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
FAQ on FASB’s Current Expected Credit Loss (CECL) Model Released
The Board of Governors of the Federal Reserve System (Fed), Federal Deposit Insurance Corp. (FDIC), National Credit Union Administration (NCUA), and Office of the Comptroller of the Currency (OCC) on Dec. 19, 2016, issued “Frequently Asked Questions on the New Accounting Standard on Financial Instruments – Credit Losses
,” to help financial institutions as they prepare to implement the FASB’s new standard on credit losses, Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
.” Each agency released the guidance jointly as follows: the Fed’s Supervisory Release (SR) 16-19, “Frequently Asked Questions on the Current Expected Credit Losses Methodology (CECL)
”; FDIC’s Financial Institution Letter (FIL) 79-2016, “New Accounting Standard on Credit Losses: Frequently Asked Questions
”; and the OCC’s Bulletin 2016-45, “Interagency Frequently Asked Questions on the New Accounting Standard on Financial Instruments – Credit Losses
Topics addressed in the 18-page FAQs include changes the new standard makes to existing U.S. generally accepted accounting principles (GAAP), the standard’s effective dates, its application upon initial adoption, acceptable allowance estimation methods under the current expected credit loss model, and portfolio segmentation for credit loss estimation on a pool basis.
The agencies plan to periodically add and update FAQs.
FDIC “Quarterly Banking Profile” Issued
The FDIC issued
on Nov. 29, 2016, its “Quarterly Banking Profile
,” covering the third quarter of 2016. According to the report, FDIC-insured banks and savings institutions earned $45.6 billion in the third quarter, up 12.9 percent from the industry’s earnings a year before. The rise in net earnings resulted primarily from an increase of $10 billion in net interest income and $1.2 billion in noninterest income, offset by an increase in loan-loss provisions of approximately $2.9 billion.
The report provides these additional third-quarter statistics:
- Community banks’ earnings were $5.6 billion in the third quarter, up 11.8 percent from the same period in 2015.
- Total loan balances increased by $590.8 billion, or 6.8 percent, from a year prior and increased $112 billion during the third quarter. Residential mortgages rose by 2.2 percent during the quarter, while real estate loans secured by nonfarm, nonresidential real estate properties rose by 1.5 percent, and credit card balances grew by 2.1 percent.
- Loan-loss provisions were up 34 percent year on year. Net charge-offs during the third quarter rose by 16.9 percent over the previous year to $10.1 billion. As loss provisions exceeded charge-offs, loss reserves rose by 0.3 percent.
- The proportion of banks that were unprofitable in the third quarter fell from 5.2 percent in 2015 to 4.6 percent for 2016.
- Capital rose to $1.89 trillion, a 0.9 percent increase over 2015.
Additionally, the number of institutions on the problem banks list continued to decline from 147 at the end of the second quarter of 2016 to 132 at the end of the third quarter, and the Deposit Insurance Fund balance rose to $80.7 billion from $77.9 billion in the previous quarter.
Third-Quarter 2016 Data on Credit Union Performance Released
On Dec. 5, 2016, the NCUA reported
quarterly figures for federally insured credit unions based on call report data submitted to and compiled by the agency for the third quarter of 2016. These are highlights:
- The number of federally insured credit unions continued to drop – from 5,887 at the end of the second quarter of 2016 to 5,844 at the end of the third quarter. This represents a decrease by 246 from a year earlier.
- Annualized net income was $9.7 billion for the first three quarters of 2016, a 5.7 percent increase over the third quarter of 2015.
- Total assets were $1.28 trillion, which represents growth of 8.2 percent for the year ending Sept. 30, 2016.
- Return on average assets increased slightly to 78 basis points for the third quarter of 2016 from 77 basis points at the end of the second quarter but is down from 80 basis points a year earlier.
- Outstanding loan balances increased 10.1 percent year over year, to $847.1 billion, and net member business lending rose 14 percent year over year.
- The delinquency rate fell slightly in the third quarter to 0.77 percent as compared to 0.78 percent in the third quarter of 2015. The net charge-off ratio was 53 basis points for the nine months ended Sept. 30, 2016, up from 46 basis points in the first three quarters of 2015.
- Deposits (shares) grew 8.6 percent year over year, to nearly $1.1 trillion.
Potential Fintech Charter Discussed
In a speech
on Nov. 3, 2016, at the Chatham House “City Series” Conference, “The Banking Revolution: Innovation, Regulation & Consumer Choice,” held in London, Comptroller of the Currency Thomas J. Curry discussed the potential for a federal charter for fintech companies that conduct banking activities. Curry stated, “If the OCC decides to grant a national charter in this area, the institution will be held to the same high standards of safety, soundness, and fairness that other federally chartered institutions must meet.” He continued, “Having a national charter has tremendous value, and because of that it carries certain responsibilities.” He also said that the OCC would issue a paper “soon” outlining its stand on the subject and requesting public comment.
In his speech, Curry also shared his thoughts on pilot programs for innovation and stated that he does not support the approach of creating “a ‘safe space’ to allow companies to try out new products and processes without the risk of penalty if the trial runs afoul of consumer protection laws or other regulations.” However, he does support “carefully designed pilots” that can limit liability for companies if their scope and duration are controlled and if tests are diligently monitored.
Community Bank Supervision Booklet Updated
On Nov. 3, 2016, the OCC issued
an updated version of the Comptroller’s Handbook booklet on community bank supervision. Among other enhancements to the booklet, the latest version includes several updates on how examiners should assess asset quality, including the scope of the asset quality review, the quantity of credit risk in the portfolio and from other assets, the adequacy of the allowance for loan and lease losses, the quality of credit risk management, and overall credit risk assessment and verification procedures.
Revised Interagency Consumer Compliance Rating System Released
The Federal Financial Institutions Examination Council (FFIEC), whose members include the Fed, the Consumer Financial Protection Bureau, the FDIC, the NCUA, the OCC, and the State Liaison Committee, on Nov. 7, 2016, issued
its updated Uniform Interagency Consumer Compliance Rating System
. The new rating system reflects changes in consumer compliance supervision – including regulatory, examination, technological, and market changes – since the system was first introduced in 1980. The final system was adopted substantially as proposed with a few points of clarification.
The revisions incorporate the adoption by the regulatory agencies of risk-based supervision focused on an institution’s compliance management systems, in contrast to the transaction testing that was common when the system was first introduced. The model maintains the 1-through-5 rating, and institutions will be assessed in three categories: board and management oversight, compliance program, and violations of law and consumer harm.
The new rating system will apply to all institutions, including nondepository institutions, and is effective March 31, 2017.
Final Deposit Recordkeeping Rule Approved
The FDIC approved
, on Nov. 15, 2016, a final rule for banks with more than 2 million deposit accounts. The rule establishes certain enhanced recordkeeping requirements to expedite the determination of FDIC-insured deposits in the event of a bank failure. Under the rule, the FDIC will use the failing bank’s systems, data, and staff to calculate the insured and uninsured amounts for each depositor and place holds on portions of uninsured deposits. To comply with the rule, these banks will be required to collect and maintain more detailed depositor information and make upgrades to their systems so that they are able to calculate most insured deposits within 24 hours of failure.
The rule is effective April 1, 2017, and covered institutions will have three years to comply from the effective date of the rule or the date they reach the threshold of 2 million deposit accounts. Currently, 38 banks would be covered institutions.
NCUA Vendor Management Webinar Held
On Dec. 7, 2016, the NCUA hosted a webinar, “Vendor Management and Due Diligence,” to provide information to credit unions on cybersecurity and strengthening relations with digital vendors. The presentation focused on regulatory guidance and requirements as well as risk management controls to protect member information, and it included a discussion of risk-based due diligence, effective vendor management programs, management of third-party connectivity risk, and vendor contracts.
A recording is available on the NCUA website
From the Consumer Financial Protection Bureau (CFPB)
Investigation Into Third-Party Access to Customer Data Launched
On Nov. 17, 2016, the CFPB announced
the launch of a formal inquiry into problems consumers encounter in accessing personal financial records held by banks and other institutions and in sharing such information with third parties.
CFPB Director Richard Corday said in the press release, “Consumers should be able to use their financial records and account information and securely share access in an electronic format. Technology provides opportunities to use these records to create new consumer tools that help improve financial lives. To realize that potential, we are launching a public inquiry into how much control consumers have over their records and how easy and secure it is for them to share their records with third parties.”
The CFPB also is seeking comments on several aspects of consumer data access and sharing, including current practices and potential market developments.
Comments are due 90 days after publication in the Federal Register.
Warning About Sales and Production Incentives Released
The CFPB issued
a compliance bulletin on Nov. 28, 2016, titled “Detecting and Preventing Consumer Harm From Production Incentives
,” outlining expectations of incentive programs for employees and service providers. The bulletin provides guidance previously issued by the CFPB in other contexts and highlights examples from its supervisory and enforcement experience. While the CFPB acknowledged that properly managed incentive programs can benefit both companies and customers and that the types of incentive programs used by banks vary widely, it cautioned financial institutions that inadequate oversight or unrealistic goals could lead to consumer harm. Examples of problems described in the bulletin include opening accounts without consent, misrepresenting benefits of products, and guiding customers toward less favorable products or terms.
To protect consumers, the CFPB repeated its expectation that banks using incentive programs have proper compliance management systems in place to monitor and quickly respond to any potential violations of consumer protection laws. The CFPB said that this system should be robust and appropriately tailored to reflect the risk, nature, and significance of the incentive programs.
From the Financial Accounting Standards Board (FASB)
Guidance on the Presentation of Restricted Cash on the Statement of Cash Flows Issued
The FASB, on Nov. 17, 2016, issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash
.” The guidance addresses the diversity in practice regarding the classification and presentation of changes in restricted cash on the statement of cash flows.
In current practice, transfers between cash and restricted cash are reflected as operating, investing, or financing activities, or a combination, on the cash flow statement. Also, some entities present direct cash receipts from and payments to a restricted cash bank account on the cash flow statement, and others disclose those cash flows as noncash activities.
The new guidance requires that the statement of cash flows include restricted cash and cash equivalents in total cash and cash equivalents, and therefore, the transfers solely between cash and restricted cash would not be reflected in the cash flow activities.
In addition, the balance sheet line items that include restricted cash and cash equivalents and the related amounts must be disclosed either in the cash flow statement or in the notes to the financial statements, and they should reconcile to total cash and cash equivalents on the cash flow statement, which will include restricted cash and cash equivalents. The FASB decided not to define “restricted” in the final standard. However, an entity will be required to disclose the nature of restrictions on the restricted cash and cash equivalent amounts.
For public business entities, the guidance is effective for fiscal years beginning after Dec. 15, 2017, and interim periods within those fiscal years, which will be the first quarter of 2018 for calendar year-ends. For all other entities, the amendments are effective for fiscal years beginning after Dec. 15, 2018, and interim periods within fiscal years beginning after Dec. 15, 2019, which will be Dec. 31, 2020, for calendar year-ends. Early adoption is permitted, and the amendments are to be applied retrospectively.
Changes to the Scope of Share-Based Payment Modification Accounting Proposed
The FASB issued a proposed ASU, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting
,” on Nov. 17, 2016, to provide guidance for which share-based payment award changes require modification accounting. Today, some entities evaluate whether changes are substantive, some apply modification accounting for any change unless it’s purely administrative, and others apply modification accounting when the change results in a change to the fair value, vesting, or classification. In addition, questions had been posed on whether changes for the adoption of ASU 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” – namely, changes to statutory tax withholding requirements – would require modification accounting.
For changes to the terms or conditions of a share-based payment award, the proposed amendments would provide guidance about when to apply modification accounting in Topic 718. Modification accounting would apply unless all of the following are the same immediately before and after the modification:
- The award’s fair value (or calculated value or intrinsic value, if such an alternative measurement method is used)
- The award’s vesting provisions
- The award’s classification as an equity instrument or a liability instrument
Current disclosure requirements in Topic 718 would apply whether or not an entity is required to use modification accounting under the proposed amendments.
The amendments would be applied prospectively to awards modified on or after the effective date.
Comments are due Jan. 6, 2017.
Proposal Released on Distinguishing Liabilities From Equity
On Dec. 7, 2016, the FASB proposed amendments to remove some complexity for financial instruments that have both equity and liability characteristics. The two-part exposure draft, “Distinguishing Liabilities From Equity (Topic 480): I. Accounting for Certain Financial Instruments With Down Round Features and II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests With a Scope Exception
,” addresses the following two issues.
- The first issue relates to financial instruments with down-round features (that is, features that result in the exercise price declining based on the price of future equity offerings) and would more closely align the accounting with the economics of those features. Specifically, an entity would no longer consider down-round features when determining whether a financial instrument is indexed to its own stock under the liability or equity classification analysis. Instead, the effect of the down-round feature would be recognized when triggered:
In the period when the down-round feature is triggered, disclosure would be required, including the quantitative effect of the feature being triggered and financial statement line item where the effect is recorded.
- For equity-classified instruments, the effect would be recognized in equity as a dividend.
- For liability-classified instruments, it would be recognized in earnings.
- In 2003, the FASB deferred the effective date of FASB Statement 150, “Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equity,” for mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests, which is memorialized in ASC 480-10-65-1. Some find the content in the codification difficult to read and to navigate, so the board decided to replace the indefinite deferral with a scope exception. As such, there is no expected accounting impact.
Comments are due Feb. 6, 2017.
From the Securities and Exchange Commission (SEC)
“AICPA National Conference on Current SEC and PCAOB Developments” Presented
Audit and accounting professionals assembled in Washington, D.C., or participated by video feed, for the annual “AICPA National Conference on Current SEC and PCAOB [Public Company Accounting Oversight Board] Developments” on Dec. 5-7, 2016. The conference included speeches from SEC staff and its chief accountant, the FASB chair, the PCAOB chair and its chief auditor, and many other representatives of the profession.
See more about the conference in the Crowe e-communication, “Headline Speeches From the 2016 AICPA SEC Conference
Plan to Create Consolidated Audit Trail Approved
On Nov. 15, 2016, the SEC voted
to approve a national market system plan to create a single, comprehensive database: the consolidated audit trail (CAT). The purpose of the CAT is to allow regulators to track all trading activity in the U.S. equity and options markets in a more efficient and thorough manner. The plan outlines how self-regulatory organizations and broker-dealers will record and report information that will “provide the complete lifecycle of all orders and transactions in the U.S. equity and options markets.” The plan also details how the CAT data will be maintained to verify its accuracy, integrity, and security.
Within two months of the national market system plan’s approval, the self-regulatory organizations must select a plan processor to build and operate the CAT, and within one year of approval, they will be required to begin reporting to the CAT. Large broker-dealers will begin reporting the next year, and small broker-dealers will start the year after.
From the Center for Audit Quality (CAQ)
Tool for Revenue Recognition Released
On Dec. 13, 2016, the CAQ released a tool
for audit committees to use in assessing the status of a company’s implementation of the new revenue recognition standard. The tool’s four sections include recommended questions to be asked of management:
- “Understanding the New Revenue Recognition Standard – What Is It?”
- “Evaluating the Company’s Impact Assessment – How Will Revenue Recognition Change?”
- “Evaluating the Implementation Project Plan – How Do We Need to Prepare?”
- “Other Implementation Considerations – What Else Do We Need to Consider?”
It also contains a resource list of executive summaries and technical guides on the new revenue standard; these have been produced by industry representatives.
Non-GAAP Measures Tool for All Stakeholders Released
On Dec. 5, 2016, the CAQ released a tool that can be used to continue the dialogue about the presentation of non-GAAP measures, “Non-GAAP Financial Measures: Continuing the Conversation
.” This new article is not targeted solely to audit committee members, as was the previous one, “Questions on Non-GAAP Measures: A Tool for Audit Committees
.” Instead, it poses questions to all stakeholders, including the SEC, investors, and the FASB, in the quest to improve the use and presentation of non-GAAP measures. The CAQ plans to use the questions in future discussions of non-GAAP measures.