Banking Agencies Approve Final Rule on CECL Regulatory Capital Effects

Current financial reporting, governance, and risk management topics

From the federal financial institution regulators

FDIC acts on brokered deposit regulations

On Dec. 19, 2018, the Federal Deposit Insurance Corp. (FDIC) released two actions related to brokered deposits: a final rule regarding the treatment of reciprocal deposits and an advance notice of proposed rulemaking (ANPR) on brokered deposits and interest-rate restrictions.

As part of implementation of Section 202 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), the final rule exempts certain reciprocal deposits from being considered as brokered deposits. Institutions that are well-rated and well-capitalized under this exemption do not have to regard reciprocal deposits as brokered deposits up to the lesser of 20 percent of their total liabilities or $5 billion. Under certain circumstances, reciprocal deposits may be excluded from brokered deposits for institutions that are not well-capitalized or well-rated. The final rule also makes conforming amendments to the FDIC’s regulations governing deposit insurance assessments.

Through the ANPR, the FDIC, in an effort to review its policies and regulations, will accept comments about brokered deposits and interest-rate regulations and will consider additional actions or rulemaking efforts.

The final rule will take effect 30 days after publication in the Federal Register.

Comments on the ANPR are due 90 days after publication in the Federal Register.

Agencies propose exempting community banks from Volcker rule

The federal banking regulators, including the FDIC, the Federal Reserve Board (Fed), and the Office of the Comptroller of the Currency (OCC), issued a proposed rule jointly with the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) on Dec. 21, 2018. Consistent with the EGRRCPA, this rule would exclude some community banks from the Volcker rule, which restricts banks from such actions as engaging in proprietary trading or owning or sponsoring private equity or hedge funds. The agencies propose to exclude community banks with $10 billion or less in total consolidated assets as well as total trading assets and liabilities of 5 percent or less of total consolidated assets from the restrictions of the Volcker rule.

Comments are due 30 days after publication in the Federal Register.

Agencies approve final rule on three-year phase-in for CECL’s regulatory capital effects

On Dec. 21, 2018, the FDIC, the Fed, and the OCC (banking agencies) approved a final rule, “Regulatory Capital Rule: Implementation and Transition of the Current Expected Credit Losses Methodology for Allowances and Related Adjustments to the Regulatory Capital Rule and Conforming Amendments to Other Regulations.” The agencies are modifying regulatory capital rules and giving banks the option to phase in over a three-year period the day-one adverse regulatory capital effects of adopting the current expected credit loss (CECL) model under the Financial Accounting Standards Board’s Accounting Standards Update 2016-13, “Financial Instruments–Credit Losses (Topic 326).”

The final rule was adopted as proposed, with one change from the proposal that affected terminology only. A new term, “adjusted allowance for credit losses” (AACL), replaces the term “allowance for credit losses” (ACL), as used in the proposal. AACL is narrower than the allowance for credit losses recorded under GAAP.

• AACL includes, for example, the allowance on non-purchased credit deteriorated (PCD) loans and held-to-maturity (HTM) debt securities.
• AACL is eligible for inclusion in tier two capital, subject to the current limit for including the allowance for loan and lease losses (ALLL) in tier two capital (up to 1.25 percent of its standardized total risk-weighted assets, excluding its standardized market risk-weighted assets, if applicable).
• AACL does not include allowances on PCD assets and available-for-sale (AFS) debt securities, and those amounts will be treated differently for regulatory capital purposes. Those allowances will not be included in tier two capital, and the carrying value of PCD assets and AFS debt securities would be net of allowances, for risk-weighted assets.

The agencies noted in the final rule that they would continue to monitor the impact of CECL adoption on banks.

The final rule is effective on April 1, 2019, and banks that early adopt CECL are permitted to early adopt the final rule.

Regulators propose higher thresholds for management interlock rules

The federal banking agencies jointly issued, on Dec. 20, 2018, a proposal to increase the major asset thresholds at which bank directors or other management officials are prohibited from serving at more than one depository institution or holding company as prescribed in the Depository Institution Management Interlocks Act (DIMIA). Currently, the DIMIA prohibits directors or management officials working at an institution with total assets of more than $2.5 billion from serving at the same time as a management official of an unaffiliated depository organization with assets exceeding $1.5 billion. The agencies are proposing to raise both major asset thresholds to $10 billion. 

The current thresholds were established in 1996. The agencies are considering the increase because of consolidation and growth in the industry.

Comments on the proposal are due 60 days after publication in the Federal Register.

Treasury releases “National Illicit Finance Strategy” and risk assessments

On Dec. 20, 2018, the U.S. Department of the Treasury issued its “National Strategy for Combating Terrorist and Other Illicit Financing,” also known as the “National Illicit Finance Strategy.” The U.S. government’s efforts toward fighting illicit finance threats, as well as recognizing any priorities, objectives, and areas for future improvement, are assessed by the strategy. Efforts to combat such threats domestically and internationally and updated guidance to assist financial institutions in detecting and combating illicit finance activities also are addressed.

The strategy further describes threats to the U.S. financial system that were identified in three separate risk assessments released in conjunction with the strategy. These three risk assessments are on money laundering, terrorist financing, and national proliferation financing. Together, the risk assessments and strategy highlight money laundering and terrorist financing methods used in the U.S. and the risks that these activities pose to the U.S. financial system in order to allow financial institutions and U.S. agencies to more effectively identify illicit threat actors and mitigate the related risks.

The Office of Terrorist Financing and Financial Crimes within the Treasury’s Office of Terrorism and Financial Intelligence, in conjunction with bureaus and agencies fighting illicit finance threats, prepared the strategy and risk assessments.

Agencies expand exam cycle for certain small banks

The federal banking agencies issued, on Dec. 21, 2018, the final rules to implement Section 210 of the EGRRCPA, which was enacted on May 24, 2018. The final rules adopt without change the August 2018 interim final rules allowing qualifying banks with up to $3 billion in assets to be eligible for an 18-month on-site examination cycle. The previous threshold was $1 billion. 

Under the final rules, insured depository institutions, including federal or state branches of foreign banks, qualify for the 18-month cycle if they have an “outstanding” or “good” composite safety and soundness exam rating. The final rules are effective Jan. 28, 2019.

Fed proposes to amend company-run stress-test threshold and requirements

On Jan. 8, 2019, the Fed issued a proposed rule that would make changes to company-run stress-testing requirements in order to conform to Section 401 of the EGRRCPA. The OCC and the FDIC released similar proposals for national banks and state nonmember banks, respectively, in December.

The proposed rule, consistent with the EGRRCPA, would effectively increase the threshold for state-member banks to conduct their company-run stress tests from $10 billion to $250 billion in total consolidated assets. For firms above the $250 billion mark, the ruling likely would mandate company-run stress tests once every other year rather than annually as required under current rules. The hypothetical “adverse” scenario from both company-run and supervisory stress tests would be eliminated as well. Organizations still would be required to perform company-run stress tests against the “severely adverse” scenario, which will remain a part of supervisory stress testing.

Comments on the proposal are due Feb. 19, 2019.

From the Financial Accounting Standards Board (FASB)

FASB staff issues Q&A on estimating current expected credit losses (CECL)

On Jan. 10, 2019, the FASB staff released a question-and-answer (Q&A) document, “Topic 326, No. 1, Whether the Weighted-Average Remaining Maturity Method Is an Acceptable Method to Estimate Expected Credit Losses,” to address questions the staff has received about whether the weighted-average remaining maturity (WARM) method is an acceptable method to estimate expected credit losses. The WARM method was first introduced in a Feb. 27, 2018, webinar, “Community Bank Webinar: Implementation Examples for the Current Expected Credit Losses Methodology (CECL),” as an approach for smaller, less complex portfolios.
The Q&A addresses these five questions specific to the WARM method: 

1. “Is the WARM method an acceptable method to estimate allowances for credit losses under Subtopic 326-20?”
2. “What factors should an entity consider when determining whether to use the WARM method?”
3. “How can an entity estimate the allowance for credit losses using a WARM method?”
4. “Are there other ways to perform the WARM estimation?”
5. “When an entity implements CECL using a loss rate method such as the WARM method, is it acceptable to adjust historical loss information for current conditions and the reasonable and supportable forecasts through a qualitative approach as was done in the example rather than a quantitative approach?”

FASB to hold public CECL roundtable

On Jan. 9, 2019, the FASB announced that it will hold a public roundtable to discuss the credit losses standard on Jan. 28, 2019. Participants will include representatives of various size banks, regulators, and other stakeholders. Topics will include:

• Research on credit losses agenda requests, including an alternative to the income statement impact of the CECL model
• Disclosure of charge-offs and recoveries within the vintage disclosures
• Other transition issues

Advance registration is required to attend in person. Live audio of the meeting will be webcast, and the recorded meeting will be available on the FASB website for 90 days.

From the Securities and Exchange Commission (SEC)

SEC provides update on operational status

The SEC updated its operational status on Dec. 27, 2018, due to the federal government shutdown, stating “until further notice, the agency will have a very limited number of staff members available. The SEC has staff available to respond to emergency situations involving market integrity and investor protection, including law enforcement. In addition, our plan calls for the continuing operation of certain Commission systems, including EDGAR.” 

SEC allows Exchange Act reporting companies to use Regulation A exemptions

On Dec. 19, 2018, the SEC adopted final rules to allow Exchange Act reporting companies to apply the registration exemption offered by Regulation A. This will allow those companies to complete Securities Act offerings of securities up to $50 million in a 12-month period without separately registering those offerings with the SEC and without additional reporting obligations.

The final rules are effective once published in the Federal Register.

OCIE reveals 2019 examination priorities

On Dec. 20, 2019, the SEC’s Office of Compliance Inspections and Examinations (OCIE) – the office that examines broker-dealers – revealed its examination priorities for 2019. According to the release, the examination priorities will emphasize “digital assets, cybersecurity, and matters of importance to retail investors, including fees, expenses, and conflicts of interest.”

The OCIE’s 2019 examination priorities are categorized as follows:

1. Compliance and risk for registrants responsible for critical market infrastructure
2. Matters of importance to retail investors, including seniors and those saving for retirement
3. Financial Industry Regulatory Authority and Municipal Securities Rulemaking Board oversight and examination
4. Digital assets
5. Cybersecurity
6. Anti-money laundering programs

From the Public Company Accounting Oversight Board (PCAOB)

PCAOB adopts new standards on estimates and using the work of specialists

The PCAOB adopted a new auditing standard, “Auditing Accounting Estimates, Including Fair Value Measurements,” on Dec. 20, 2018, to replace three existing PCAOB auditing standards on estimates. Changes in the standard address the auditor’s professional skepticism, including potential management bias, when auditing estimates. A special topics appendix addresses auditing fair values of financial instruments, including the use of information from third-party pricing sources.

Concurrent with the new standard, the PCAOB also adopted amendments related to using the work of a company’s employed or engaged specialists and the work of an auditor’s employed or engaged specialists. With the issuance of PCAOB Release No. 2018-006, “Amendments to Auditing Standards for Auditor’s Use of the Work of Specialists,” the board amended two existing auditing standards, Auditing Standard (AS) 1105, “Audit Evidence,” and AS 1201, “Supervision of the Audit Engagement.” AS 1210, “Using the Work of a Specialist,” was retitled and replaced by AS 1210, “Using the Work of an Auditor-Engaged Specialist.”

Subject to approval by the SEC, the new and amended standards will be effective for audits of financial statements for fiscal years ending on or after Dec. 15, 2020.

From the Center for Audit Quality (CAQ)

CAQ releases “Audit Quality Disclosure Framework”

On Jan. 9, 2019, the CAQ released “Audit Quality Disclosure Framework” to assist audit firms in developing their transparency or audit quality reports. The framework is voluntary and flexible, and it addresses disclosure of quality control at the firm level. It provides six focus points:

1. Leadership, culture, and firm governance
2. Ethics and independence
3. Acceptance and continuance of clients and engagements
4. Engagement team management
5. Audit engagement performance
6. Monitoring

The framework also includes examples of firm-level audit quality indicators.