Financial Institutions Executive Briefing – June 18, 2014
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
FDIC Quarterly Banking Profile Available
The Federal Deposit Insurance Corp. (FDIC) has published its “Quarterly Banking Profile” for the first quarter of 2014. The profile provides an early comprehensive summary of financial results for all FDIC-insured institutions. Highlights include these findings:
- Net income of $37.2 billion at FDIC-insured banks and savings institutions reflected a decline of 7.6 percent from the first quarter of 2013. The $3.1 billion year-over-year decrease in earnings was due principally to lower noninterest income, according to the FDIC. Sharply lower income from mortgage sales, securitizations, and servicing led to the decline in noninterest income.
- While net income for the total industry fell, 54 percent of institutions reported increased earnings compared to the prior-year period.
- Average return on assets for the quarter was 1.01 percent, down from 1.12 percent in 2013.
- Net interest income was $361 million (0.3 percent) higher than 2013. More than two-thirds of all banks, but only seven of the 20 largest banks, reported year-over-year increases in net interest income. The average net interest margin fell to 3.17 percent, from 3.27 percent in first-quarter 2013, with larger institutions experiencing the greatest margin erosion.
- For the 18th consecutive quarter, loan-loss provisions declined year over year. The $3.3 billion (30.3 percent) reduction in loan-loss provisions was the largest positive contributor to the year-over-year change in earnings. Net charge-offs of $10.4 billion represented a decline of 34.8 percent from the first quarter of 2013 and were the lowest quarterly net charge-off total since the second quarter of 2007. Loan and lease balances 90 days or more past due or in nonaccrual status declined 5.8 percent during the quarter, to $195.1 billion.
- Equity capital increased by $29.8 billion (1.8 percent) in the quarter. At the end of the quarter, 98.2 percent of all insured institutions, representing 99.8 percent of industry assets, met or exceeded the highest regulatory capital category requirements.
- The number of institutions on the FDIC’s list of problem banks declined from 467 to 411 during the quarter. Assets of problem banks fell from $152.7 billion to $126.1 billion. Five insured institutions failed during the quarter.
Data for Quarter Released by NCUA
On June 3, 2014, the National Credit Union Administration (NCUA) released new figures based on Call Report data submitted to and compiled by the agency for the quarter ending March 31, 2014. These are highlights for federally insured credit unions for the quarter:
- The number of federally insured credit unions fell to 6,491 at the end of the first quarter, 262 fewer than at the end of the first quarter of 2013, a decline of 3.9 percent.
- Total assets grew $42.6 billion, or 4.0 percent, from the first quarter of 2013, to reach $1.1 trillion.
- Outstanding loan balances were up 8.8 percent from the first quarter of 2013 to $652.7 billion. However, the pace of mortgage originations dropped significantly in the first quarter.
- Investments totaled $291 billion at the end of the first quarter, a decline of $1.7 billion, or 0.6 percent, from the first quarter of 2013.
- Return on average assets ratio remained at 78 basis points at the end of the first quarter, equal to the 2013 year-end figure and down five basis points from a year earlier. Net income in the quarter ending March 31 was $2.1 billion, down slightly from a year earlier.
- The aggregate net worth ratio was 10.61 percent at the end of the first quarter, 16 basis points below the ratio in the previous quarter but 31 basis points higher than at the end of the first quarter of 2013.
- The delinquency ratio fell to 0.81 percent from 1.02 percent in the first quarter of 2013. The net charge-off ratio was 50 annualized basis points, down from 61 basis points a year earlier.
On June 5, 2014, the NCUA released state-level data for federally insured credit unions as of March 31, 2014. The release also includes the “NCUA Quarterly U.S. Map Review,” prepared by NCUA’s Office of the Chief Economist, which tracks performance indicators for federally insured credit unions in the 50 states and the District of Columbia. The review includes two primary state-level economic indicators: unemployment rates and home price changes. The review also has data on median loan growth and median return on average assets to aid comparisons of typical credit unions across states.
Joint Supplemental Guidance on Income Tax Allocation Agreements Finalized by Banking Regulators
On June 13, 2014, the federal banking regulators announced the issuance of final supplemental guidance, “Addendum to the Interagency Policy Statement on Income Tax Allocation in a Holding Company Structure.” The guidance was issued in response to disputes between holding companies in bankruptcy and failed depository institutions regarding ownership of tax refunds. Courts have come to differing conclusions regarding the ownership of tax refunds between holding companies and depository institutions based on their interpretation of language in tax allocation agreements.
The guidance instructs insured institutions and their holding companies to review and revise their tax allocation agreements to ensure that the agreements expressly acknowledge that the holding company receives a tax refund from a taxing authority as agent for the insured institution. The guidance includes a sample paragraph that institutions could include in their tax allocation agreements to facilitate compliance.
Institutions and holding companies should implement the guidance as soon as reasonably possible, which the regulators expect would not be later than Oct. 31, 2014.
Supervision Peer Review Recommendations Responded to by OCC
On May 28, 2014, the Office of the Comptroller of the Currency (OCC) announced changes it will make as a result of an international peer review report on the agency’s supervision of large and midsize institutions. Actions the OCC will take are described in the report’s summary of responses to the peer review recommendations and include the following:
- Expand the large-bank lead expert program’s organization, functions, and responsibilities to improve horizontal perspective and analysis, systemic risk identification, quality control and assurance, and resource prioritization.
- Establish a formal rotation process for large-bank examiners and assistant deputy comptrollers.
- Reduce the number of examiners resident at individual large institutions.
- Formalize an enterprise risk management framework.
- Conduct regular benchmarking reviews of the OCC’s regulatory framework and compare to domestic and international peers.
- Develop a formal decision-making process, including decision criteria and required action points, to identify growing risks that lack clear policy guidelines, and establish timelines commensurate with the identified risks.
- Strengthen internal processes to identify deteriorating banks and make supervisory expectations clear to those institutions’ boards of directors and management earlier in the supervisory process.
Enhanced Risk Management Efforts Discussed by Comptroller
In a May 8, 2014, speech at the Risk Management Association’s Governance, Compliance, and Operational Risk Conference, Comptroller of the Currency Thomas J. Curry discussed the OCC’s proposed guidelines on heightened expectations for risk management, internal audit, and governance in large national banks. Curry said he believes the proposed guidelines “hold real promise for improving the safety and soundness of the banking system.” He emphasized that the proposal is focused on only large and complex institutions with total average consolidated assets of $50 billion or more. Smaller institutions might fall under the heightened expectations guidelines “only in the most extraordinary circumstances.”
Curry described the two major components of the guidelines. The first component sets forth the minimum standards for the design and implementation of a bank’s risk governance framework. It is intended to “ensure that the bank has an effective system to identify, measure, monitor, and control risk taking, and to ensure that the board of directors has sufficient information on the bank’s risk profile and risk management practices to do their job, providing management with effective direction and advice.” The second component sets criteria for the board’s composition and responsibilities to “ensure that boards have a minimum number of independent directors and that all board members have the information, status, and authority to ensure effective oversight, including the ability to pose a credible challenge to management.”
Curry pointed out that “many, if not all, of the specific requirements of our heightened expectations ask no more of our large, complex banks than they are – or should be – doing already.” Some of the reasons new guidelines are needed, according to Curry, include an increase in the volume and sophistication of cyberattacks, banks’ increasing reliance on third parties, and increasing concentration of service providers.
From the Financial Stability Board (FSB)
Risk Culture and Enhanced Supervision Addressed by FSB
The FSB on April 7, 2014, announced the publication of two documents intended to strengthen risk management supervision. The first document, “Guidance on Supervisory Interaction With Financial Institutions on Risk Culture: A Framework for Assessing Risk Culture,” offers a framework to assist regulators in their assessment of a bank’s risk culture. It does not define a "target" culture but does identify some foundational elements that contribute to the soundness of a financial institution’s risk culture. In addition, it aims to help supervisors identify practices, behavior, and attitudes that might influence the risk culture.
The second document, “Supervisory Intensity and Effectiveness: Progress Report on Enhanced Supervision,” describes changes in supervisory practices, particularly those for systemically important financial institutions, since the global financial crisis and identifies areas where more work is needed. It discusses the tools and methods that regulators increasingly use to intensify supervision.
The FSB, based in Basel, Switzerland, was established to coordinate the work of national financial authorities. Members from the United States include the Federal Reserve, the Securities and Exchange Commission (SEC), and the Department of the Treasury.
From the Consumer Financial Protection Bureau (CFPB)
Examination Findings Reported by CFPB
The CFPB has published the spring 2014 edition of “Supervisory Highlights.” In it, the CFPB reports to industry participants on such examination findings as regulatory violations or unfair, deceptive, or abusive acts or practices in selected program areas. Industry participants can use the information to ensure their operations remain in compliance with federal consumer financial law.
The spring edition highlights supervision work completed from November 2013 through February 2014. One area of interest to financial institutions addressed in the report is fair lending practices. The findings discuss the importance of maintaining adequate documentation and oversight when a lender makes exceptions to its established credit standards. The CFPB notes that a strong compliance management system should include clear policies and procedures for granting exceptions and documenting those exceptions as well as for retaining those records in compliance with Regulation B (which generally requires retention for 25 months).
The findings also emphasize the importance of appropriate management or board oversight, training related to the policies and procedures, monitoring and auditing for compliance with the policies and procedures, and corrective action when areas of fair lending risk have been identified.
Other supervisory observations included in the report are in the areas of:
- Consumer reporting agencies
- Larger participants in the debt collection market as well as sales of debts by financial institutions
- Short-term, small-dollar lending (payday lenders)
From the Financial Accounting Standards Board (FASB)
Revenue Recognition Standard Issued
On May 28, 2014, the FASB and the International Accounting Standards Board (IASB) jointly issued their converged standard on the recognition of revenue from contracts with customers. Accounting Standards Update (ASU) No. 2014-09, “Revenue From Contracts With Customers (Topic 606),” consists of three sections:
- Section A – “Summary and Amendments That Create Revenue From Contracts With Customers (Topic 606) and Other Assets and Deferred Costs – Contracts With Customers (Subtopic 340-40)”
- Section B – “Conforming Amendments to Other Topics and Subtopics in the Codification and Status Tables”
- Section C – “Background Information and Basis for Conclusions”
The core principle of ASU 2014-09 is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this principle, a company applies the following five steps:
- Step 1: Identify the contract with a customer.
- Step 2: Identify the performance obligations (promises) in the contract.
- Step 3: Determine the transaction price.
- Step 4: Allocate the transaction price to the performance obligations in the contract.
- Step 5: Recognize revenue when (or as) the reporting organization satisfies a performance obligation.
For the financial institution industry, wholesale changes are not expected given that most financial instruments (including debt securities, loans, and derivatives) are not in the scope. The challenge will be to discern how the core principle and accompanying steps apply. A few areas of possible applicability for financial institutions include loyalty point programs, asset management fees, credit card interchange fees, deposit account fees, and sales of real estate.
For a public business entity, the guidance in ASU 2014-09 is effective for annual reporting periods beginning after Dec. 15, 2016, including interim reporting periods within that reporting period. Early application is not permitted. For nonpublic entities, the new guidance will be required for annual reporting periods beginning after Dec. 15, 2017, and interim and annual reporting periods after those reporting periods. A nonpublic entity may elect early application but no earlier than the effective date for public entities.
The FASB published a “FASB in Focus” article and a three-part video series that describe the new standard.
Repurchase Agreements: New Guidance and New Disclosures
The FASB issued ASU 2014-11, “Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures,” on June 12, 2014. While the changes in accounting will have an impact on certain repurchase agreements that are off-balance sheet, the disclosures will apply to the majority of repurchase agreements. This ASU changes the accounting for repurchase-to-maturity transactions and linked repurchase financings to secured borrowing accounting, which is consistent with the accounting for other repurchase agreements. Changes in accounting for transactions outstanding on the effective date are to be presented as a cumulative-effect adjustment to retained earnings as of the beginning of the adoption period.
The standard also introduces two new disclosure requirements. The first requires an entity to disclose information about certain transactions that are economically similar to a repurchase agreement. The second disclosure increases transparency about the types of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings.
For public business entities, the accounting changes and disclosure for certain transactions accounted for as a sale are effective for the first period (interim or annual) beginning after Dec. 15, 2014. Earlier application for a public business entity is prohibited. The disclosure for transactions accounted for as secured borrowings is required for annual periods beginning after Dec. 15, 2014, and for interim periods after March 15, 2015.
For all other entities, the accounting changes and both new disclosures are effective for annual periods beginning after Dec. 15, 2014, and interim periods after Dec. 15, 2015. These entities may elect early application and apply the requirements for interim periods beginning after Dec. 15, 2014.
For all entities, the disclosures are not required to be presented for comparative periods before the effective date.
The FASB has prepared a "FASB in Focus" article describing the new ASU. A short video discussing the guidance also is available on the FASB website.
From the Financial Accounting Foundation (FAF)
2013 FAF Annual Report Available
On May 8, 2014, the FAF, the parent organization of the FASB and the Governmental Accounting Standards Board (GASB), released its 2013 annual report. The report, titled “The Road Ahead,” highlights the accomplishments of the FAF, the FASB, and the GASB in 2013 and discusses the organizations’ plans. The report also includes the 2013 management’s discussion and analysis and audited financial statements.
From the Securities and Exchange Commission (SEC)
Investor Alert Issued on Virtual Currency-Related Investments
On May 7, 2014, the SEC’s Office of Investor Education and Advocacy issued “Investor Alert: Bitcoin and Other Virtual Currency-Related Investments.” The alert is intended to make investors aware of the potential risks of investments involving bitcoins and other forms of virtual currency. It describes bitcoin as “a decentralized, peer-to-peer virtual currency that is used like money” but cautions that bitcoin operates without central authority or banks and is backed by no government. The alert discusses some of the risks associated with bitcoin-related investment opportunities and includes links to resources and guidance from other organizations, including the Internal Revenue Service.
Global Accounting Standards and Other Matters Discussed by SEC Chair
In remarks at the Financial Accounting Foundation Trustees Dinner held on May 20, 2014, SEC Chair Mary Jo White indicated that considering whether to further incorporate International Financial Reporting Standards (IFRS) into the U.S. financial reporting system continues to be one of her priorities. White provided no time frame, but she reiterated views previously expressed by SEC members, including:
- The interests of U.S. investors remain in the forefront as the SEC considers IFRS.
- The FASB remains the ultimate standard setter of accounting standards for U.S. companies.
- The role the United States plays in the development of global standards must be an important consideration.
Another issue White addressed was recent work of the FASB, including the new standard on revenue recognition. White said that the SEC’s staff will “actively monitor implementation of the new standard to help limit inconsistencies in application and will also seek out the views of investors, issuers, auditors, the PCAOB and others.” White also commented on current SEC enforcement and rulemaking activities and the SEC’s disclosure effectiveness project.