Financial Institutions Executive Briefing

 

Financial Institutions Executive Briefing – Sept. 20, 2017

Current financial reporting, governance, and risk management topics

From the Federal Financial Institution Regulators

FDIC Issues “Quarterly Banking Profile”

The Federal Deposit Insurance Corp. (FDIC) issued, on Aug. 22, 2017, its “Quarterly Banking Profile,” covering the second quarter. According to the report, FDIC-insured banks and savings institutions earned $48.3 billion in the second quarter, up 10.7 percent from the industry’s earnings a year before. The rise in net earnings resulted primarily from an increase of 9.1 percent in net interest income.

The report provides these additional second-quarter statistics:
  • Return on assets, a benchmark for industry performance, reached 1.14 percent – a level not seen since 2007.
  • Net interest margin improved to 3.22 percent, up from 3.08 percent the year before and the highest level since 2013.
  • Total loans and leases increased by 1.7 percent, or $161.2 billion.
  • Residential mortgages grew by 1.8 percent, credit card balances by 3.1 percent, and commercial loans by 1.1 percent.
  • Banks set aside $12 billion in second-quarter loan loss provisions, up 2.3 percent from 2016; noninterest expenses rose by 3.3 percent.
  • Community banks earned $5.7 billion in net income during the second quarter, up 8.5 percent from the second quarter in 2016.
The number of FDIC-insured commercial banks and savings institutions declined from 5,865 to 5,787 during the second quarter. The number of insured institutions on the problem bank list dropped from 112 to 105, the fewest since 2008, and the Deposit Insurance Fund balance rose to $87.6 billion.

NCUA Releases Second-Quarter 2017 Performance Data

On Sept. 6, 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 second quarter of 2017. These are highlights:
  • The number of federally insured credit unions continued to drop – from 5,737 at the end of the first quarter to 5,696 at the end of the second quarter, a decrease of 191 from a year earlier.
  • Net income at an annual rate was $10.2 billion, up $0.65 billion (6.8 percent) from a year ago.
  • Total assets were $1.35 trillion, 7.7 percent greater than a year ago.
  • Compared to one year earlier, the return on average assets remained at 77 basis points for the year ending in the second quarter of 2017.
  • Outstanding loan balances increased 10.9 percent year over year, to $913 billion.
  • The delinquency rate was 0.75 percent, unchanged from one year earlier. The net charge-off ratio was 57 basis points, up from 51 basis points one year earlier.
  • Deposits (shares) grew $78 billion (7.8 percent) year over year, to $1.1 trillion.

Regulators Update FAQs on FASB’s CECL Model

The Board of Governors of the Federal Reserve System (Fed), FDIC, NCUA, and Office of the Comptroller of the Currency (OCC) on Sept. 6, 2017, updated the “Frequently Asked Questions on the New Accounting Standard on Financial Instruments – Credit Losses,” which provides guidance on the application and supervisory expectations for the standard and current expected credit loss (CECL) model.

New topics addressed in the FAQs (questions 24-37) include the following:
  • Continued relevance of qualitative factors
  • Data collection and maintenance needs
  • Accounting for changes in expected credit losses for purchased credit deteriorated (PCD) assets
  • Evaluating whether an institution meets the definition of a public business entity (PBE) or Securities and Exchange Commission (SEC) filer definition, and the effect of PBE and SEC filer status on adoption date
  • How and when a financial institution should adopt CECL in its regulatory reports (including call reports) for:
    • An entity that is not a PBE
    • A PBE that is not an SEC filer and has a non-calendar fiscal year
     
  • Continued requirement to use the fair value of collateral to determine the allowance for a collateral-dependent loan
The federal financial institution regulatory agencies continue to emphasize preparation for the implementation of CECL and scalability to institutions of all sizes.

FDIC Publication Examines Liquidity Risk and BSA/AML Trends

The FDIC issued, on Aug. 30, 2017, its summer 2017 issue of “Supervisory Insights,” focusing on recent trends in liquidity risk management and compliance with the Bank Secrecy Act (BSA). Many institutions continue to reduce liquid asset holdings, and the publication is meant to help bankers who wish to increase their knowledge of liquidity and funds management. The issue also includes a discussion about the purpose of, development of, and changes to the BSA over the years. This article provides an overview of the examination process and includes information on recent trends in BSA examination findings, with examples of failures in BSA/anti-money laundering (AML) compliance programs.

Regulators Propose Delay in Basel III Phase-in for Banks not Subject to Advanced Approach

On Aug. 22, 2017, the Fed, FDIC, and OCC issued a proposed rule that would extend indefinitely the current regulatory capital treatment of specific assets, investments, and minority interests for banks not subject to the advanced approach under capital rules (such as community, midsize, and some regional banks). The proposed rule is intended to simplify capital rules and reduce regulatory burden for community banks by delaying full transition to Basel III capital treatment for certain instruments.

Comments on the proposed rule are due Sept. 25, 2017.

Fed Proposes Guidance on Corporate Governance

On Aug. 3, 2017, the Fed issued a proposal on corporate governance aimed at streamlining its supervisory expectations for bank boards of directors. The proposal clarifies the difference between the roles of bank boards and senior management teams and suggests that in most cases, matters requiring attention should be directed to a bank’s senior management team, not the board. It also includes revisions or rescissions to existing supervisory expectations that do not relate to boards’ core responsibilities.

For banks with $50 billion or more in assets, the proposal includes new criteria by which the Fed will assess bank boards, including setting clear, consistent strategic direction and risk tolerance; actively managing information flow and board discussions; holding senior management accountable; supporting independent risk management and internal audit functions; and maintaining a capable board composition and governance structure.

Comments are due Oct. 10, 2017.

Fed Proposes New Risk Rating System for Large Financial Institutions

The Fed, on Aug. 3, 2017, proposed a new supervisory rating scale for large bank holding companies with $50 billion or more in assets. The proposal is to better align the rating system with the Fed’s existing supervisory program and to clarify its supervisory expectations and the consequences of supervisory ratings.

Ratings for capital planning, liquidity risk management, and governance and controls would be assigned under the proposed scale. Banks would be assigned ratings in each category rather than receiving a stand-alone composite rating, and all categories would have to be highly rated for the bank holding company to be considered “well-managed.”

Comments are due Oct. 16, 2017.

Regulators Clarify Capital Treatment of Centrally Cleared Derivative Contracts

The Fed, FDIC, and OCC on Aug. 14, 2017, jointly issued guidance on the regulatory capital treatment of certain centrally cleared derivative contracts in response to recent changes to the rule books of certain central counterparties. The guidance addresses the regulatory capital treatment of variation margin requirements for such contracts and will result in more beneficial regulatory capital treatment.

Previously, variation margin transferred to cover the price changes for centrally cleared derivative contracts was considered pledged collateral, with title to the collateral remaining with the posting party. However, under the revised rule books of central counterparties, such variation margin is considered a payment to settle the exposure.

Under this guidance, if banks, after conducting accounting and legal analyses, determine that variation margin payments represent settlement of outstanding exposure, then variation margin would no longer be considered pledged collateral. Thus, the payments will be subject to lower capital requirements than when they were treated as collateral on forward risks.

NCUA Seeks Comments on Regulatory Reform Plan

The NCUA has invited credit union stakeholders to comment on a package of regulatory reforms. These reforms, as recommended by an internal agency task force, would be implemented over a four-year period to clarify, improve, or eliminate regulations. The internal agency reform task force was established this year to comply with an executive order that requires federal agencies to conduct regulatory reviews. The recommendations for regulatory changes will require an affirmative vote by the NCUA’s board.

The NCUA already has taken steps toward reform in some of the areas addressed in the proposal, including field-of-membership, alternative capital, asset securitization, and appeals to the NCUA’s supervisory review committee.
 
Comments are due Nov. 20, 2017.

From the Basel Committee on Banking Supervision

Consultative Paper Highlights Fintech Issues

On Aug. 31, 2017, the Basel Committee on Banking Supervision publishedSound Practices: Implications of Fintech Developments for Banks and Bank Supervisors,” which presents 10 key recommendations for banks and bank supervisors to address the challenges of financial technology (fintech).

Recommendations include:
  • Take a balanced approach to innovation that considers the safety and soundness of the banking system.
  • Have effective governance structures and risk management and IT processes in place.
  • Establish appropriate processes for monitoring third-party risk.
  • Cooperate with regulators to develop appropriate standards for banking services delivered by both banks and fintech companies.
In addition, the recommendations emphasize the importance of collaboration among bank regulators.

Comments are due Oct. 31, 2017.

From the Consumer Financial Protection Bureau (CFPB)

Summary Details Latest TRID Changes

The CFPB released, on Aug. 30, 2017, a detailed summary of the changes and clarifications to the Truth in Lending Act and the Real Estate Settlement Procedures Act of 1974 (TILA-RESPA) integrated disclosures (TRID), which were finalized on July 7, 2017.

The summary refers to the 500-page final TRID rule and covers exemptions from TRID for certain loans, applicability of the disclosures to co-op units, and the sharing of disclosures, among other topics. In addition, the summary addresses the extensive technical corrections that were included in the July 2017 final rule.

Online Portal Opens for Regulatory Inquiries

On Aug. 17, 2017, the CFPB replaced an email address for regulatory inquiries with a new online portal. Through the portal, the bureau’s Office of Regulations staff will respond to inquiries and provide informal guidance to financial institutions and financial service providers within 10 to 15 business days.

CFPB Proposes New Disclosure Form for Overdraft Fees

The CFPB, on Aug. 4, 2017, released four new prototype overdraft disclosure forms as part of its “Know Before You Owe” campaign. These new forms are intended to make it easier for customers to understand the costs and evaluate the risks and benefits of opting in to overdraft coverage. Further testing is planned to determine whether they are more effective than the model opt-in form that banks currently use.

Along with the prototype disclosure forms, the CFPB also published a report that says frequent overdraft users typically pay more in fees, carry low daily balances, and have low or no credit scores. The report notes that approximately 9 percent of consumers are considered to be frequent overdrafters, incurring more than 10 overdraft or nonsufficient funds fees annually. In addition, 30.5 percent of frequent overdrafters are opted in to overdraft protection services, a rate 2.5 times higher than opt-in rates for other consumers.

From the Financial Accounting Standards Board (FASB)

FASB Overhauls Hedge Accounting

The FASB has been working to simplify existing standards, and this may be the most impactful update yet – significantly changing the hedging landscape. On Aug. 28, 2017, the FASB issued Accounting Standards Update (ASU) No. 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,” to simplify certain aspects of hedge documentation, effectiveness assessments, and accounting and disclosures. This update, several years in the making, offers simplification, opens the doors to new strategies, and may entice nonhedgers to become hedgers.

These are the most significant changes applicable to financial institutions:
  • Fair value hedges
    • Allows cash flows based on benchmark interest rates to be used in assessment of effectiveness, substantially reducing ineffectiveness in hedges of interest rates
    • Permits partial-term hedging (for example, hedging of first two years of 10-year instrument) without causing ineffectiveness
    • Introduces a new hedge method (“last-of-layer”), which allows for simplified hedging of pools of fixed-rate financial instruments (for example, mortgage loans)
     
  • Cash flow hedges
    • Replaces benchmark rate concept with contractually specified rate (for example, permits direct hedging of prime interest rate)
     
  • Both fair value and cash flow hedges
    • Permits certain hedges to use qualitative quarterly effectiveness assessments instead of quantitative assessments (for example, regression analysis), even if not 100 percent effective
    • Allows migration to long-haul method if shortcut method is determined to be inappropriate
    • No longer measures or records ineffectiveness; if effective (80 to 125 percent), records hedges as if fully effective
     
The update provides for a reclassification of certain debt securities from held-to-maturity to available-for-sale only if the debt security is eligible to be hedged using the last-of-layer method. Any unrealized gain or loss existing at the time of transfer is recorded in accumulated other comprehensive income. As a permitted activity, the reclassification of securities will not taint future held-to-maturity classification so long as the securities transferred are eligible to be hedged under the last-of-layer method.

For PBEs, the update is effective for fiscal years beginning after Dec. 15, 2018, and interim periods within. For non-PBEs, it is effective for fiscal years beginning after Dec. 15, 2019, and interim periods beginning after Dec. 15, 2020.

Certain items must be applied using the modified retrospective method with an adjustment to opening retained earnings, while others may be applied only prospectively. Caution should be used when adopting as certain elections are permitted only during adoption.

For more in-depth analysis, please read “FASB Just Moved a Mountain, Changed Landscape on Hedging,” issued by Crowe on Sept. 13, 2017.

FASB Clarifies Impact of TDRs on CECL Estimate

On Sept. 6, 2017, the FASB discussed unresolved issues for troubled debt restructurings (TDRs) under the credit loss standard. The issues, previously debated at the June 12, 2017, meeting of the Credit Losses Transition Resource Group (TRG), related to when an allowance estimate for TDRs should be recognized and the complexities of measuring certain TDR concessions (such as interest-rate and term concessions) using a method other than a discounted cash flow (DCF) method.

At the FASB meeting (memorialized in Memo 6A on the TRG Meetings page), the board clarified that it did not intend to change the identification method for TDRs; as such, identification of a TDR is required when an individual asset is specifically identified as a reasonably expected TDR. In addition, the board concluded that once specifically identified, a TDR must be measured using a DCF method (or a method that reconciles to a DCF model) when an entity grants a concession that can be measured only using a DCF model (such as an interest-rate or term concession). The FASB said it did not intend to allow measurement of TDRs in a way that avoids capturing TDR concessions.

Furthermore, if an entity uses a DCF method for measurement of credit losses on a performing loan portfolio, adjustments for TDRs that are incremental to what is embedded in the historical loss information should not be incorporated as an input to the model until a TDR is individually identified.

From the Securities and Exchange Commission (SEC)

Chief Accountant Discusses CECL Implementation, PCAOB Activity, and Digital Token Offerings

SEC Chief Accountant Wesley R. Bricker addressed the 2017 AICPA National Conference on Banks and Savings Institutions on Sept. 11, 2017. In his remarks, he discussed FASB’s standard for measuring CECL and the improvements it offers, including earlier recognition of credit losses and transparency of a financial asset portfolio’s credit quality. Regarding CECL implementation, he reminded the audience that portions of Financial Reporting Release (FRR) 28 and Staff Accounting Bulletin (SAB) 102 will continue to apply and that existing practices are a good starting point for transitioning to the standard. Bricker also highlighted important judgments to consider related to selecting a methodology, identifying data, and developing assumptions. Finally, he emphasized the importance of internal control over financial reporting in adopting the standard, including the importance of the tone at the top, technology, and documentation.

He commented on Public Company Accounting Oversight Board (PCAOB) activity and the requirement for the SEC to take action on the PCAOB’s new auditor’s reporting model standard by Oct. 26, 2017. He stated that the SEC staff is evaluating comments received at this point. He also emphasized the PCAOB’s oversight of broker-dealer compliance activities.

Finally, he discussed initial coin offerings (or token sales) and the recent SEC report clarifying that federal securities laws apply to these digital token sales or offerings purchased using either traditional currency or virtual currency. Furthermore, the digital token offerings are subject to SEC oversight and registration whether the entity is a traditional company or not. He illustrated financial reporting considerations for both issuers and holders of these digital tokens.

At the end of his speech, he answered a question from the audience related to SAB 74 on disclosing the anticipated effect of new accounting pronouncements in a future period. His advice was that registrants should describe the relevant information about what the company does know, and companies should not disclose what they do not know about the anticipated effect, whether quantitative or qualitative.

SAB Eliminates Previous Revenue Guidance

On Aug. 18, 2017, the SEC staff issued SAB 116, on revenue recognition, to conform to the FASB’s new revenue guidance in Accounting Standards Codification (ASC) Topic 606. The new SAB eliminates SAB Topic 13, “Revenue Recognition,” which includes interpretations and four specific criteria for the FASB’s previous revenue model in ASC Topic 605. The new SAB is consistent with the effective dates for ASC Topic 606, and once adopted, reference to previous guidance in SAB Topic 13 will no longer be appropriate.

Corp Fin Describes Financial Statement Relief in Confidential Registration Statements

The SEC’s Division of Corporation Finance (Corp Fin) on Aug. 17, 2017, updated its Compliance and Disclosure Interpretations (C&DIs) to reflect staff policy that companies may omit certain financial information from confidential registration statements. If a company reasonably believes that interim or annual financial statements will not be required at the time of the contemplated offering (for emerging growth companies – EGCs), or at the time of publicly filing the registration statement (for non-EGCs), those financial statements are not required in the confidential submission.

Corp Fin Adds Information on Who to Contact for Financial Statement Relief

On Aug. 25, 2017, Corp Fin added a section in its Financial Reporting Manual on how to communicate with Corp Fin’s Office of the Chief Accountant (CF-OCA) and whom to contact regarding financial statement relief in filings with the SEC under Rule 3-13 of Regulation S-X. For example, financial institutions might request relief from Rule 3-05 for financial statements of an acquired troubled financial institution, and instead present an audited statement of assets acquired and liabilities assumed (see SAB Topic 1K). These types of formal requests should be emailed to the CF-OCA staff, and relief, if appropriate, would be granted in the form of a waiver letter from the staff.
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