Financial Institutions Executive Briefing
July 18, 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
Risks Faced by Institutions Highlighted in OCC Report
On June 18, 2013, the Office of the Comptroller of the Currency (OCC) released its “Semiannual Risk Perspective” for spring 2013. The report presents data in four main areas: operating environment; condition and performance of banks; funding, liquidity, and interest-rate risk; and regulatory actions. The report focuses on issues that pose threats to the safety and soundness of OCC-regulated financial institutions and is intended as a resource for the industry, examiners, and the general public. The report reflects data as of Dec. 31, 2012.
The report discusses primary risks the banking industry faces, including the following:
- Strategic risk remains high and continues to increase for many banks as they re-evaluate strategy and business models to generate returns amid slow economic growth, low interest rates, and regulatory requirements. OCC examiners will focus on potential compliance, reputation, and operational risks, as well as banks’ strategic planning processes and new product planning, so that bank executives adequately consider sound business practices.
- Cyber threats continue to grow in sophistication. Identifying and mitigating the associated risks require heightened awareness and appropriate resources.
- Demand for domestic loans, particularly commercial loans, has risen. Increased competition for limited commercial and industrial lending opportunities, especially leveraged lending, is weakening underwriting standards.
- The low-interest-rate environment increases vulnerability for banks that reach for yield, as they could experience significant earnings pressure, potentially to the point of capital erosion, when interest rates increase.
- Bank Secrecy Act (BSA) and anti-money-laundering (AML) risks are on the rise as money-laundering methods evolve, electronic bank fraud increases in volume and sophistication, and banks fail to evolve or incorporate appropriate controls into new products and services.
Community Banking Booklet Available on OCC Website
The OCC announced on June 13, 2013, the publication on its website of a booklet that shares the agency’s perspective on the best practices that distinguish high-performing community banks. The booklet, “A Common Sense Approach to Community Banking,” focuses on risk assessment and management, strategic planning, and capital planning. It highlights the key role of the OCC portfolio manager in supervising national banks and federal thrifts and is aimed at helping those institutions succeed.
Final Rule on Lending Limits Issued by OCC
A final rule was issued by the OCC on June 19, 2013, to implement Section 610 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which applies the lending limit statute to credit exposures arising from derivative transactions and securities financing transactions. Under the rule, a temporary exception period is extended for three months so that compliance with the Section 610 provisions will not be required until Oct. 1, 2013.
Credit Risk Assessment Addressed in FDIC Publication
“Credit Risk Assessment of Bank Investment Portfolios” is the lead article in the summer 2013 issue of “Supervisory Insights,” published by the Federal Deposit Insurance Corp. (FDIC). The article discusses supervisory expectations and the new standards of creditworthiness banks now must apply to investment portfolios and reinforces the importance of effective credit-risk due diligence by financial institutions. The article includes examples of how to conduct due diligence and lists questions examiners might consider when assessing an institution's credit-risk management practices. Other articles in the issue, published June 6, 2013, cover compliance considerations when planning for mergers and acquisitions and bank information technology examinations.
Lessons Learned From the Financial Crisis
The U.S. Senate Banking Committee held a hearing titled “Lessons Learned From the Financial Crisis Regarding Community Banks” on June 13, 2013. The text of testimony FDIC Chief Economist Richard Brown gave at that hearing has been posted on the FDIC website.
In his remarks, Brown described the findings of the “FDIC Community Banking Study,” a comprehensive review published in December 2012 based on 27 years of data on community banks. He noted that the study found “that community banks that grew prudently and that maintained diversified portfolios or otherwise stuck to their core lending competencies during the Study period exhibited relatively strong and stable performance over time.” Brown described the FDIC’s examination and rulemaking review performed after the financial crisis and the resulting enhancements made to the supervisory and rulemaking processes.
From the Consumer Financial Protection Bureau (CFPB)
Small-Entity Compliance Guides Issued on Loan Origination and Servicing
The CFPB has issued compliance guides for small entities about the loan originator and mortgage servicing rules that take effect Jan. 10, 2014. The guides provide easy-to-use summaries of the rules and highlight issues that small entities might find helpful to consider when implementing the rules.
The loan originator rules clarify a number of issues under existing loan originator compensation rules and implement the new Dodd-Frank requirements. These rules regulate who pays loan originators and how, governance of their qualifications and identification, and the prohibition of mandatory arbitration clauses and waivers of federal statutory causes of action in contracts.
The mortgage servicing rules cover error resolution and information requests, lender-placed insurance, early intervention and continuity of contact with delinquent borrowers, and loss mitigation. The guide also covers exemptions, including an exemption from the rules for servicers that have 5,000 or fewer mortgage loans and do not service loans they did not originate.
Exam Guidance on New Mortgage Rules Released
The CFPB announced on June 4, 2013, the publication of the first updates to its examination procedures for new mortgage regulations on appraisals, escrow accounts, and compensation and qualifications for loan originators. The applicable sections of the exam procedures manuals for two laws, the Truth in Lending Act (TILA) and the Equal Credit Opportunity Act (ECOA), have been updated to provide financial institutions and mortgage companies guidance on what the CFPB will be looking for when most of the new rules become effective in January 2014. The CFPB plans to publish additional interim exam procedures and is coordinating its procedures with other federal banking regulators to promote a consistent regulatory experience among financial institutions. Within the next several months, the CFPB will publish its first round of exam procedures for the ability-to-repay and mortgage servicing rules.
From the Financial Accounting Standards Board (FASB)
Summary of Feedback on Credit Losses Proposal Issued
On July 10, 2013, the FASB issued a summary of the feedback received about “Financial Instruments – Credit Losses (Subtopic 825-15),” the proposed Accounting Standards Update (ASU) the FASB issued Dec. 20, 2012. The “Feedback Summary” is the result of the FASB’s efforts to understand whether the proposal would improve financial reporting for the benefit of financial statement users and to understand the cost of application and operational considerations. The FASB received feedback via several vehicles, including outreach to approximately 70 analysts and investors and 17 field visits with preparers as well as the 362 comment letters from stakeholders.
For the current expected credit loss (CECL) model proposed in the exposure draft, the FASB found that the views of investors and other users differ significantly from those of preparers. By a margin of nearly three to one, investors and other users prefer a model that recognizes all expected credit losses. In contrast, most preparers prefer a model that either recognizes only some of the expected credit losses or maintains a threshold that must be met before all expected credit losses can be recognized. In addition, financial institutions raised significant concerns about the potential impact of the CECL model on regulatory capital.
The FASB also learned that many preparers are under the impression that an entity would be expected to forecast economic conditions over the remaining life of the assets. While this was not the intention of the proposal, the FASB understands how constituents could arrive at that misunderstanding. Upon comprehending the FASB’s expectations about estimating expected credit losses, “nearly all preparers participating in the field visits and outreach sessions indicated that the measurement of lifetime expected credit losses was operational,” according to the feedback summary. However, the preparers pointed out the incremental cost and effort of moving to a “life of loan” expected credit loss model and again expressed a preference for a model that either recognizes only some of the expected credit losses or maintains a threshold that must be met before all expected credit losses are recognized.
The FASB will continue to analyze the feedback received about its proposal as well as the comments the International Accounting Standards Board (IASB) has received on its proposal, “Financial Instruments: Expected Credit Losses.” The IASB exposure draft was issued on March 7, 2013, and its comment period ended July 5, 2013. The next step is expected to be discussions to determine the plan for the project.
Private Company Council Proposals Issued
The FASB issued three proposals on July 1, 2013 – all addressing private-company stakeholder concerns. The exposure drafts reflect alternatives within U.S. generally accepted accounting principles (GAAP) proposed by the Private Company Council (PCC). The PCC serves as the primary adviser body to the FASB on matters under active consideration on the FASB’s technical agenda that affect private companies and also recommends alternatives to existing U.S. GAAP to better meet the needs of private-company financial statement users.
The first proposed ASU, “Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination,” would modify the requirements for private companies to separately recognize all intangible assets acquired in a business combination. Private companies would have the option of electing to recognize only those intangible assets arising from noncancellable contractual terms or those arising from other legal rights. No other intangibles would have to be recognized separately from goodwill even if they are separately identifiable.
“Intangibles – Goodwill and Other (Topic 350): Accounting for Goodwill,” the second proposed ASU, would permit private companies to amortize goodwill for a period not to exceed 10 years and provides a simplified goodwill impairment model.
The third proposed ASU, “Derivatives and Hedging (Topic 815): Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps,” would allow private companies, other than financial institutions, the option to use simpler approaches to account for certain interest-rate swaps entered into for the purpose of economically converting variable-rate borrowing to fixed-rate borrowing.
The FASB also published a “FASB in Focus,” a short summary of the proposals.
Comments on all three exposure drafts are due Aug. 23, 2013.
Transfers to Other Real Estate: Forthcoming Proposal
The Emerging Issues Task Force (EITF) of the FASB has a project, Issue 12-E, “Reclassification of Collateralized Mortgage Loans Upon a Troubled Debt Restructuring,” to address the timing of classification from a loan to other real estate upon receipt of collateral in order to clarify when an in-substance foreclosure has occurred. At its meeting on June 11, 2013, the EITF reached a proposed consensus that a creditor would be considered to have taken possession of real estate property collateralizing a loan, such that the loan should be reclassified, when either the creditor obtains legal title to the real estate or the borrower voluntarily conveys all interest in the real estate to the lender to satisfy the loan. In addition, the EITF proposes to require recurring disclosures of roll-forwards of other real estate owned and information about nonperforming loans in foreclosure.
The FASB ratified the consensus-for-exposure at its meeting on June 26, 2013.
Hedge Accounting: Conclusion Reached on Benchmark Interest Rates
At its June 11, 2013, meeting, the EITF reached a consensus to include the federal funds effective swap rate (also known as the overnight index swap rate) as a U.S. benchmark interest rate for hedge accounting purposes. Previously only the interest rates on direct U.S. Treasury obligations and the London Interbank Offered Rate (LIBOR) swap rate could be used as benchmark interest rates. EITF Issue No. 13-A, “Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes,” will apply on a prospective basis for qualifying new or redesignated hedging relationships and requires no new recurring disclosures.
The FASB ratified the final consensus at its meeting on June 26, 2013.
Improvements Proposed for Reporting of Going-Concern Uncertainties
The FASB published a proposed ASU, “Presentation of Financial Statements (Topic 205): Disclosure of Uncertainties About an Entity’s Going Concern Presumption,” on June 26, 2013. The proposal would provide guidance on management’s responsibilities in evaluating an entity’s going-concern uncertainties and on the timing, nature, and extent of related financial statement disclosures. Currently U.S. GAAP includes no guidance on management’s responsibilities for evaluating and disclosing going-concern uncertainties. Building on much of the guidance currently in auditing standards, the proposal would:
- Require management to evaluate going-concern uncertainties more frequently
- Prescribe a threshold and related guidance for starting disclosures
- Require an assessment period of 24 months after the financial statement date
- Provide a threshold for SEC filers to determine whether there is substantial doubt about an entity’s ability to continue as a going concern
The proposed guidance on the disclosure of going-concern uncertainties would apply to all reporting entities, including public and private companies and not-for-profit organizations.
The FASB also published a “FASB in Focus,” a short summary of the proposal.
Comments on the exposure draft are due Sept. 24, 2013.
Proposal Issued on Accounting for Insurance Contracts
The FASB published an exposure draft of a proposed ASU, “Insurance Contracts (Topic 834),” on June 27, 2013. The proposed guidance is intended to improve financial reporting of insurance contracts, including the measurement of insurance liabilities and the related effect on the statement of comprehensive income. It is important to note that the proposed guidance would apply to all contracts that meet the definition of an insurance contract, not just those written by insurance companies. The contractual features of the contract, not the type of insurer, would determine whether it is insurance. Banks, guarantors, service providers, and other noninsurance companies that issue product warranties, financial guarantees, performance bonds, or other contracts may be covered under the proposal.
Under the proposal, a contract issuer would apply one of two measurement models based on the characteristics of the contract. The building-block approach would apply to most life, annuity, and long-term health contracts. The premium allocation approach would be applied to most property, liability, and short-term health contracts, as well as some guarantees and service contracts.
With both approaches, changes in an insurer’s estimate of expected cash flows would be recorded to net income, except for the effect on the expected cash flows as a result of changes in the discount rates, which would be recorded to other comprehensive income. Under both approaches, an insurer would recognize revenue in net income in proportion to the value of coverage or services provided. Claims- and contract-related expenses would be recognized when incurred. Any amounts received that are expected to be returned to the policyholder or the policyholder’s beneficiary regardless of whether an insured event occurs would be excluded from revenue and expenses.
The proposal was developed as part of a joint project with the IASB, which also issued an exposure draft containing similar fundamental principles but significant differences as well. The FASB’s exposure draft includes a comparison of the FASB and IASB proposals.
The FASB also published two “FASB in Focus” articles – one a general overview and the other a scope overview – along with a podcast.
Comments on the FASB and IASB exposure drafts are due Oct. 25, 2013.
Certain Disclosures Deferred for Nonpublic Employee Benefit Plans
The FASB issued ASU No. 2013-09 on July 8, 2013. The standard, “Fair Value Measurement (Topic 820): Deferral of the Effective Date of Certain Disclosures for Nonpublic Employee Benefit Plans in Update No. 2011-04,” indefinitely defers certain disclosures about investments held by a nonpublic employee benefit plan in its plan sponsor’s own nonpublic equity securities. The deferral applies to certain quantitative information about the significant unobservable inputs used in Level 3 fair value measurements. The deferral applies specifically to employee benefit plans, other than those plans subject to U.S. Securities and Exchange Commission (SEC) filing requirements, that are holding investments in their plan sponsor’s own nonpublic entity equity securities, including equity securities of their nonpublic affiliated entities.
The deferral is effective immediately for all financial statements that have not yet been issued.
From the Securities and Exchange Commission (SEC)
SEC Enforcement Initiatives Announced
The SEC announced on July 2, 2013, three new initiatives that will direct the Division of Enforcement’s resources, skill, and experience toward high-impact areas. The division’s three initiatives are:
- The Financial Reporting and Audit Task Force – The principal goal of this task force will be fraud detection and increased prosecution of violations involving false or misleading financial statements and disclosures. It will concentrate on expanding and strengthening the division’s effort to identify securities law violations relating to the preparation of financial statements, issuer reporting and disclosure, and audit failures. The task force will focus on identifying and exploring areas susceptible to fraudulent financial reporting, including ongoing review of financial statement restatements and revisions, analysis of performance trends by industry, and use of technology-based tools such as the SEC’s Accounting Quality Model.
- The Microcap Fraud Task Force – This task force will investigate fraud in the issuance, marketing, and trading of microcap securities. The principal goal of the task force will be to develop and implement long-term strategies for detecting and combating fraud in the microcap market, especially by targeting "gatekeepers," such as attorneys, auditors, broker-dealers, and transfer agents, and other significant participants, such as stock promoters and purveyors of shell companies.
- The Center for Risk and Quantitative Analytics (CRQA) – The CRQA will support and coordinate the division's risk identification, risk assessment, and data analytics activities by identifying risks and threats that could harm investors, and it will assist staff nationwide with conducting risk-based investigations and developing methods of monitoring for signs of possible wrongdoing. It will work closely with other SEC offices and divisions, especially the Division of Economic and Risk Analysis, and provide guidance to the Enforcement Division's leadership on how to allocate resources strategically in light of identified risks. As a central point of contact for risk-based initiatives nationwide, the CRQA will serve as both an analytical hub and source of information about characteristics and patterns that might indicate fraud or other illegal activity.
Comments Made by SEC Officials
In a speech on June 25, 2013, SEC Commissioner Elisse Walter indicated that the “cornerstone of securities regulation and investor protection is the timely disclosure to investors of accurate and complete information.” Other highlights of her remarks made at the 19th Annual Stanford Directors College in Palo Alto, Calif., include:
- Comprehensive corporate disclosure is critical to maintaining and improving investor confidence in the markets.
- As stewards of robust, transparent communication with their companies’ shareholders, directors of public companies are critical to building this confidence. This is not only a responsibility but also an opportunity.
- The management discussion and analysis (MD&A) should give investors the when, the where, the why, and, perhaps most important, the what’s next.
- Know the audience – that is, the investors. Address investors as though they are business partners; the MD&A should reflect that perspective. Boilerplate disclosures should be avoided.
- Full disclosure is a hallmark of good corporate governance, which should help to create a positive corporate culture resulting in the processes and procedures necessary to reveal the important information investors need to know.
In remarks made at the 32nd Annual SEC and Financial Reporting Institute Conference on May 30, 2013, the chief accountant of the SEC, Paul Beswick, gave his views on why the United States has a vested interest in making sure that the IASB continues to function as a strong and independent standard setter. Beswick’s comments focused on why International Financial Reporting Standards (IFRS) matter in today’s U.S. capital markets and gave no indication of what might happen next. Beswick also discussed:
- The definition of a successful implementation of an accounting standard
- Accomplishments of the Public Company Accounting Oversight Board (PCAOB)
- Internal controls and the new Committee of Sponsoring Organizations of the Treadway Commission (COSO) framework
Regarding the new COSO framework, Beswick said that the SEC staff “plans to monitor the transition for issuers using the 1992 framework to evaluate whether and if any staff or Commission actions become necessary or appropriate at some point in the future.” At this time, however, the SEC will refer users of the framework to the statements COSO has made.
For More Information
Sydney K. Garmong
Dennis M. Hild