Financial Institutions Executive Briefing

 

Financial Institutions Executive Briefing – Nov. 18, 2015

 

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

Credit Risk Discussed by Comptroller of the Currency

Comptroller of the Currency Thomas Curry in a speech before the Exchequer Club on Oct. 21, 2015, expressed concern about growing credit risk, particularly in auto loans, citing relaxed underwriting standards and that 30 percent of current new vehicle loans have maturities of more than six years.
“While I have no intention of letting up in our emphasis on operational risk, we are clearly reaching the point in the cycle where credit risk is moving to the forefront,” Curry said. “Although delinquency and losses are currently low, it doesn’t require great foresight to see that this may not last.”

Furthermore, in a speech on Nov. 2, 2015, made during the Risk Management Association’s Annual Risk Management Conference, Comptroller Curry again said that credit risk, in the form of relaxed underwriting and increased loan concentrations, is on the rise. Curry also noted that credit risk has been growing since 2012, and he recommended that bankers address it now, “without supervisory action.”

“Risk is never static,” Curry stated. “It rises and falls with the cycles of the economy and changes in technology and the evolving operational environment.” With the economic recovery, banks have increased their risk appetites while relaxing underwriting processes. In order to remain competitive, they are extending more loans to customers that are less creditworthy and are increasing their loan concentration in higher-risk business.

Curry urged risk managers to evaluate their loan loss allowance and adjust as appropriate with consideration of going beyond three years of historical experience. Curry said, “What we would expect, at minimum, is directional consistency: when credit risk rises, so should the allowance.”
 

Floor Plan Lending Guidance Updated

On Oct. 27, 2015, the Office of the Comptroller of the Currency (OCC) released its updated “Comptroller’s Handbook” guidance on floor plan lending, which combines information from booklets issued in 1990, 1994, and 1998. The revised booklet provides an overview of the floor plan lending business, related risks, and risk management practices. For examiners, it also presents examination procedures and tools.
 

Swap Margin Rule Finalized

The Federal Reserve, Federal Deposit Insurance Corp. (FDIC), OCC, Federal Housing Finance Agency, and Farm Credit Administration jointly approved, on Oct. 30, 2015, a final rule, “Margin and Capital Requirements for Covered Swap Entities,” that spells out minimum margin requirements for swaps and security-based swaps that are not cleared through a clearinghouse. The rule establishes margin requirements that vary based on the risk of the noncleared swap or noncleared security-based swap and include the exchange of initial and variation margins between covered swap entities and certain counterparties.

The margin and capital requirements under the rule do not apply to swaps entered into for hedging purposes by small banks, savings associations, Farm Credit System institutions, and credit unions with $10 billion or less in assets.

In addition, the rule defines what eligible collateral is and establishes a schedule whereby initial margin is phased in from Sept. 1, 2016, to Sept. 1, 2020, and variation margin is phased in from Sept. 1, 2016, to March 1, 2017.

The final rule is effective April 1, 2016.
 

Final Risk-Based Capital Rule Approved by NCUA

On Oct. 15, 2015, the National Credit Union Administration (NCUA) board voted to approve its “Risk-Based Capital” rule (Part 702), which is designed to provide enhanced protection from potential losses to the credit union system and the Share Insurance Fund if complex credit unions fail. The rule applies only to federally insured credit unions with more than $100 million in assets and does not include a supplemental capital provision.

The rule amends the current regulations regarding prompt corrective action and includes the following changes to the risk-based capital rule:
  • Creates a new risk-based capital ratio for federally insured natural person credit unions with more than $100 million in assets
  • For capital requirement purposes, redefines “complex credit unions” as credit unions with assets greater than $100 million
  • Establishes a risk-based capital ratio of 10 percent for well-capitalized credit unions and of 8 percent for adequately capitalized credit unions
  • Updates risk weights to reflect recent changes made by other banking regulators under the Basel system
  • Requires higher minimum capital levels for credit unions with concentrations of assets in real estate loans, commercial loans, or noncurrent loans
  • Provides details on how the NCUA can deal with a credit union that does not hold capital corresponding with its risk
The rule will be effective Jan. 1, 2019.

October Issue of “The NCUA Report” Released

The NCUA posted the October 2015 issue of “The NCUA Report” on Oct. 14, 2015. This latest issue includes a column from the NCUA board chairman as well as articles from various NCUA offices on the NCUA’s initiatives and information on supervisory, regulatory, and compliance issues.

Articles in this month’s edition include:
  • “NCUA Board Doubles Small Credit Union Threshold to $100 Million”
  • “Chairman’s Corner: Keys to Success”
  • “Board Actions: Matz Will Propose Streamlining Community Charter Approvals”
  • “Understanding What an Originating Lender Is”
  • “Risks in the Shadows: Understanding NCUA’s Need for Vendor Authority – Part 1”
  • “New Video Series Gives Board Members Tools to Succeed”
 

From the Consumer Financial Protection Bureau (CFPB)

Marketing Services Agreements Targeted in Compliance Bulletin

The CFPB issued on Oct. 8, 2015, a compliance bulletin to provide guidance on marketing services agreements, including descriptions of related risks, and to remind those in the mortgage industry of the federal prohibition on kickbacks and referral fees under the Real Estate Settlement Procedures Act (RESPA). The bulletin also includes examples from the CFPB’s enforcement experience and recognizes that marketing services agreements often are designed to evade the federal prohibitions on kickbacks and referral fees.

Within the bulletin, the CFPB advises all mortgage industry participants to consider carefully the negative consequences of noncompliance with RESPA’s requirements and restrictions.
  

Home Mortgage Disclosure Act Expansion Rule Finalized

On Oct. 15, 2015, the CFPB issued a final rule mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act that increases the data lenders are required to collect and report under the Home Mortgage Disclosure Act. The rule is designed to improve reported residential mortgage market information and provide information for monitoring fair lending compliance and access to credit. Newly required information includes the property value, loan term, duration of any introductory interest rates, and underwriting and pricing details, including an applicant’s debt-to-income ratio and the loan’s interest rate and discount points.

The rule also aims to simplify reporting requirements as it exempts from the reporting requirements small depository institutions located outside a metropolitan statistical area and institutions that made fewer than 25 closed-end mortgage loans or fewer than 100 open-end lines of credit in each of the two preceding calendar years. In addition, the rule is designed to align its reporting requirements with industry data standards.

The majority of the provisions are effective Jan. 1, 2018. Lenders will be required to start collecting new data in 2018 and will report the data by March 1, 2019.

From the Financial Accounting Standards Board (FASB)

Effective Dates Set for Credit Losses, Classification and Measurement, and Leases

On Nov. 11, 2015, the FASB announced effective dates for the forthcoming standard for credit losses using the current expected credit loss (CECL) model and its sister project on classification and measurement, which primarily makes changes for equity securities and disclosures. On the same day, the FASB determined effective dates for leases as well.

Financial Instruments – Impairment
For the financial instruments – impairment standard, the board recognized the pervasive impact that the final standard will have, particularly on the financial institutions industry, and decided to depart slightly from its definitions of public business entity (PBE) and all other entities for purposes of the effective dates. For this standard, the board defines smaller PBEs as PBEs that do not meet the U.S. Securities and Exchange Commission filer definition contained in U.S. generally accepted accounting principles.

For the effective dates, the FASB decided:
  • For PBEs – fiscal years beginning after Dec. 15, 2018, including interim periods within those fiscal years
  • For smaller PBEs – fiscal years beginning after Dec. 15, 2019, including interim periods within those fiscal years
  • For all entities other than PBEs – fiscal years beginning after Dec. 15, 2019, and interim periods within the fiscal years beginning after Dec. 15, 2020
For all entities other than PBEs (that is, smaller PBEs and entities other than PBEs), the board decided to permit early adoption using the effective dates for PBEs.

The staff plans to discuss remaining issues at the Nov. 23, 2015, board meeting. The board expects to issue a final standard in the first quarter of 2016.

Financial Instruments – Classification and Measurement
The staff provided results from the external review process, including the areas of significant comments. The board concurred with the staff that none of the areas required re-deliberation of the tentative decisions previously reached.

For the effective dates, the FASB decided:
  • For PBEs – fiscal years beginning after Dec. 15, 2017, including interim periods within those fiscal years
  • For all entities other than PBEs – fiscal years beginning after Dec. 15, 2018, and interim periods beginning after Dec. 15, 2019
The board decided to permit early adoption upon issuance only for the following:
  • Fair value change resulting from own credit risk for financial liabilities measured under fair value option recognized through other comprehensive income
  • The elimination of fair value disclosure requirements for financial instruments not recognized at fair value by entities that are not PBEs
Also, the board decided that all entities other than PBEs could early adopt using the PBE effective dates.

The board gave the staff permission to proceed with drafting a final standard. Given the early adoption provisions, the board has an objective of issuing the final standard before year-end.

Leases
The FASB also announced it will move forward with a new Accounting Standards Update (ASU) on leases, which will bring most leases onto the balance sheet.

For the effective dates, the FASB decided:
  • For PBEs – fiscal years beginning after Dec. 15, 2018, including interim periods within those fiscal years
  • For all entities other than PBEs – fiscal years beginning after Dec. 15, 2019, and interim periods within the fiscal years beginning after Dec. 15, 2020
The board decided to permit early adoption upon issuance.

The board also gave the staff permission to proceed with drafting a final standard, which it expects to issue in early 2016.

For our understanding of the results of these announcements, see “FASB Answers the Million-Dollar Question: What Is the Effective Date for Credit Losses (CECL)?” Crowe Horwath LLP, Nov. 11, 2015, http://www.crowehorwath.com/insights/effective-date-for-cecl.aspx.

Disclosures About Government Assistance Proposed

The FASB issued a proposed ASU, “Government Assistance (Topic 832): Disclosures by Business Entities About Government Assistance,” on Nov. 12, 2015, to increase transparency about government assistance arrangements. For financial institutions, this would seem to include loss-share arrangements entered into with the FDIC.

The proposed ASU would require disclosures about existing government assistance agreements to understand the nature of the assistance and the agreements’ significant terms and conditions. It would require disclosures about (1) the types of arrangements, (2) the accounting for government assistance, and (3) their effect on the financial statements.

Comments are due Feb. 10, 2016.
  

From the Securities and Exchange Commission (SEC)

Final Rules to Permit Crowdfunding Adopted

On Oct. 30, 2015, the SEC adopted final rules, “Regulation Crowdfunding,” which will allow companies to offer and sell securities through crowdfunding, a method of raising capital for a project or venture through the Internet by obtaining small amounts from a large number of parties. Title III of the Jumpstart Our Business Startups Act created a federal exemption under the securities laws so that securities can be offered and sold via crowdfunding.

The new rules allow individuals to invest in securities-based crowdfunding transactions subject to certain investment limits and also limit the amount of money an issuer can raise using the crowdfunding exemption. Additionally, the rules require issuers to disclose certain information about their business and securities offering, and they establish a regulatory framework for the broker-dealers and funding portals that facilitate the transactions.

The new rules will be effective 180 days after publication in the Federal Register.

Amendments to Intrastate and Regional Securities Offerings Rules Proposed

The SEC voted, on Oct. 30, 2015, to propose amendments to existing Securities Act rules to facilitate intrastate and regional securities offerings. The proposed amendments are intended to help smaller companies with capital formation and give investors additional protections, and they would modernize the rule for intrastate offerings by adding intrastate crowdfunding provisions. Additionally, the proposed rule would amend Securities Act Rule 504 to increase the total amount of money that may be offered and sold pursuant to the rule to $5 million and identify bad actor disqualifications to Rule 504 offerings.

Comments are due within 60 days of publication in the Federal Register.
 

Treasury Market Regulation Discussed by SEC Chair

SEC Chair Mary Jo White gave the keynote address at the Evolving Structure of the U.S. Treasury Market Conference held in New York on Oct. 20, 2015. She discussed primary features of equity market regulation that may be most useful when considering enhanced regulation for the Treasury market. White provided the following insights in her speech:
  • “We have learned through experience that operational integrity is an essential foundation of electronic markets. While individual market participants obviously have incentives to use high-quality systems, it also is true that problems with one participant’s systems can lead to market disruptions that can harm many other participants.”
  • “Another persistent concern about electronic markets is that they are vulnerable, or at least perceived by many to be vulnerable, to periods of excessive short-term – or “transitory” – price volatility. … I have directed the SEC staff to develop another type of volatility moderator – an anti-disruptive trading rule – that would focus on the demand side of a liquidity imbalance. In particular, there is a need to consider how to address the concern that the use of aggressive, destabilizing trading strategies in vulnerable market conditions could be seriously exacerbating price volatility.”
  • “Any review of Treasury market structure and regulation must address the important questions of whether post-trade transparency in this market segment would be beneficial and, if so, the most appropriate means to achieve this objective.”
  • “The message volume generated in active electronic markets is enormous. For regulators to understand market dynamics and exercise their market oversight function, they need access to this voluminous data in a way that facilitates analysis with automated tools.”

2015 Enforcement Results Released

On Oct. 22, 2015, the SEC announced its fiscal year 2015 enforcement results for the year that ended Sept. 30, 2015. The SEC stated that it continued to build a strong record of first-of-their-kind cases in the securities industry. During fiscal year 2015, the SEC filed 807 enforcement actions covering a wide range of misconduct and obtained orders totaling approximately $4.2 billion in penalties and disgorgement. Of the actions filed, 507 were independent actions for violations of the federal securities laws; 300 were either actions against issuers delinquent in making required SEC filings or administrative proceedings seeking bars against individuals based on criminal convictions, civil injunctions, or other orders.

The results included “first-of-their-kind cases” involving all of these:
  • A private equity adviser for misallocating broken deal expenses
  • An underwriter for pricing-related fraud in the primary market for municipal securities
  • A “Big Three” credit rating agency
  • Violations arising from a dark pool’s disclosure of order types to its subscribers
  • An action under the Foreign Corrupt Practices Act against a financial institution
  • An admissions settlement with an auditing firm
  • An SEC rule prohibiting the use of confidentiality agreements to impede whistleblower communication with the SEC

Private Funds Statistics Report Published

The SEC published a report, “Private Funds Statistics: Fourth Calendar Quarter 2014,” on Oct. 16, 2015, providing statistics and trends of the private fund industry. The information is from private fund advisers’ reported aggregated data on Form ADV and Form PF. Most of this data is being made public for the first time.

The report reflects information from the first calendar quarter of 2013 through the fourth calendar quarter of 2014 and includes statistics about the distribution of borrowings, an analysis of hedge fund gross notional exposure to net asset value, and a comparison of average hedge fund investor and hedge fund portfolio liquidity.

Form ADV is used by investment advisers to register with the SEC and/or certain state securities authorities and to report general information about private funds that they manage. SEC-registered investment advisers with at least $150 million in private funds assets under management file Form PF to report information about the private funds that they manage.

 

From the Institute of Internal Auditors (IIA)

High Risk in Corporate Culture Revealed in Survey

A survey by the IIA Financial Services Audit Center reveals that although more than half (56 percent) of respondents – internal audit professionals in the financial services sector – consider corporate culture a big risk in their organizations, less than 10 percent have programs dedicated specifically to auditing culture. The survey also found that 37 percent of respondents include assessing of culture in existing audit programs; however, only 7 percent said they have specific audit programs focused on organizational culture.

According to IIA President and CEO Richard Chambers, the findings should raise concerns about the current attitude toward culture as a risk and internal audit’s role in providing assurance and oversight for that facet of business.

Evolving Role of Internal Audit on Risk Management Reports Published

The IIA on Oct. 20, 2015, released three new reports based on data from the Common Body of Knowledge (CBOK) 2015 Practitioner Survey from the IIA Research Foundation.

According to the IIA, risk in all its forms is central to internal audit as it shapes annual audit plans, affects staff makeup, and influences the profession’s relationship with management, audit committees, and stakeholders. These new reports examine how risk affects business and internal audit’s role in an organization.

The reports are based on data collected from more than 14,500 internal audit practitioners in 166 countries who responded to the CBOK survey. They include:
  • “Who Owns Risk? A Look at Internal Audit’s Changing Role”
  • “Responding to Fraud Risk: Exploring Where Internal Auditing Stands”
  • “Combined Assurance: One Language, One Voice, One View” 
 

From the Center for Audit Quality (CAQ)

Self-Study Program on Corporate Ethics Announced

On Oct. 20, 2015, the Anti-Fraud Collaboration, which represents a cooperative effort of the CAQ, IIA, Financial Executives International, and the National Association of Corporate Directors, released a set of online self-study courses for corporate ethics training.

The individual courses in the self-study program are designed for accountants, financial executives, directors, external and internal auditors, and other members of the financial reporting supply chain.

The courses include the following:
  • “Building a Fraud Resistant Organization”
  • “Deterring Financial Fraud: What Else Can Be Done?”
  • “How Corporate Culture Can Breed Fraud if Left Unchecked”
  • “How to Improve Your Whistleblower Program and Address Impediments to Reporting”
  • “Your Role in Sustaining a Culture That Deters Fraud”
Each course is led by a panel of experts who examine the topics from a variety of perspectives.

From the American Institute of Certified Public Accountants (AICPA)

New SAS Issued on Audits of ICFR Integrated With Financial Statements

The AICPA’s Auditing Standards Board has issued Statement on Auditing Standards (SAS) No. 130, “An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements,” which establishes requirements and guidance for auditors performing audits of internal control over financial reporting (ICFR) that are integrated with an audit of financial statements. This new guidance applies to private banks and savings institutions that are subject to the internal control over financial reporting  requirements under the FDIC Improvement Act of 1991 (FDICIA).

The amendments in SAS 130 include the following requirements:
  • Auditors must examine and report directly on the effectiveness of ICFR.
  • The requirements of AU-C Section 610, “Using the Work of Internal Auditors,” must be applied when using the work of others in ICFR audits.
  • Auditors must consider the same risk factors in the audit of ICFR as they do in the audit of financial statements in identifying significant classes of transactions, account balances, and disclosures and their relevant assertions.
SAS 130 is effective for integrated audits for periods ending on or after Dec. 15, 2016.


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