Financial Institutions Executive Briefing

 

Financial Institutions Executive Briefing – April 19, 2017

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

Joint Report to Congress Detailing EGRPRA Review Issued

Member agencies of the Federal Financial Institutions Examination Council (FFIEC), including the Board of Governors of the Federal Reserve System (Fed), the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corp. (FDIC), and the National Credit Union Administration (NCUA), issued a joint report to Congress on March 21, 2017, covering their review of rules affecting financial institutions as part of their efforts to decrease regulatory burdens under the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA).

In accordance with EGRPRA, the federal banking agencies, along with the FFIEC, must review their rules at least every 10 years to identify outdated or unnecessary regulations. The NCUA is not required to participate in this review; however, the NCUA chose to participate to enhance its regulatory review process.

Several joint actions planned or taken by the regulators are detailed in the report, including:
  • Simplifying community banks’ and savings associations’ regulatory capital rules
  • Streamlining reports of condition and income (call reports)
  • Raising commercial real estate loans’ appraisal threshold
  • Increasing the number of institutions eligible for less frequent examination cycles
Individual actions taken by each agency to update its own rules, remove unnecessary requirements, and streamline supervisory procedures also are covered in the report.

According to the press release, the agencies “will continue their efforts to tailor regulations to the size and risks posed by financial institutions while ensuring the safety and soundness of the nation’s financial institutions and banking system.”

Draft Licensing Manual Supplement for Fintech Charter Applicants Issued

On March 15, 2017, the OCC released a draft supplement to its licensing manual for financial technology (fintech) companies seeking the agency’s new limited-purpose national bank charter. The draft specifies how applicants can seek a charter and how the OCC will review applications and examine newly chartered fintech firms. Consistent with previous OCC communications and releases, the draft supplement clearly states that the special-purpose charters will be subject to all applicable banking laws and regulations and that they will not authorize deposit-taking.

The draft further details the initial steps of applying for the charter, the standards the OCC will apply, the business plan the applicant is expected to provide, and the OCC’s final decision-making process. It is noted in the draft that the management and board of the fintech company usually will be expected to have experience in regulated financial services.

Comments on the draft manual were accepted through April 14, 2017.

From the Consumer Financial Protection Bureau (CFPB)

Regulatory Review Discussed

In a speech at the Chamber of Commerce 11th Annual Capital Markets Summit held in Washington, D.C., on March 30, 2017, CFPB Director Richard Cordray stated that the CFPB is sensitive to the compliance burden of further changes to the rules as it begins its five-year retrospective review of the Dodd-Frank Wall Street Reform and Consumer Protection Act remittance and mortgage rules.

“One thing we have learned is that whenever you try to ‘improve’ things, you create new transitional challenges as industry finds itself facing a moving target for compliance management,” Cordray said. “So we will try to be sensitive to the need for further changes.”

Cordray emphasized that the CFPB intends to continue working closely with industry participants to facilitate compliance and provide clarity. He noted that even attempts to streamline regulation, such as the CFPB’s integration of Truth in Lending Act and Real Estate Settlement Procedures Act mortgage disclosures, “can come at considerable implementation cost”; however, “many businesses prefer more comprehensive language that answers questions explicitly up front, leaves less terrain undefined and uncertain, and minimizes the prospect of protracted and costly litigation.”

From the Basel Committee

Capital Treatment of Right-of-Use (ROU) Asset Under New Lease Accounting Standard Addressed

The Basel Committee issued a press release on April 6, 2017, to respond to three frequently asked questions on how to treat an ROU asset under the new lease accounting standards issued separately by the Financial Accounting Standards Board and the International Accounting Standards Board (IASB) in 2016. The committee’s responses indicate that an ROU asset should be treated as a tangible asset for capital reporting purposes, as long as the underlying asset being leased is a tangible asset.

Specifically, when the underlying leased asset is a tangible asset, the ROU asset should:
  • Not be deducted from regulatory capital
  • Be included in the risk-based capital and leverage ratio denominators
  • Be risk-weighted at 100 percent

From the Financial Accounting Standards Board (FASB)

Final Standard on Premium Amortization for Callable Debt Securities Issued

The FASB issued Accounting Standards Update (ASU) No. 2017-08, “Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities,” on March 30, 2017, which will shorten the amortization period for premiums on callable debt securities by requiring that premiums be amortized to the first (or earliest) call date instead of as an adjustment to the yield over the contractual life. This change more closely aligns the accounting with the economics of a callable debt security and the amortization period with expectations that already are included in market pricing on callable debt securities.

This guidance is in response to a stakeholder request that the board address the accounting for the premiums associated with the purchase of callable municipal securities. Under current generally accepted accounting principles (GAAP), premiums and discounts are amortized and accreted over contractual life, not to call date. Some stakeholders observed that significant premiums on assets exist, particularly on instruments issued by municipalities that are likely to be repaid earlier than maturity. Under current GAAP, the result is overrecognition of interest income during the holding periods before the call and recognition of a loss during the period when the call occurs. The new standard eliminates the misalignment of accounting and economics in these transactions by requiring amortization to the earliest call date.

The guidance does not change the accounting for discounts on callable debt securities, which will continue to be amortized to the maturity date.

The scope of the ASU includes only instruments that are held at a premium and have explicit call features. The scope does not include instruments that contain prepayment features, such as mortgage backed securities; nor does it include call options that are contingent upon future events or in which the timing or amount to be paid is not fixed.

For public business entities (PBEs), the effective date is in fiscal years and interim periods within, beginning after Dec. 15, 2018, which first applies to March 31, 2019, interim financial statements for calendar year-end PBEs. For non-PBEs, the standard is effective in fiscal years beginning after Dec. 15, 2019, and interim periods in fiscal years beginning after Dec. 15, 2020.

Transition is on a modified retrospective basis with an adjustment to retained earnings as of the beginning of the period of adoption.

Early adoption is permitted, including in an interim period. If early adopted in an interim period, adjustments should be reflected as of the beginning of the fiscal year that includes that interim period.

Final Standard on the Presentation of Pension and Postretirement Benefit Costs Issued

On March 10, 2017, the FASB issued ASU 2017-07, “Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,” to change the presentation of defined benefit cost.

Rather than reporting pension expense as a net amount under existing GAAP, employers will present the service cost component of pension expense consistent with other compensation for the same employees, and separately present the other components (including interest, expected return on plan assets, any gain or loss on settlements or curtailments, and termination costs) of pension expense. The income statement line item(s) that includes the other components of pension expense should be appropriately described, or if a separate line item is not used, the line(s) where the other components are presented must be disclosed.

In addition, only the service cost component of pension expense is eligible for capitalization as part of assets such as deferred loan costs. This is a change in GAAP as all components of pension expense are eligible for capitalization under existing GAAP.

The standard is effective for PBEs for annual reporting periods beginning after Dec. 15, 2017, including interim periods in that reporting period. For calendar year-end PBEs, it first applies to March 31, 2018, interim financial statements. For non-PBEs, it is effective for annual reporting periods beginning after Dec. 15, 2018, and interim periods beginning after Dec. 15, 2019. For calendar year-end non-PBEs, it first applies to Dec. 31, 2019, annual financial statements. Early adoption is permitted as of the beginning of an annual period, which would mean adoption in the first interim period if an entity issues interim financial statements.

The income statement presentation amendments are applied retrospectively, and the amendments for the capitalization of the service cost component are applied prospectively. The ASU provides a practical expedient for entities to use the amounts for the prior comparative periods disclosed in the pension footnote as the estimation basis for applying retrospective presentation requirements. If the practical expedient is applied, that fact must be disclosed.

From the Securities and Exchange Commission (SEC)

Effective Internal Control and Credible Financial Reporting Addressed by Chief Accountant

In a speech on March 21, 2017, SEC Chief Accountant Wesley R. Bricker addressed the Annual Life Sciences Accounting & Reporting Congress. He discussed implementation of the revenue recognition standard, including themes related to the new gross versus net presentation guidance. He highlighted the need for disclosure of details related to a principal versus agent assessment in order to assist investors in understanding the arrangement.

Additionally, Bricker reminded the audience that the scope of the new standard includes not only recognition, measurement, and presentation but also disclosure. He guided entities to consider the impact of changes to disclosure when they are evaluating the extent of the impact of the new standard.

In his remarks about internal control over financial reporting, he mentioned areas that may be affected by the transition to the new standard, including attracting and retaining competent personnel, management’s tone at the top, changes to established business practices and information reporting systems, and comprehensive and timely risk assessments.

The Role and Effectiveness of Audit Committees Discussed

In a March 24, 2017, speech to audit committee members at the University of Tennessee’s C. Warren Neel Corporate Governance Center, Bricker addressed the critical role of today’s audit committee in overseeing the quality of the audit and financial reporting processes, and he called on audit committees to consider a number of actions, including:
  • Developing an understanding of the business operating environment of the company that a member serves
  • Evaluating the risk of audit committee work overload
  • Assessing the tone at the top as part of the control environment evaluation
  • Educating members on developments in accounting and financial reporting and evaluating their company’s implementation progress on new accounting standards
  • Evaluating non-GAAP measures, including disclosure controls and procedures for accurate and consistent measures
  • Overseeing the external auditor relationship and considering voluntary audit committee reporting, including the disclosures outlined in the 2015 SEC concept release related to the evaluation and approval of the auditor’s compensation

New Deputy Chief Accountant Announced

On March 30, 2017, the SEC named Sagar S. Teotia as a deputy chief accountant in the Office of the Chief Accountant (OCA). He will lead the activities of OCA’s accounting group, which includes consultations with public companies on accounting matters. Teotia previously served as a professional accounting fellow in OCA.

T+2 Settlement Cycle for Securities Transactions Adopted

The SEC, on March 22, 2017, adopted an amendment to shorten the standard settlement cycle for most broker-dealer securities transactions by one business day. The standard settlement cycle for these transactions currently is three business days, also known as T+3. The amended rule will reduce the settlement cycle to two business days, T+2.

The amendment is designed to improve efficiency, decrease risk, and expedite a coordinated transition by market participants to a shortened settlement cycle. Beginning on Sept. 5, 2017, broker-dealers will be required to comply with the shortened cycle.

From the Center for Audit Quality (CAQ)

Close Focus on Complex Accounting Areas to Deter Fraud Recommended

On March 16, 2017, the Anti-Fraud Collaboration, comprised of the CAQ, Financial Executives International, the Institute of Internal Auditors, and the National Association of Corporate Directors, released a report, “Addressing Challenges for Highly Subjective and Complex Accounting Areas,” which compiles recommendations for ways to help deter financial reporting misstatements due to error or fraud.
 
Audit committee members, corporate executives, internal and external auditors, and regulators met at two 2016 workshops that explored certain SEC enforcement actions where the SEC asserted that there were serious issues with companies’ internal control over financial reporting. Based on these discussions, the report provides recommendations on improving accounting policies, internal controls, and staffing for highly subjective and complex areas, including a specific focus on revenue recognition.
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