Financial Institutions Executive Briefing

Dec. 19, 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

Final Rules Implementing Volcker Rule Issued
On Dec. 10, 2013, five federal agencies – the Board of Governors of the Federal Reserve System (Fed), the Federal Deposit Insurance Corp. (FDIC), the Office of the Comptroller of the Currency (OCC), the Commodity Futures Trading Commission (CFTC), and the Securities and Exchange Commission (SEC) – jointly issued final rules to implement Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as the Volcker Rule. The final rules prohibit insured depository institutions and affiliated companies (“banking entities”) from, or impose limits on:

  • Engaging in short-term proprietary trading of certain securities, derivatives, commodity futures, and options on those instruments for their own account
  • Owning, sponsoring, or having certain relationships with hedge funds or private equity funds, referred to as “covered funds”

The final rules become effective April 1, 2014. Banking entities subject to the rules must be in compliance by July 21, 2015. The agencies have published a fact sheet and a community bank guide providing an overview of the new rules.

An Important Note on the Volcker Rule. The final rule is complicated. Over the past week, a flurry of activity has occurred regarding the scope of the covered funds provision. Many people have been surprised by the implications, particularly for community banks. Assessments at this juncture are that many investments in trust-preferred collateralized debt obligations (CDOs) and certain collateralized loan obligations (CLOs) are considered “ownership interests in covered funds” and thus impermissible investments. If the CDOs and CLOs are considered ownership interests in covered funds, they must be divested by July 2015. For institutions holding such investments that are in unrealized loss positions, this calls into question their ability to hold the investment until recovery of amortized cost. As a result, an other than temporary impairment (OTTI) charge, in this quarter (fourth quarter of 2013), would be likely. Because the rule is complicated, other instruments could be identified as impermissible and therefore would require divestiture. A careful analysis is warranted so that permissible investments are not inadvertently sold and impermissible investments are sold as required.

This evening, three of the agencies issued a news release as well as a document of frequently asked questions (FAQ) document, “FAQ Regarding Collateralized Debt Obligations Backed by Trust Preferred Securities Under the Final Volcker Rule.” The FAQ focuses on trust-preferred CDOs. Careful consideration is needed in the determination of whether those instruments are to be considered covered funds. While at this juncture it appears most trust-preferred CDOs are considered covered funds, there could be certain CDOs that are not.

Regulatory Capital Estimation Tool Released

The Fed, the FDIC, and the OCC announced on Nov. 19, 2013, the release of a downloadable calculator to help banks assess the potential effects of the Basel III regulatory capital framework on their capital ratios. The agencies note that this new tool provides only a simplified estimate that may not be a precise reflection of a bank’s actual capital ratios under the new standards and warn that the tool requires certain manual inputs that could have a meaningful effect on the results. When using the tool, banks should refer to the revised capital adequacy guidelines.

Rules on Liquidity Coverage Ratio Proposed
The Fed, the FDIC, and the OCC jointly issued on Nov. 29, 2013, a notice of proposed rulemaking that would implement a quantitative liquidity requirement consistent with the Basel III liquidity standards. Entities subject to the proposed rules would be required to hold high-quality liquid assets on each business day in an amount equal to or greater than its projected cash outflows minus its projected inflows over a 30-day period of significant stress.

The proposed rules would apply to internationally active banking organizations – generally, those with $250 billion or more in total consolidated assets or $10 billion or more in on-balance-sheet foreign exposure; to systemically important nonbank financial institutions; and to any consolidated bank or savings association subsidiary of one of these companies that, at the bank level, has total consolidated assets of $10 billion or more.

On its own, the Fed also proposed a modified liquidity coverage ratio standard that is based on a 21-calendar-day stress scenario rather than a 30-calendar-day stress scenario for bank holding companies and savings and loan holding companies without significant insurance or commercial operations that, in each case, have $50 billion or more in total consolidated assets.

Comments on the proposed rules are due Jan. 31, 2014.

Quarterly Banking Profile Available
The FDIC’s Quarterly Banking Profile for the third quarter of 2013 is now available. The publication provides an early comprehensive summary of financial results for all FDIC-insured institutions. Some of the highlights noted in the report include:

  • Bank earnings in the third quarter of 2013 declined 3.9 percent from the prior year. This is the first reported year-over-year decline in quarterly earnings since the second quarter of 2009.
  • Net charge-offs were down 47.4 percent from the third quarter of 2012, for a total of $11.7 billion in the quarter. This is the lowest quarterly total for charge-offs since the third quarter of 2007.
  • Assets increased by $191.1 billion (1.3 percent) in the quarter. Loan and lease balances rose by $69.7 billion (0.9 percent), the eighth increase in the past 10 quarters.
  • The number of institutions on the FDIC’s problem bank list declined from 553 to 515. This is the 10th consecutive quarter the number has fallen.

Advanced Approaches Guidance Published by OCC
The OCC published “Guidance on Advanced Approaches GAA 2013-01: Implementing the Supervisory Formula Approach for Securitization Exposures.” The publication addresses technical matters relating to the implementation of the advanced approaches risk-based capital rule. The guidance generally applies only to large banks and does not apply to community banking organizations, defined as institutions with total consolidated assets of $10 billion or less.

New Guidance Released on Third-Party Risk Management
On Dec. 5, 2013, the Fed announced the release of guidance describing the factors financial institutions should consider when choosing and overseeing service providers. The new publication, “Guidance on Managing Outsourcing Risk,” addresses the characteristics, governance, and operational effectiveness of a financial institution's service provider risk management program for outsourced activities beyond traditional core bank processing and information technology services. The guidance, which applies to all service provider relationships regardless of the type of bank activity that is outsourced, includes descriptions of:

  • Risks associated with using service providers
  • Supervisory expectations for a financial institution's board of directors and senior management in managing risks associated with service provider relationships
  • The broad framework and processes an institution should have in place to effectively manage risks associated with service provider relationships

OCC Guidance on Consultants for Enforcement Actions Issued
The OCC issued guidance for employing outside consultants as required by an enforcement action. OCC Bulletin 2013-33 focuses on enforcement actions that require employing an independent consultant to address significant violations of law, fraud, or harm to consumers. The bulletin addresses the OCC’s:

  • Assessment of the need to require a bank to hire an independent consultant
  • Expectations for a bank to assess via its due diligence process that the independent consultant has sufficient independence, capacity, resources, and expertise to address the OCC’s concerns
  • Review of the proposed consultant’s qualifications and the proposed contractual terms of the consultant’s engagement
  • Oversight of the consultant’s performance

Social Media Guidance Issued
On Dec. 11, 2013, the Federal Financial Institutions Examination Council (FFIEC) released final guidance for activities conducted via social media by banks, savings associations, and credit unions. The guidance addresses various applicable consumer protection and compliance laws, regulations, and policies that apply to financial institutions. 

While this guidance is effective immediately, financial institutions already might be following much of what it describes. Financial institutions’ existing policies and procedures that address consumer protection and compliance laws and regulations now need to be extended to the use of social media. The guidance constitutes a recognition that social media is another vehicle used for marketing, advertising, communication with customers, and other normal business activities.

The guidance also helps institutions to understand the expectations for managing social media risk, including conducting a social media risk assessment and creating and distributing social media policies and procedures.

From the Consumer Financial Protection Bureau (CFPB)

New Mortgage Disclosure Forms Issued
On Nov. 20, 2013, the CFPB announced the issuance of a final rule requiring lenders to use two new mortgage forms that combine and streamline disclosures required by the Truth in Lending Act and the Real Estate Settlement Procedures Act. The new rule is effective Aug. 1, 2015, and will require lenders to use:

  • A three-page “Loan Estimate” form, which must be given to a borrower within three days of a loan application. Information on the form includes the mortgage’s significant features, costs, and risks. It replaces the early Truth in Lending statement and the Good Faith Estimate.
  • A “Closing Disclosure” form, which must be provided to borrowers at least three days before the loan closing. This five-page form provides details on all costs associated with the loan. It replaces the Truth in Lending statement and the HUD-1 form.

The CFPB has prepared a fact sheet, “Know Before You Owe: Mortgages,” about the new mortgage disclosure forms.

From the Financial Accounting Standards Board (FASB)

ASUs for 2013 Still Forthcoming
The FASB has several Accounting Standards Updates (ASUs) that, according to its Project Roster & Status, it plans to issue yet this year. Several of those stand to affect financial institutions and may be adopted early. As such, readers might wish to watch for issuance of the following final ASUs:

  • Transfers to Other Real Estate (ORE). This ASU will clarify when an in-substance repossession or foreclosure has occurred. An asset would be transferred to ORE only when the lender has obtained legal title or a deed in lieu of foreclosure (or other legal agreement) has been completed.  The FASB ratified this Emerging Issues Task Force (EITF) issue, referred to as 13-E, at its Dec. 11, 2013, meeting.
  • Investments in Affordable Housing Tax Credits. This ASU will modify the conditions that must be met to allow reporting entities that invest in a qualified affordable housing project through a limited-liability entity to elect to account for the investment using the effective yield method. The FASB ratified this EITF issue, referred to as 13-B, at its Dec. 11, 2013, meeting.
  • Definition of a Public Business Entity. This ASU will define when a business entity is deemed to be public for financial reporting purposes. Of importance is that the definition will apply more broadly than to just those entities that file with the SEC.
    Understanding the final definition of a public business entity will be important because any financial institution meeting the definition will not be able to avail itself of any alternatives provided by the Private Company Council (PCC). In addition, it will be important to understand whether the federal financial institution regulators will accept the PCC alternatives for regulatory reporting.
  • Amortizing Goodwill. This ASU will permit a private company (which elects the alternative within U.S. generally accepted accounting principles) to amortize goodwill over 10 years or less than 10 years unless another useful life is demonstrably more appropriate. The FASB endorsed this PCC alternative, referred to as 13-01B, at its Nov. 25, 2013, meeting.

Private Company Webcast Announced 
A webcast, “In Focus: FASB Update for Nonpublic Entities,” was held on Dec. 16, 2013. The free webcast is expected to be available on the FASB website through March 8, 2014. Topics covered on the webcast included:

  • The work of the PCC
  • FASB’s project to improve not-for-profit financial reporting
  • The latest developments on the FASB’s joint projects with the International Accounting Standards Board (IASB) on leases, revenue recognition, and accounting for financial instruments
  • An update on other FASB projects of interest to private companies and not-for-profit organizations
  • Discussion of some recently issued ASUs

From the Center for Audit Quality (CAQ)

Enhanced Report Disclosures From Audit Committees Requested
The American Institute of Certified Public Accountants’ Center for Audit Quality (CAQ), along with several other organizations that focus on corporate governance, issued a paper  on Nov. 20, 2013, calling for the audit committees of public companies to strengthen public disclosures about their work. The paper, “Enhancing the Audit Committee Report: A Call to Action,” advances the premise that it is important for investors and others with a stake in financial markets to understand and have confidence in audit committees’ work. The audit committee has the opportunity to educate others about its responsibilities through enhanced disclosures in the audit committee report and in annual reports, in proxy statements, or on a company’s website.

The paper includes examples taken from 2013 filings of emerging, voluntary practices of strengthened disclosures by audit committees, including:

  • Processes for conducting periodic evaluations of independent auditors
  • Rationales for recommending the retention or replacement of external auditors
  • Ways the audit committee carries out its responsibilities for compensating auditors
  • Actions taken by the audit committee to promote auditor independence and skepticism
  • Tenure of the auditors and the audit committee’s role in selecting the lead engagement partner
  • Types of information the audit committee discusses with its auditors

From the Securities and Exchange Commission (SEC)

Compliance and Disclosure Interpretations Updated
The staff of the SEC Division of Corporation Finance (Corp Fin) has updated several Compliance and Disclosure Interpretations (C&DIs). C&DIs, which are published in a question-and-answer format, reflect the views of the Corp Fin staff on various SEC rules and regulations. The C&DIs are intended as general guidance and should not be relied on as definitive; due to their highly informal nature, they are not binding.

The following are among the updated C&DIs:

  • Section 138. Rule 144A – Private Resales of Securities to Institutions
  • Section 260. Rule 506 – Exemption for Limited Offers and Sales Without Regard to Dollar Amount of Offering

From the Public Company Accounting Oversight Board (PCAOB)

Center for Economic Analysis to Be Established
On Nov. 6, 2013, the PCAOB announced that it is establishing a Center for Economic Analysis. The center will study and encourage economic research on the role and relevance of the audit in capital formation and investor protection. It will advise the PCAOB on how it can use economic theory, analysis, and tools to enhance the effectiveness of PCAOB standard setting, inspections, and other oversight activities.

The center’s director will be economist Luigi Zingales, the Robert C. McCormack Professor of Entrepreneurship and Finance and the David G. Booth Faculty Fellow at the University of Chicago Booth School of Business. Staff hiring and operations are expected to begin in early 2014.

Audit Committee Resources Website Now Available
The PCAOB has established a Web page that provides links to resources and information of interest to audit committee members. Resources that can be accessed through the Web page include the PCAOB’s strategic plan, public reports about the PCAOB’s inspection process and findings, Auditing Standard No. 16 (“Communications With Audit Committees”), speeches and statements related to audit committees, and information about PCAOB programs.



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