Guidance from the SEC: Disclosures for Smaller Financial Institutions

April 27, 2012

The staff of the Division of Corporation Finance (Corp Fin) of the U.S. Securities and Exchange Commission (SEC) has issued important guidance for smaller financial institutions. The SEC staff frequently issues comments on topics that affect Management’s Discussion and Analysis (MD&A) and accounting policy disclosures. The guidance issued April 20, “Staff Observations Regarding Disclosures of Smaller Financial Institutions,” summarizes the staff’s observations in order to assist smaller financial institutions with enhancing the disclosure in their periodic reports (Forms 10-Q and 10-K).

Readers may recall that the SEC has issued guidance previously, in the form a slide presentation, first in December 2009 and again in December 2010. During the 2011 American Institute of Certified Public Accountants (AICPA) National Conference on Current SEC and Public Company Accounting Oversight Board (PCAOB) Developments – held in Washington, D.C., in early December – the SEC staff signaled its intention to provide updated information for smaller financial institution registrants.

The guidance covers the following areas:

  • Asset quality/loan accounting issues
    • Allowance for loan losses
    • Charge-off and nonaccrual policies
    • Commercial real estate
    • Loans measured for impairment based on collateral value
    • Credit risk concentrations
    • Troubled debt restructurings (TDRs) and modifications
    • Other real estate owned
  • Deferred taxes
  • Federal Deposit Insurance Corporation (FDIC)-Assisted Transactions

For each area, the guidance provides staff observations and suggestions for enhanced disclosure. Most of the guidance focuses on asset quality and loan accounting issues. Much of that guidance is similar to previously issued guidance, which suggests that the staff continues to find deficiencies in the disclosures.

The following are a few of the significant additions to the most recent version:

  • Allowance for loan losses. For loans that are not evaluated individually, the allowance typically is calculated based on historical loss rate. The staff has added the following to the list of items it may ask registrants to address if that component of the allowance is significant:

    • “Discuss how qualitative and environmental factors are considered in their methodologies (e.g. as an adjustment to historical loss rates or as a separate adjustment to the allowance, etc.) and how such factors are reflected in the allowance.”
    • “Quantify any portion of the allowance for non-impaired loans that they do not calculate by applying historical or adjusted historical loss rates, describe how they calculate the associated allowance, including why they do not use historical or adjusted historical loss rates, and explain the reasons for any changes in the calculation during the period.”

  • Charge-off and nonaccrual policies. If a registrant has a material amount of loans on nonaccrual status or charged off in a period, the staff may ask for more information on charge-off and nonaccrual policies, particularly when the registrant’s disclosure states only that the policies comply with bank regulatory requirements. For example, the staff has added the following to the list of items it may ask registrants to address:

    • “Disclose the relevant thresholds they use to place loans on nonaccrual status or charge off past-due loans.”
    • “Explain why a loan was not charged off at a specific past-due threshold, including the specific factors they considered in reaching that conclusion.”

  • TDRs and modifications. Some registrants may remove loans from their TDR Guide 3 disclosures in certain circumstances. For such removed loans, the staff may ask registrants to:

    • “Discuss the circumstances under which they would remove loans from their TDR disclosures;
    • Quantify the amount of loans removed; and
    • Provide a roll-forward of TDRs, if necessary to provide a transparent analysis of TDR activity.”

  • Deferred taxes. For registrants that (1) have material deferred tax assets for which a valuation allowance has not been recorded and (2) have experienced cumulative losses in recent years, the staff has added the following to the list of items it may ask the registrant to explain:

    • “Why it believes projections of future income are sufficient to overcome the significant negative evidence of cumulative losses in recent years”;
    • “Why it believes it is appropriate to exclude items such as loan loss provisions when it evaluates whether it has experienced cumulative losses in recent years.”

  • FDIC-assisted transactions. For registrants that have acquired material assets through FDIC-assisted transactions, the staff has added the following to the list of items related to loss-sharing agreements. Registrants may be asked to:

    • “Disclose their accounting policies for any indemnification assets arising from loss-sharing agreements when changes to expected cash flows occur.”
    • “Disclose how changes in expected cash flows on the loans subject to the loss-sharing agreement are presented in the income statement in relation to the provision for loan losses, interest income, and non-interest income.”
    • “Include the assets subject to the loss-sharing agreement in their Guide 3 disclosures, with separate footnotes highlighting the special nature of the assets. Alternatively, these assets could be presented separately within the Guide 3 disclosures.”

While these disclosures are in addition to those provided in previous documents, we encourage registrants to review the full Corp Fin release, particularly because the staff continues to issue comments on these topics. Although this guidance is written to assist smaller financial institution registrants, it might be useful for all financial institution registrants to review their disclosures in light of the content of this document.

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Sydney Garmong

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Sydney K. Garmong
Office Managing Partner, Washington, D.C.