Financial Institutions Executive Briefing – Aug. 13, 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
Technical Corrections to Risk-Based Capital Rules Finalized
The Federal Reserve Board, the Federal Deposit Insurance Corp. (FDIC), and the Office of the Comptroller of the Currency (OCC) announced on July 16, 2014, the adoption of a final rule revising the definition of “eligible guarantee” in the risk-based capital rules. The correction in the final rule removes the requirement that an eligible guarantee be made by an eligible guarantor for purposes of calculating the risk-weighted assets of an exposure – other than a securitization exposure – under the advanced approaches risk-based capital rule included in subpart E of the 2013 capital rule. The advanced approaches framework generally applies to banking organizations with total consolidated assets of $250 billion or more or at least $10 billion in total on-balance-sheet foreign exposure.
The rule is effective Oct. 1, 2014, and may be adopted early.
New FDIC Guidance on S-Corporation Dividend Exceptions Issued
On July 21, 2014, the FDIC issued Financial Institution Letter FIL-40-2014 describing how the agency will consider requests from S-corp institutions to pay certain dividends. The letter discusses requests by a bank to pay dividends to shareholders to cover taxes on their pass-through share of the bank’s earnings when those dividends otherwise would not be permitted under requirements in the Basel III rules. Those rules include a capital conservation buffer that limits the amount of dividends a bank can pay when the bank’s capital ratios are below the buffer’s threshold levels. And the rules place additional regulatory limits on the distributions that may be paid by an adequately capitalized bank or a bank whose capital ratios exceed by less than 0.5 percentage points any of its well-capitalized risk-based capital ratio thresholds.
The letter indicates that, unless there are significant concerns about the safety and soundness of the requesting bank, the FDIC generally would expect to approve exception requests by well-rated S-corp banks that are limited to the payment of dividends to cover shareholders’ taxes on their portion of an S-corp’s earnings. The FDIC will consider all requests on a case-by-case basis, and requests generally will be approved if they satisfy each of the following factors:
- Is the S-corp requesting a dividend of no more than 40 percent of net income?
- Does the requesting S-corp believe that the dividend payment is needed so the bank’s shareholders can pay income taxes associated with their pass-through share of the institution’s earnings?
- Is the requesting S-corp bank rated 1 or 2 under the Uniform Financial Institutions Rating System and not subject to a written supervisory directive?
- Is the requesting S-corp bank at least adequately capitalized, and would it remain adequately capitalized after the requested dividend?
FIL-40-2014 applies to all FDIC-supervised S-corp banks with total assets of less than $1 billion.
Supervisory Considerations for Mutuals Discussed by OCC
OCC Bulletin 2014-35, issued July 22, 2014, discusses unique characteristics of mutual federal savings associations and the resulting supervisory concerns. The OCC notes that although safety and soundness principles for mutuals are generally the same as those for stock institutions, there are operational differences that the OCC factors into its risk-based supervision process.
The bulletin outlines mutuals’ traditional operations and describes the mutual governance structure and members’ rights. The bulletin also highlights supervisory considerations in rating mutuals for each component of the CAMELS rating system: capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to market risk. The bulletin emphasizes the importance of long-term capital planning because mutuals have limited means to quickly increase regulatory capital.
New Regulatory Relief Actions Planned by NCUA
As part of her speech at the National Association of Federal Credit Unions’ annual conference on July 23, 2014, National Credit Union Administration (NCUA) board chairman Debbie Matz announced a series of planned regulatory relief changes. Matz described three relief proposals planned for upcoming open meetings of the NCUA board: eliminating the fixed-assets cap, modernizing member business lending, and updating appraisal provisions. At its July 31, 2014, meeting, the board approved a proposed rule to provide federal credit unions with regulatory relief and greater flexibility in managing fixed assets by removing the waiver requirement for credit unions to exceed the 5 percent aggregate limit on fixed-asset investments.
During her remarks, Matz also addressed the NCUA’s proposed rule on risk-based capital, noting the agency is acting on the comments and ideas received, including revising the risk weights for investments, mortgages, member business loans, credit union service organizations, and corporates. She also reiterated the NCUA’s concerns about cyberattacks and interest rate risk.
From the Consumer Financial Protection Bureau (CFPB)
Addition of Customer Narratives to Consumer Complaint Database Proposed
On July 16, 2014, the CFPB proposed a policy that would add consumers’ narratives to the publicly available material in the CFPB’s consumer complaint database. When consumers submit a complaint, they would have the option to share their account of what happened. The CFPB believes publishing consumer narratives would provide relevant context to the complaint, help the public to identify trends in the market, aid consumer decision-making, and improve consumer service. Companies would be given the opportunity to post a written response that would appear next to the consumer’s story. No personal information would be shared in the complaint or the company response.
The original due date for comments on the proposal was Aug. 22, 2014, but the CFPB has announced that the comment period has been extended until Sept. 22, 2014.
The CFPB also released a snapshot overview of complaints handled since the program began. The report, “Consumer Response: A Snapshot of Complaints Received,” discusses the CFPB’s work collecting, investigating, and responding to consumer complaints and includes aggregate data and analyses of approximately 395,000 complaints received from July 21, 2011, through June 30, 2014.
HMDA Changes Proposed
The CFPB proposed a rule on July 24, 2014, that would update the reporting requirements of the Home Mortgage Disclosure Act (HMDA) regulations. Under the HMDA, many lenders must report information about the home loans for which they receive applications or those that they originate or purchase. That information allows the public and regulators to monitor whether financial institutions are serving the housing needs of their communities and identify possible discriminatory lending patterns. The Dodd-Frank Wall Street Reform and Consumer Protection Act directed the CFPB to expand the HMDA data set to include additional information about loans that would help provide a better understanding of these aspects of the mortgage market.
Some of the proposed changes are intended to provide better information about the mortgage market. The new information to be reported includes the property’s value, the loan’s term, total points and fees, the duration of any teaser or introductory interest rates, and the applicant’s age and credit score. The CFPB also proposes that financial institutions provide more information about underwriting and pricing to help regulators monitor consumers’ access to credit.
The CFPB also is attempting to simplify the HMDA reporting requirements for financial institutions. The proposal generally would require that institutions report HMDA data only if they make 25 or more closed-end loans or reverse mortgages in a year. In addition, the reporting of certain home improvement loans would be eliminated. HMDA data requirements also would be more closely aligned with industry data standards already in use by a significant portion of the mortgage market.
Comments on the proposed rule are due Oct. 22, 2014.
From the Financial Accounting Standards Board (FASB)
Guidance Issued on Classification of Certain Government-Guaranteed Loans Upon Foreclosure
On Aug. 8, 2014, the FASB issued Accounting Standards Update (ASU) 2014-14, “Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans Upon Foreclosure.” The new guidance in ASU 2014-14 is intended to reduce diversity in how, upon foreclosure, creditors classify government-guaranteed mortgage loans, including those guaranteed by the Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA). Currently, there is diversity in practice. Some creditors account for the guarantee as a separate unit of account, while others do not. Classification categories range from loans to other real estate or other receivables.
The new guidance requires that upon foreclosure a government-guaranteed mortgage loan be transferred from loans to other receivables when all the following conditions are met:
- The loan has a government guarantee that is not separable from the loan before foreclosure.
- At the time of foreclosure, the creditor has the intent to convey the real property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim. The creditor must have maintained compliance with the conditions and procedures required by the guarantee program to have the ability to recover under that claim.
- At the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of real estate is fixed.
The amount of the separate other receivable should be measured based on the amount of the loan balance, including interest, expected to be recovered from the guarantor.
The amendments in ASU 2014-14 are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after Dec. 15, 2014. For all other entities, the amendments are effective for annual periods ending after Dec. 15, 2015, and interim periods beginning after Dec. 15, 2015. The amendments in the ASU should be adopted using the same prospective or modified retrospective transition method as elected under ASU 2014-04, “Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure.” Early adoption is permitted if ASU 2014-04 has already been adopted.
Guidance for Consolidated Collateralized Financing Entities Issued
The FASB on Aug. 5, 2014, issued ASU 2014-13, “Consolidation (Topic 810): Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity,” to address measurement for consolidated collateralized financing entities, such as collateralized debt obligation (CDO) or collateralized loan obligation (CLO) entities, for reporting entities that elect or are required to account for the financial assets and financial liabilities of the collateralized financing entity at fair value. The fair value, as determined under generally accepted accounting principles (GAAP), of a collateralized financing entity’s financial assets might differ from the fair value of its financial liabilities even when the financial liabilities have recourse only to the financial assets. Diversity in practice had developed in the accounting for the measurement difference in both the initial consolidation and the subsequent measurement.
The ASU provides an election to measure the financial assets and liabilities of a consolidated collateralized financing entity using either the measurement alternative in the ASU or Accounting Standards Codification Topic 820, “Fair Value Measurement.” Under the measurement alternative, the reporting entity measures both the financial assets and liabilities of the collateralized financing entity in its consolidated financial statements using the more observable of the fair value of the financial assets and the fair value of the financial liabilities. The ASU provides guidance depending upon which is more observable.
When the measurement alternative is not elected, (1) the fair value of the financial assets and liabilities should be measured using the requirements of Topic 820, and (2) any difference should be reflected in earnings and attributed to the reporting entity in the consolidated statement of income (loss).
The amendments are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after Dec. 15, 2015. For entities other than public business entities, the amendments are effective for annual periods ending after Dec.15, 2016, and interim periods beginning after Dec.15, 2016. Early adoption is permitted.
FASB Third-Quarter Newsletter Available
The third-quarter issue of “FASB Outlook” can be viewed on the FASB website. This e-newsletter is designed to inform FASB stakeholders about FASB projects and activities and presents current accounting and financial reporting issues in a plain-English, easy-to-use format that provides quick access to stories of interest. The current issue offers a discussion of the FASB disclosure framework project, information about other projects on the agenda, and links to featured videos. The issue also includes a discussion about how implementation matters related to the new revenue recognition standard can be submitted for consideration by the Joint Transition Resource Group for Revenue Recognition.
Redesigned Technical Agenda Web Page Launched
On July 17, 2014, the FASB announced the launch of an easier-to-use technical agenda Web page. The new design includes an alphabetical listing of all projects as well as a comprehensive timeline reflecting the current status of each project, links to documents and other project resources, and a summary of completed and forthcoming project steps.
From the Securities and Exchange Commission (SEC)
Comments on Related Party Auditing Standards Sought by SEC
On July 24, 2014, the SEC published in the Federal Register for public comment the Public Company Accounting Oversight Board (PCAOB) auditing standard on related parties. Subject to SEC approval, the standard will be effective for audits of financial statements for fiscal years beginning on or after Dec. 15, 2014. The PCAOB issued Auditing Standard No. 18, “Related Parties: Amendments to Certain PCAOB Auditing Standards Regarding Significant Unusual Transactions and Other Amendments to PCAOB Auditing Standards,” on June 10, 2014. The new standard and the related amendments to other standards require specific audit procedures and are intended to strengthen the auditor performance requirements in three critical areas:
- Related party transactions
- Significant unusual transactions
- A company’s financial relationships and transactions with its executive officers
The PCAOB has issued a fact sheet describing the new requirements. Comments are due to the SEC by Aug. 14, 2014.
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). Published in Q&A format, C&DIs reflect the views of Corp Fin staff about various SEC rules and regulations. C&DIs are intended as general rather than definitive guidance; due to their informal nature, they are not binding. C&DIs in the Securities Act Rules section updated July 3, 2014, provide guidance relating to:
- Rule 501 – definitions and terms used in Regulation D
- Rule 506 – exemption for limited offers and sales without regard to dollar amount of offering
From the Center for Audit Quality (CAQ)
Study Published Showing Decline in Restatements
A recently published academic study commissioned by the CAQ, “Financial Restatement – Trends in the United States: 2003-2012,” reports a substantial drop in the number and severity of financial statement restatements over the 10-year period following enactment of the Sarbanes-Oxley Act of 2002 (SOX). Significant findings from the study include:
- The number of restatement announcements peaked at 1,784 in 2006, soon after the implementation of the SOX Section 404 internal control reporting requirements.
- The volume of restatements has declined significantly, with 255 reported in 2012 – an 86 percent decline from the 2006 peak.
- Restatement periods have become shorter, declining from an average of two or more years in 2005 to less than 18 months in 2012.
From the International Accounting Standards Board (IASB)
Revisions Completed for Accounting for Financial Instruments
On July 24, 2014, the IASB announced the completion of final amendments to International Financial Reporting Standard (IFRS) 9, “Financial Instruments.” The amendments complete a three-phase project to replace International Accounting Standard 39, “Financial Instruments: Recognition and Measurement.” Previous versions of IFRS 9 had established classification and measurement requirements (issued in 2009 and 2010) and a new hedge accounting model (issued in 2013). The most recent amendments replace those earlier versions of IFRS 9. Changes include a new expected-loss impairment model that will require more timely recognition of expected credit losses.
IFRS 9 will be effective for annual periods beginning on or after Jan. 1, 2018, with earlier application permitted. The IASB has made available a project summary that provides an overview of the requirements of IFRS 9. An article available on the IASB website, “IFRS 9: A Complete Package for Investors,” discusses the new standard from an investor perspective. A recording of a July 29, 2014, Web presentation and Q&A session on the final standard is also available on the IASB website.