protection Bureau (CFPB). Registration information is available on the FDIC website.
From the Financial Accounting Standards Board (FASB)
Credit Loss Proposal FAQ Issued, Comment Deadline Extended
The FASB posted to its website on March 25, 2013, a staff document that responds to frequently asked questions (FAQ) about its recently proposed Accounting Standards Update (ASU), “Financial Instruments – Credit Losses (Subtopic 825-15).” With the FAQ document, the staff aims to clarify the proposal by addressing some common questions stakeholders have posed.
In the exposure draft, the FASB proposes a new accounting model intended to require more timely recognition of credit losses and provide additional transparency about exposure to credit risk. The FAQ document discusses the objectives of the proposal, measuring expected credit losses, and other alternative approaches considered by the FASB.
At its meeting on March 28, 2013, the FASB voted to extend the comment period on the proposed ASU for an additional month. The decision was made in response to stakeholder requests for more time to consider the FASB’s proposals on credit losses as well as the related staff FAQ document. Stakeholders also expressed a desire to consider the International Accounting Standards Board's proposal on credit losses, which was issued for public comment on March 7, 2013.
Comments on the FASB’s proposed ASU are now due May 31, 2013.1
Leases Project Updated
At its April 10, 2013, meeting the FASB decided to move forward on its project to improve the financial reporting for leases. In a close vote, the board directed its staff to draft a proposed ASU for exposure. The FASB’s previous exposure draft on leases, published in August 2010, was criticized for being too complex and resulting in a profit and loss recognition pattern that did not reflect the economics of the leasing transaction.
The new exposure draft, expected to be issued in May, will also call for most leases, excluding short-term leases, to be recognized on the balance sheet. If approved, the guidance would require a dual expense-recognition approach depending on whether there is consumption of more than an insignificant portion of the underlying asset over the lease term. When published, the re-exposure is expected to have a 120-day comment period.
Codification Changes Proposed for the Recognition and Measurement Exposure Draft
On April 12, 2013, the FASB issued a proposed ASU, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities – Proposed Amendments to the FASB Accounting Standards Codification®.” The 345-page proposal is a companion to the FASB’s proposed ASU on recognition and measurement, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” which was issued for comment on Feb. 14, 2013. The latest proposal provides a marked version of the FASB Accounting Standards Codification (ASC) changes proposed by the recognition and measurement exposure draft. Comments on the proposed changes to the codification are due May 15, 2013, as are comments on the proposed ASU on recognition and measurement.2
Guidance Proposed on Discontinued Operations
On April 2, 2013, the FASB published an exposure draft of a proposed ASU, “Presentation of Financial Statements (Topic 205): Reporting Discontinued Operations.” While not common among financial institutions, the discontinuance of operations does occur occasionally. If approved, the new guidance would redefine “discontinued operations” so that only those disposals of components that represent a significant strategic shift for the entity would qualify for discontinued operations reporting. Expanded disclosures would be required. A “FASB in Focus” article, a short recap of the proposal, was also published.
Comments on the exposure draft are due Aug. 30, 2013.
Response to FAS 131 Post-Implementation Review Report Announced
On Feb. 19, 2013, the FASB responded to the Financial Accounting Foundation (FAF)’s “Post-Implementation Review Report on FASB Statement No. 131, Disclosures About Segments of an Enterprise and Related Information” (FAS 131). The FASB also announced it will review the issues raised in the post-implementation review report of its business-segment reporting standard to determine whether further review of the standard is warranted.
In its response, the FASB noted that the FAF’s findings affirm that segment information is better aligned with an organization’s internal structure and is more consistent with financial information reported outside the financial statements, allowing users and those who might invest to better understand an organization’s activities and potential for growth. In addition, the report commented that additional guidance on certain operational aspects of FAS 131, possibly presented by segment, might be helpful to some preparers and practitioners.
Print Edition of the Codification Updated
An updated print edition of the FASB ASC was released on March 11, 2013. The updated four-volume bound edition of the ASC contains all of the content of the online codification as of Oct. 31, 2012. The annual bound edition of the ASC is intended to be used as a reference tool in conjunction with the up-to-date online codification. The print edition can be ordered from the store section of the FASB website.
From the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
Updated Internal Control Framework to Be Issued
COSO announced that its updated “Internal Control – Integrated Framework: 2013” has been approved and is expected to be issued on May 14, 2013. The issuance will include a volume of “Illustrative Tools for Assessing Effectiveness of a System of Internal Control.”
Simultaneously, COSO also expects to issue “Internal Control Over External Financial Reporting: A Compendium of Approaches and Examples” to help users apply the framework. COSO’s goal in updating the original framework has been to reflect changes in business and operating environments, to formalize more explicitly the principles in the original framework that facilitate development of effective internal control and assessment of its effectiveness, and to increase ease of use.
The COSO board believes that users should make the transition to the 2013 framework in their applications and related documentation as soon as is feasible. The original framework will continue to be available during the transition period, which ends Dec. 15, 2014. During the transition period, users who apply the framework that involves external reporting should clearly disclose whether they used the original or 2013 version.
From the Securities and Exchange Commission (SEC)
Guidance on Social Media Announced
In a press release issued April 2, 2013, the SEC makes it clear that companies may use social media outlets, such as Facebook and Twitter, to announce key information in compliance with Regulation Fair Disclosure (Regulation FD). Regulation FD requires material information be distributed in a manner reasonably designed to get that information out to the general public broadly and nonexclusively. The announcement is based on an SEC report, “Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: Netflix, Inc., and Reed Hastings,” which confirms that Regulation FD applies to social media and other emerging forms of communications the same way it applies to company website announcements. The report clarifies that communications made through social media channels could constitute selective disclosure and therefore require careful Regulation FD analysis. Investors must be alerted about which social media will be used to disseminate such information in order to comply with Regulation FD.
Slides Available on Issues Encountered During Staff Reviews
The staff of the SEC’s Division of Corporation Finance (Corp Fin) published slides that were presented at the “Forums on Auditing in the Small Business Environment,” which the Public Company Accounting Oversight Board (PCAOB) hosted throughout 2012. The Corp Fin staff intends for the slides to provide a sampling of issues frequently encountered during staff reviews of filings for smaller public companies as well as an overview of developments in Corp Fin. Detailed notes accompanying the slides provide additional context.
Internal Audit Function Requirement Proposed by Nasdaq
The Nasdaq Stock Market LLC filed a proposed rule change with the SEC that, if approved, will require listed companies to establish and maintain an internal audit function. The proposed rule, filed Feb. 20, 2013, does not prescribe specifics for the implementation of an internal audit function but would allow a company to outsource the function while the audit committee maintains sole responsibility for oversight.
Companies listed on Nasdaq on or before June 30, 2013, would have to establish an internal audit function by no later than Dec. 31, 2013. Companies listing after June 30, 2013, would be required to establish an internal audit function prior to listing. If implemented, the new rule would make Nasdaq requirements more like those of the New York Stock Exchange, which already requires an internal audit function.
New SEC Chair Sworn In
Mary Jo White was sworn in as the 31st SEC chair April 10, 2013, the SEC announced the same day. President Barack Obama nominated White to the position on Feb. 7, 2013, and the U.S. Senate confirmed her appointment on April 8, 2013. White succeeds Elisse Walter, who has served as chair since Mary Schapiro stepped down in December 2012. White has experience as a federal prosecutor and a securities lawyer specializing in complex securities and financial institution frauds and international terrorism cases.
Upcoming EDGAR Release Won’t Support Older GAAP Taxonomy
The SEC reminded registrants on April 5, 2013, that the next release of its Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system will support the 2013 U.S. GAAP taxonomy but not the older 2011 taxonomy. If approved by the SEC, EDGAR 13.1, the latest release, is scheduled to take effect on April 29, 2013. Remaining filers who have not yet made the transition from the 2011 U.S. GAAP taxonomy must move to a supported version with their next submission on or after this date. The U.S. GAAP taxonomy uses interactive data based on eXtensible business reporting language (XBRL) technology.
Financial Reporting Manual Updated
Corp Fin issued on April 4, 2013, an updated “Financial Reporting Manual,” reflecting changes through Dec. 31, 2012. The manual is intended as an internal reference document for SEC staff, but preparers and others might find it a useful reference for financial reporting matters.
The latest version includes updates of issues related to foreign private issuers and financial statement requirements for foreign incorporated acquirees or investees not qualifying as a foreign business. The update also cautions that the manual has not yet been revised for financial and reporting requirements for emerging growth companies enacted by Title I of the Jumpstart Our Business Startups Act (JOBS Act). The JOBS Act and staff guidance can be viewed here.
For More Information
Sydney K. Garmong
Dennis M. Hild
1 For additional information about the FASB proposal, see Sydney K. Garmong and Christopher L. Moore, “More Than an Oil Change: FASB Proposes Overhaul for Financial Assets and Liabilities,” Crowe Horwath LLP, April 2013.