Financial Institutions Executive Briefing

 

Financial Institutions Executive Briefing – June 21, 2017

Current financial reporting, governance, and risk management topics

From the Federal Financial Institution Regulators

FDIC “Quarterly Banking Profile” Issued

The Federal Deposit Insurance Corp. (FDIC) issued, on May 24, 2017, its “Quarterly Banking Profile,” covering the first quarter of 2017. According to the report, FDIC-insured banks and savings institutions earned $44 billion in the first quarter, up 12.7 percent from the industry’s earnings a year before. The rise in net earnings resulted primarily from an increase of $8.8 billion in net interest income and a $2.1 billion increase in noninterest income.

The report provides these additional first-quarter statistics:
  • Community banks earned $552.9 million more in net income during the first quarter as compared to a year ago, which is a 10.4 percent increase from the same time last year.
  • Loan growth in banks slowed across all major lending categories in the first quarter. Total loan and lease balances rose by $358.1 billion, or 4 percent, year over year, compared to 5.3 percent for the 12 months ended March 2016. Total loan balances declined by 0.1 percent, the first quarterly decline since 2013.
  • For the first time in almost three years, there was a decrease in loan loss provisions. Banks recorded $12 billion in provisions for loan losses, a decline of 4.3 percent from the first quarter of 2016.
  • Across the industry, capital rose to $1.89 trillion, a 1.5 percent increase over last year.
The number of FDIC-insured commercial banks and savings institutions declined from 5,913 to 5,856 during the first quarter. The number of insured institutions on the FDIC’s problem bank list fell from 123 to 112 during the first quarter, the smallest number since first-quarter 2008.

First-Quarter 2017 Data on Credit Union Performance Released

On June 5, 2017, the National Credit Union Administration (NCUA) reported quarterly figures for federally insured credit unions based on call report data submitted to and compiled by the agency for the first quarter of 2017. These are highlights:
  • The number of federally insured credit unions continued to decline – from 5,785 at the end of the fourth quarter of 2016 to 5,737 at the end of the first quarter, a decrease of 217 from a year earlier.
  • Net income at an annual rate was $9.4 billion in the first quarter of 2017, up $0.2 billion (2.6 percent) from a year ago.
  • Total assets were $1.34 trillion, 7.8 percent greater than a year ago.
  • Return on average assets decreased slightly to 71 basis points for the first quarter of 2017 from 75 basis points for the first quarter of 2016.
  • Outstanding loan balances increased 10.6 percent year over year, to $884.6 billion.
  • The delinquency rate was 0.69 percent in the first quarter of 2017, compared to 0.71 percent one year earlier. The net charge-off ratio was 58 basis points in the first quarter of 2017, up slightly from 55 basis points in the fourth quarter of 2016.
  • Shares and deposits grew $78 billion (7.8 percent) year over year, to $1.1 trillion.

Supervisory Guidance on Model Risk Management Adopted by FDIC

On June 7, 2017, the FDIC issued a Financial Institution Letter, FIL-22-2017, “Adoption of Supervisory Guidance on Model Risk Management,” to adopt the supervisory guidance  previously issued by the Board of Governors of the Federal Reserve System (Fed) (SR 11-7) and the Office of the Comptroller of the Currency (OCC) (OCC Bulletin 2011-12), with technical conforming changes to apply the guidance to certain FDIC-supervised institutions. The guidance, “Supervisory Guidance on Model Risk Management,” addresses supervisory expectations for model risk management, including model development, implementation, and use; model validation; and governance, policies, and controls. The FDIC adopted this guidance to facilitate consistent model risk management expectations across the banking agencies and industry.

Appraiser Availability Advisory Issued

The Fed, the FDIC, the NCUA, and the OCC on May 31, 2017, jointly issued a reminder to financial institutions of the options available to help such institutions facilitate timely consideration of loan applications when faced with a shortage of qualified state-certified and state-licensed appraisers.

Two existing approaches are highlighted in the advisory:
  • Temporary practice permits allow appraisers certified in one state to provide services in other states.
  • Temporary waivers may be requested by financial institutions facing a documented scarcity of appraisers that has led to “significant delays” in appraisals on federal-related transactions in a specific geographic area. Such institutions may apply to the Appraisal Subcommittee (ASC) for a temporary waiver of the requirement to use a state-certified or state-licensed appraiser. The ASC is required to issue decisions on temporary waiver requests within 15 days after the close of a 30-day public comment period.

Policies Related to Violations of Laws and Regulations Updated

As part of its international peer review, on May 23, 2017, the OCC announced the updating of several agency policies and processes related to violations of laws and regulations. The updates apply to examinations of all national banks, federal savings associations, and federal branches and agencies.

The new policies, effective July 1, 2017, are reflected in various booklets and sections of the Comptroller’s Handbook and emphasize the timely detection and correction of violations. The updates include guidelines for consistent terminology, communication, format, follow-up, analysis, documentation, and reporting of violations. Among other updates, the new policies provide examiners with guidance on communicating violations with board members and management as well as on identifying previously communicated violations as “past due” (if the bank has taken no or insufficient action), “pending validation” (if more time is needed to validate the corrective action), or “closed” (provided the bank has corrected the violation and the agency has validated the correction).

Frequently Asked Questions to Supplement OCC Bulletin on Third-Party Relationships Issued

On June 7, 2017, the OCC issued Bulletin 2017-21 to provide answers to frequently asked questions related to OCC Bulletin 2013-29, “Third-Party Relationships: Risk Management Guidance.” Among other topics, questions relate to:
  • When financial technology (fintech) companies meet the definition of a third-party relationship
  • How a bank can reduce its oversight costs for lower-risk relationships
  • How a bank should structure the third-party risk management process
  • How banks can collaborate to meet expectations for managing third-party relationships and individual bank responsibilities
  • When fintech company arrangements are considered critical activities
  • Engaging with start-up fintech companies
  • Considerations for entering a marketplace lending arrangement with nonbank entities
  • Outsourcing responsibilities related to compliance management systems
  • Obtaining and using interagency technology service providers’ reports of examinations and third-party Service Organization Control reports

From the Consumer Financial Protection Bureau (CFPB)

Information on Small-Business Lending Market Sought

As it prepares to implement Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), the CFPB, on May 10, 2017, issued a request for information on various aspects of the market for small-business loans. Section 1071 calls for the CFPB to collect data on women-owned, minority-owned, and small businesses.

The CFPB is seeking information in five broad categories:
  • The definition of a small business
  • Data points the CFPB should require to be collected
  • Types of lenders required to participate in the data collection
  • Kinds of financial products and credit offered to small businesses
  • Privacy concerns related to the data collection
Comments are due July 14, 2017.

The CFPB also released a preliminary report providing the agency’s perspective on the market for lending to small, minority-owned, and women-owned firms and gaps in its understanding.

From the U.S. House of Representatives

Financial Choice Act Passed by House

The U.S. House of Representatives, on June 8, 2017, passed the Financial Choice Act (Choice Act) by a vote of 233 to 186. The 600-page bill is aimed at reforming parts of the extensive supervisory requirements of Dodd-Frank and providing regulatory relief for financial institutions.

The bill contains regulatory relief provisions including a qualified mortgage safe harbor for mortgage loans held in portfolio, more tailored supervision based on an institution’s risk profile and business model, relief from various reporting requirements, and repeal of the Volcker rule.

For larger institutions subject to heightened prudential standards of Dodd-Frank and capital and liquidity standards of Basel III, provided those institutions elect to maintain a 10 percent nonrisk weighted leverage ratio, the bill provides exemptions from federal and capital liquidity requirements, blocks on capital distributions, systemic risk regulations, and limitations on mergers and acquisitions. The Choice Act also replaces Dodd-Frank’s orderly liquidation authority provision with a new bankruptcy code designed to accommodate the failure of a large, complex financial institution, making sure that no institution is “too big to fail.”

For smaller issuers, the bill extends the five-year on-ramp for institutions that have graduated out of the emerging growth company status but continue to have an average annual gross revenue below $50 million, such that those entities do not have to comply with Sarbanes-Oxley Act (SOX) Section 404(b) (that is, the requirement for auditor attestation on the company’s internal control over financial reporting). Additionally, the Choice Act raises the threshold for smaller issuers to allow more entities to maintain the exemption from the SOX 404(b) auditor attestation; the revised thresholds are $500 million in market cap for public companies and $1 billion in assets for depository institutions.
 
The bill also would reform the Consumer Financial Protection Bureau, which would be renamed the Consumer Law Enforcement Agency. The agency would lose its examination powers and its enforcement authority over unfair, deceptive, or abusive acts or practices. A single director removable at will by the president would lead the agency, which would be subject to the congressional appropriations process.

Now that the bill has passed in the House, it will move to the U.S. Senate for its consideration.

From the Financial Accounting Standards Board (FASB)

FASB’s Transition Resource Group (TRG) for Credit Losses Meeting Held

On June 12, 2017, the FASB’s TRG for credit losses met to discuss the following implementation matters for Accounting Standards Update No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”
  • Consideration of prepayments in the discount rate used in a discounted cash flow method: The TRG supported the FASB staff’s view in Memo No. 1 that an entity may make an accounting policy election to include prepayments in the effective interest rate used in a discounted cash flow model to measure credit losses and that the election should be made at the class level for financing receivables.
  • When beneficial interests may be within the scope of purchased credit deteriorated (PCD) assets accounting: The TRG supported the FASB staff’s view in Memo No. 2 that when an entity is performing an analysis on whether to apply the PCD model to a beneficial interest, the entity should compute contractual cash flows for the beneficial interest by assuming expected prepayments and no credit losses.
  • Transitioning pools of purchased credit impaired (PCI) assets to PCD assets accounting: The TRG supported allowing two views outlined in Memo No. 3; these are 1) maintaining PCI pools at the time of adopting the credit loss standard and continuing to use those pools for credit loss measurement purposes only if similar risk characteristics are maintained under the new standard, and 2) allowing an accounting policy election to maintain the PCI pools both at the time of adoption and on an ongoing basis for credit loss measurement.
  • Forecasting reasonably expected troubled debt restructurings (TDRs): After significant discussion, no conclusions were reached, and TRG Chair Lawrence Smith directed the FASB staff to revisit the issue summarized in Memo No. 4 as well as related issues identified during the TRG’s extensive discussion.
  • Acceptable methods for estimating the life of a credit card receivable: After significant discussion, conclusions were not reached on this issue, and the FASB staff will revisit it.
Issue memos and the agenda are available on the FASB website. A recording of this meeting is also available for viewing on the past FASB meetings web page.

From the Public Company Accounting Oversight Board (PCAOB)

New Standard to Enhance Auditor’s Report Sent to SEC for Approval

On June 1, 2017, the PCAOB adopted a new auditing standard, “The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion,” that will require auditors to provide additional information in their reports. The standard is subject to Securities and Exchange Commission approval before it can become effective, and if approved, it will apply to audits conducted under PCAOB standards.

The new standard significantly modifies the auditor’s report while retaining the pass-fail reporting model. The most significant change to the auditor’s report is the requirement to communicate in the report any critical audit matters (CAMs) arising during the current period audit. A CAM is defined as a matter that has these elements:
  • Has been or was required to be communicated to the audit committee
  • Relates to accounts or disclosures that are material to the financial statements
  • Involves especially challenging, subjective, or complex auditor judgment
The auditor’s report will include:
  • The identification of the CAMs
  • A description of the principal considerations that led the auditor to determine that the matter was a CAM
  • A description of how the CAM was addressed
  • A reference to the relevant financial statements accounts and disclosures
The standard does not require communication of CAMs for audits of emerging growth companies, brokers and dealers, investment companies other than business development companies, and employee stock purchase, savings, and similar plans.

Other changes to the auditor’s report include:
  • Disclosure of the auditor’s tenure
  • A statement on independence
  • Addition of the phrase “whether due to error or fraud” with regards to whether the financial statements are free of material misstatements
  • Standardized form on the auditor’s report
  • Requirement that the report be addressed to at least the company’s shareholders and board of directors or equivalents
The effective date is Dec. 15, 2017, for all provisions other than the disclosures of the CAMs. The CAMs disclosures are effective for large accelerated filers, in audits of fiscal years ending on or after June 30, 2019, and for all other companies, in audits of fiscal years ending on or after Dec. 15, 2020.

From the Securities and Exchange Commission (SEC)

Pending Audit Standard and New Accounting Standards Addressed by Chief Accountant

On June 8, 2017, SEC Chief Accountant Wesley R. Bricker addressed the 36th annual SEC and Financial Reporting Institute Conference and covered the following topics:
  • The PCAOB’s new auditing standard on the auditor’s report, which the SEC is expected to make available for public comment before voting
  • Audit tenure in the context of the newly released auditing standard and varied conclusions in existing research on the relationship between an auditor’s tenure and either audit quality or auditor independence
  • The importance of oversight and governance of international audit standards in delivering high-quality audits internationally
  • The new accounting standard on revenue recognition, including involvement by the audit committee and auditor during implementation, and reminders of the importance of the new required disclosures and transition disclosures as described in Staff Accounting Bulletin (SAB) 74
  • The new accounting standards on leases, classification and measurement of financial instruments, and credit losses, including an emphasis on the scoping exercise for each of those standards and a recommendation to perform implementation activities for these major standards concurrently instead of doing it sequentially
  • The importance of internal control over financial reporting (ICFR), including in the implementation periods for the new major accounting standards
  • Auditor independence, specifically in the context of an audit committee selecting a successor auditor, including consideration of whether the successor auditor would be independent under SEC rules if the successor auditor were engaged to audit prior-period financial statements (for example, in the event of a restatement) or whether the predecessor auditor’s independence would be impaired by relationships entered into after the end of the engagement period

From the Center for Audit Quality (CAQ)

White Paper on the Auditor’s Role in Addressing Cybersecurity Risks Released

On the heels of the American Institute of CPAs’ release of the cybersecurity risk management reporting framework and related attestation guide, the CAQ released a white paper, “The CPA’s Role in Addressing Cybersecurity Risk,” on May 24, 2017. The paper examines today’s cybersecurity risks and threats and how the auditing profession can improve stakeholder confidence in cybersecurity information provided by management with the use of the framework. Included in the paper are summaries of the significant components and objectives of the framework as well as frequently asked questions on the framework.

The white paper notes that in the current technological environment, organizations face varying cyberthreats, and stakeholders must gather information and communicate with each other about cybersecurity. It also notes that the CPA profession can address these issues through its values and experience in auditing IT controls and providing independent assessments.

Webcast on Improving Accounting Policies and Internal Controls Planned by Anti-Fraud Collaboration

The CAQ and other members of the Anti-Fraud Collaboration will host a webcast, “What Is Your Role? When Accounting Policy Meets ICFR,” on July 11, 2017, to share recommendations on how companies can improve accounting policies and internal controls in order to detect and deter fraud and reduce the number of financial restatements.
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