December financial reporting, governance, and risk management

| 12/16/2020
December Financial Institutions Executive Briefing

Message from Mike Percy, Managing Partner, Financial Services

Dear FIEB readers,

Is it really the last month of 2020? With all that this year has brought, I hope this message finds you, your friends, your family, and your colleagues safe.

From what we have observed, the top financial reporting issues heading into the fourth quarter are allowance for credit losses, under either CECL or the incurred loss model, closely followed by loan modifications. Also making the list are mortgage servicing rights, goodwill, and other intangible impairments. Concerns with securities impairments are at the bottom of the list, at least for now.

As we move through the fourth quarter, I wish you, your family, and your friends a delightful holiday season, whether it’s in person or virtually.

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Takeaways from the Dec. 1 update to the 2020 AICPA banks and savings institutions conference

AICPA presents additional year-end update

The 45th annual American Institute of Certified Public Accountants (AICPA) National Conference on Banks and Savings Institutions was held Sept. 14-16, 2020. Given the rapidly changing accounting and financial reporting environment due to the COVID-19 pandemic, the AICPA offered a one-day virtual year-end update on Dec. 1, 2020. Crowe has updated its comprehensive report covering the 2020 AICPA conference on banking, originally issued on Oct. 7, with information from the Dec. 1 one-day update. Key takeaways identified during the one-day conference included:

  • Banks that elected relief from the current expected credit loss (CECL) standard under Section 4014 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) are not required to restate and refile previously issued call reports for the adoption of CECL as of the beginning of their most recent fiscal year.
  • Lara Lylozian, deputy associate director and chief accountant at the Federal Reserve Board (Fed), commented that with respect to interest income on loans with deferred repayment terms, it may no longer be appropriate to rely solely on mechanical triggers for nonaccrual treatment.
  • Banks are allowed to measure their total assets as of either Dec. 31, 2019, or Jan. 1, 2021, for purposes of complying with Part 363 of the Federal Deposit Insurance Corporation Improvement Act for their 2021 fiscal year; however, the Federal Deposit Insurance Corp. (FDIC) retained a reservation of authority for banks that exceed total asset triggers due to mergers and acquisitions. Banks with this fact pattern should first perform a self-assessment and then contact their regional FDIC accountant. The use of this reservation of authority by the FDIC will be communicated in writing to the bank.

Matters of importance from the financial regulators

FDIC issues “Quarterly Banking Profile” for third quarter 2020

The FDIC issued, on Dec. 1, 2020, its “Quarterly Banking Profile” covering the third quarter. According to the report, FDIC-insured banks and savings institutions reported $51.2 billion net income, a decrease of $6.2 billion (10.7%) from a year ago but an increase of $32.4 billion from the second quarter. The increase from the prior quarter is attributable primarily to the significant decline in provision expense, while the decrease compared to the prior year is a result of lower net interest income.

The report provides these additional third quarter statistics:

  • Net interest income decreased 10% ($10 billion) from the previous year, totaling $128.7 billion. From the previous year, the average net interest margin decreased 68 basis points to 2.68%.
  • Noninterest income, compared to the previous year, grew 4.5%, driven by net gains on loan sales and an increase in trading revenue.
  • Total loans and leases decreased $84.5 billion (0.8%) from the previous quarter.
  • Net charge-offs decreased by $418.2 million (3.2%) from a year ago, and the average net charge-off rate declined 5 basis points to 0.46%.
  • From the previous quarter, the noncurrent loan rate increased by 9 basis points to 1.17%. Noncurrent loan balances (those 90 days or more past due) rose $9.3 billion (7.9%) to $127.5 billion.
  • Community banks’ net income increased 10% year over year.

The total number of FDIC-insured commercial banks and savings institutions declined to 5,033 from 5,066 the previous quarter. During the third quarter one new bank was chartered, 33 banks were absorbed by mergers, and no banks failed. The number of institutions on the FDIC’s problem bank list increased to 56.

NCUA issues third quarter 2020 performance data

The National Credit Union Administration (NCUA) reported, on Dec. 4, 2020, quarterly figures for federally insured credit unions based on call report data submitted to and compiled by the agency for the third quarter of 2020. Highlights include:

  • The number of federally insured credit unions declined to 5,133 from 5,281 in the third quarter of 2019. In the third quarter of 2020, 3,213 federal credit unions and 1,920 federally insured, state-chartered credit unions existed.
  • Total assets reported for federally insured credit unions rose by 16.1% to $1.79 trillion, up $248 billion from a year ago.
  • Net income at an annual rate totaled $11 billion, down $3.7 billion (25.1%) from the previous year.
  • The return on average assets decreased significantly from 98 to 66 basis points compared to a year ago.
  • The credit union system’s net worth ratio decreased from 11.38% the previous year to 10.43% in the third quarter of 2020.

Agencies provide temporary relief to community banks

On Nov. 20, 2020, the Fed, FDIC, and Office of the Comptroller of the Currency (OCC) issued an interim final rule in response to asset growth related to the Paycheck Protection Program (PPP) to allow banks with less than $10 billion in total assets as of Dec. 31, 2019, to use asset data as of Dec. 31, 2019, to determine the applicability of various regulatory requirements based on asset thresholds during calendar years 2020 and 2021. Some of the areas include capital adequacy, regulatory reporting, audit requirements, permissible activities, and eligibility for 18-month exam cycle. The Fed also is revising instructions for certain regulatory reports to align with these provisions.

The interim final rule was effective Dec. 2, 2020. Comments will be accepted until Feb. 1, 2021.

NCUA proposes rule on capitalization of interest

On Nov. 19, 2020, the NCUA approved a proposed rule to remove the prohibition on the capitalization of interest in connection with loan workouts and modifications. The change would apply to workouts and modifications for all loan types, including commercial and business loans. The proposed rule also would establish documentation requirements for mortgage loans to help ensure that the capitalization of interest would not hinder a member’s ability to become current on the loan.

Comments are due Feb. 2, 2021.

Agencies provide guidance on Bank Secrecy Act due diligence for charities and nonprofits

On Nov. 19, 2020, the Financial Crimes Enforcement Network (FinCEN), Fed, FDIC, NCUA, and OCC issued a joint fact sheet to clarify expectations for a risk-based customer due diligence (CDD) approach for charities and nonprofit organizations (NPOs). The fact sheet was issued in response to charities reporting difficulty in obtaining and maintaining access to financial services.

The guidance reiterates that the level of CDD should be appropriate for the risks presented by each customer and that no regulatory requirement or supervisory expectation exists for banks to have additional due diligence steps for charities or NPO customers. Considerations for applying a risk-based approach also are included within the fact sheet.

Agencies issue statement on LIBOR transition

On Nov. 30, 2020, the Fed, FDIC, and OCC issued a statement to encourage banks to transition away from using U.S. dollar (USD) London Interbank Offered Rate (LIBOR) as a reference rate as soon as workable. The statement further encourages banks to cease entering into new contracts that use USD LIBOR as a reference rate in order to facilitate an orderly LIBOR transition.

OCC issues proposed rule on CRA general performance standards

On Nov. 24, 2020, the OCC released a notice of proposed rulemaking regarding Community Reinvestment Act (CRA) general performance standards, following the final rule published in June 2020 that was designed to strengthen and modernize CRA regulations.

The OCC is seeking comment on the proposed approach to determine CRA evaluation measure benchmarks, retail lending distribution test thresholds, and community development minimums under the general performance standards. The proposed rule also clarifies how the OCC would assess significant declines in CRA activity levels in connection with performance context following the initial establishment of the benchmarks, thresholds, and minimums.

Comments are due Feb. 2, 2021.

OCC proposes rule to ensure fair access to banking services

On Nov. 20, 2020, the OCC released a notice of proposed rulemaking to help ensure fair access to banking by codifying previous OCC guidance stating that banks should provide access to services, capital, and credit based on the risk assessment of individual customers rather than making broad-based decisions affecting whole categories or classes of customers. The proposed rule would apply to large banks – generally those with more than $100 billion in assets – and was issued in response to decisions by several large banks to cease lending to certain types of business.

Comments are due Jan. 4, 2021.

CFPB finalizes advisory opinion policy, releases two new advisory opinions

On Nov. 30, 2020, the Consumer Financial Protection Bureau (CFPB) issued a final advisory opinions policy designed to provide clearer guidance within the regulations under the CFPB’s purview. Originally announced in June 2020, the program will allow regulated entities to submit requests for clarification where uncertainty exists within a regulation. The CFPB will select certain topics from these requests and make responses available to the public. Previously, responses to these types of inquiries typically were provided only to the requesting entity. Now, these responses, known as advisory opinions, will be published on the CFPB’s website and the Federal Register and will serve as official guidance for the relevant area of the regulation. Requests for advisory opinions may be submitted via email.

The CFPB also issued two new advisory opinions. One relates to earned wage access products, and the other clarifies requirements related to refinancing certain education loan products.

Paycheck Protection Program (PPP)

SBA clarifies loan necessity questionnaires

As announced on Nov. 25, 2020, the Small Business Administration (SBA) is using the Forgiveness Platform to transmit to PPP lenders two new documents that supply operational details about the previously issued Loan Necessity Questionnaires. A letter to PPP lenders describes updates to the platform and necessity questionnaire process including: 1) the provision of links to the Loan Necessity Questionnaires (SBA Form 3509, applying to for-profit borrowers, and SBA Form 3510, for nonprofit borrowers), and 2) updates to the PPP Forgiveness Platform to allow online submission of the questionnaires. Lenders are not required to reenter narrative comments from the questionnaires; however, lenders still are responsible for individually inputting borrowers’ responses to each question into the web form available on the platform. 

The second document is a user guide, “Paycheck Protection Program Lender Instructions for the Loan Necessity Questionnaire.” The SBA recommends that lenders read the complete instructions in the user guide before beginning submissions of the questionnaires.

On Dec. 9, 2020, the SBA and the U.S. Department of the Treasury added a question and answer regarding the loan necessity questionnaire to the “Paycheck Protection Program Loans: Frequently Asked Questions (FAQs)” document.

Federal Reserve programs

Fed announces extensions

On Nov. 30, 2020, the Fed announced an extension through March 31, 2021, for its Commercial Paper Funding Facility, the Money Market Mutual Fund Liquidity Facility, the Primary Dealer Credit Facility, and the Paycheck Protection Program Liquidity Facility, all of which have been designed to help the economy recover from the COVID-19 pandemic. These lending facilities were scheduled to expire on or around Dec. 31, 2020. Approved by Treasury, the extension will help planning by potential participants in the facilities and provide certainty that the programs will continue to be available through the first quarter of 2021. Additional information on the facilities can be found on the Fed website.

Fed continues to update FAQs

The Fed updated the Main Street Lending Program frequently asked questions document on Nov. 25, 2020, to provide additional guidance on the program as well as other topics. The Fed added questions and answers addressing loan participation and operational details.

On the same date, the Fed also updated its Main Street for Nonprofit Organizations frequently asked questions.

Loan modifications

Fed updates FAQs on COVID-19 supervisory and regulatory response

On Dec. 1, 2020, the Fed updated its frequently asked questions about its supervisory and regulatory response to COVID-19 to include a section addressing loan modification accounting and reporting issues. The newly added questions and answers address nonaccrual status, past due status, troubled debt restructurings (TDRs), risk ratings, allowance for credit losses, and guidance for modified loans.

From the Financial Accounting Standards Board (FASB)

FASB discusses post-implementation review of CECL

At its board meeting on Dec. 2, 2020, as part of its post-implementation review process, the FASB discussed feedback received on the post-issuance date implementation monitoring and post-effective date evaluation of costs and benefits related to Accounting Standards Update (ASU) 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” From the feedback, the board identified and discussed four issues for which it could consider making certain targeted improvements:

  • Issue 1: Accounting for assets that do not qualify as purchased financial assets with credit deterioration
  • Issue 2: Accounting for TDRs by creditors
  • Issue 3: Amending the scope of financial assets included in ASU 2016-13
  • Issue 4: Enhancing disclosures for ASU 2016-13

While no tentative decisions were made, the staff concluded that it will take these actions:

  • Perform additional research and outreach on the accounting for non-purchased credit deteriorated financial assets and TDRs for consideration as part of future request activities.
  • Continue to monitor feedback related to the scope of financial assets included in ASU 2016-13.
  • Continue to monitor feedback on disclosures under ASU 2016-13.
  • Perform additional general outreach with stakeholders and accumulate feedback for presentation to the board at future meetings.

A recording of the meeting will be available on the FASB site until March 2, 2021.

PCC discusses goodwill amortization considerations

At its Dec. 3, 2020, meeting, the FASB Private Company Council (PCC) discussed identifiable intangible assets and subsequent accounting for goodwill. At a previous meeting the board had requested that the staff consider adding amortization to the goodwill impairment model as well as changing the impairment model, accounting for identifiable intangible assets, and exploring disclosure, presentation, and transition matters. The PCC was asked to consider amortization period concerns that might arise if a new model was created that harmonizes GAAP for all types of entities including public entities, private entities, and not-for-profits. Questions included the following topics:

  • Consideration of a default period other than 10 years for amortization
  • Management’s ability to deviate from a default period and justification for that difference
  • Cap or floor on an amortization period
  • Transition challenges

Securities and Exchange Commission (SEC) need to know

SEC chief accountant addresses focus on high-quality financial reporting

The American Institute of CPAs (AICPA) held its annual Conference on Current SEC and PCAOB Developments virtually from Washington, D.C., Dec. 7-9, 2020. Chief Accountant Sagar Teotia kicked off the SEC’s participation, on Dec. 7, with a discussion of multiple topics, including the important role accountants and auditors play in protecting investors and investor confidence.

In his keynote speech Teotia addressed the focus of the SEC’s Office of the Chief Accountant (OCA) on high-quality financial reporting during an unusual year. Teotia acknowledged that 2020 has been a challenging year considering the uncertainty from and impacts of the COVID-19 pandemic and that investors have benefited from high-quality financial information.

He said that the OCA has taken quick and proactive steps to address complex accounting, reporting, and other financial matters in response to the pandemic to continue to foster high-quality financial reporting. Teotia detailed actions taken including issuing public statements, providing staff views on complex issues, working directly and closely with the FASB and the Public Company Accounting Oversight Board (PCAOB), addressing issues related to quality, and playing a key role in rulemaking efforts.

During the year, the OCA has consulted on and addressed topics including interpretation of the CARES Act, accounting for loan participation agreements, application of the TDR guidance to certain loans affected by COVID-19, application of the asset impairment and leasing frameworks to similarly affected assets, issues related to capital-raising transactions, accounting standards implementation issues, and other complex issues.

SEC OCA presents at AICPA conference

At the AICPA Conference on Current SEC and PCAOB Developments, Dec. 7-9, 2020, representatives from the SEC’s Office of the Chief Accountant delivered remarks:

  • Kevin Cherrstrom, professional accounting fellow, remarked on consultations related to performance obligations under the revenue recognition standard and presentation of cash received from a vendor in the statement of cash flows, including gross versus net cash flows.
  • Geoff Griffin, professional accounting fellow, remarked on principal versus agent guidance and accounting for right-of-use assets, including abandonment, under the leases standard.
  • Jeffery Joseph, professional accounting fellow, remarked on implementation and post-implementation of the auditor’s reporting model under PCAOB AS 3101 specifically related to CAMs, including discussion of boilerplate language versus audit-specific language.
  • Sheena Lam, professional accounting fellow, remarked on monitoring group recommendations to strengthen the international audit and ethics standard-setting system and recent amendments to auditor independence rules.
  • Jeffrey Nick, professional accounting fellow, remarked on equity method investments, determining significant influence, and consolidation under the voting interest entity model.
  • Jillian Pearce, professional accounting fellow, remarked on discontinuation of LIBOR, evaluating interest-rate reset features, and principal versus agent guidance under the revenue standard.
  • Damon Romano, professional accounting fellow, remarked on determining the primary beneficiary in a variable interest entity and customer accounting for consideration received from a vendor or supplier.

Corp Fin presents at AICPA’s SEC and PCAOB conference

At the AICPA conference, SEC Division of Corporation Finance (Corp Fin) members, including Lindsay McCord, chief accountant; Patrick Gilmore, deputy chief accountant; and Craig Olinger, senior adviser to the chief accountant, provided an overview of recent activities at Corp Fin that affect accounting and reporting for the 2020 year-end filings. They discussed the following topics:

  • Response to COVID-19 and previously issued releases on disclosure guidance with emphasis on:
    • Inclusion in disclosures of how the company has responded to the pandemic and what management is doing to plan for future impacts
    • Cautioning against using boilerplate COVID-19 disclosures
    • Careful consideration of non-GAAP financial measures that include COVID-19 items
    • Non-GAAP measures and key performance indicators
  • Current comment letter trends in the areas of revenue recognition and segments
  • Special-purpose acquisition companies
  • China-based issuers
  • Personnel changes
  • Recent rulemakings

SEC adopts final rule on MD&A and other financial disclosures

The SEC, on Nov. 19, 2020, adopted amendments that will simplify and enhance certain financial disclosure requirements in Regulation S-K. The amendments are expected to eliminate duplicative disclosures and modernize and improve management’s discussion and analysis (MD&A) for the benefit of investors while simplifying compliance efforts for registrants. Specifically, the requirement for selected financial data (item 301) has been eliminated, the requirement to disclose supplementary financial information (item 302) has been streamlined to replace the current requirement of quarterly tabular disclosure with a principles-based requirement for material retrospective changes, and MD&A (item 303) requirements have been amended.

Changes to item 303 include clarifying disclosure requirements for liquidity and capital resources, streamlining disclosure requirement for results of operations, adding a new item for critical accounting estimates, replacing off balance sheet arrangements with a requirement to discuss such obligations in a broader context, eliminating tabular disclosure of contractual obligations, and streamlining required information regarding interim periods.

The rule will be effective 30 days after publication in the Federal Register. Registrants are required to comply with the rule beginning with the first fiscal year ending on or after the date that is 210 days after publication in the Federal Register.

SEC proposes changes to worker compensation framework for securities offerings and sales

On Nov. 24, 2020, the SEC proposed amendments to Rule 701 of the Securities Act of 1933 as well as to Form S-8, the Securities Act registration statement for compensatory offerings by reporting issuers. Rule 701 provides an exemption from registration for the issuance of compensatory securities by nonreporting issuers.

Additionally, the SEC proposed rules to permit, temporarily and subject to certain conditions, an issuer to provide equity compensation to certain workers who provide services available through the issuer’s technology-based marketplace platform.

Significant changes in compensatory offerings and composition of the workforce have happened since the SEC last amended Rule 701 and Form S-8. The proposed amendments are designed to modernize the framework for compensatory securities offerings, allowing employees and other workers to receive equity compensation from their company while maintaining important investor protections.

Comments on the proposed rule are due Feb. 9, 2021.

Nasdaq initiates SEC proposal for board diversity

On Dec. 4, 2020, Nasdaq filed with the SEC a proposal to adopt new listing rules related to board diversity and disclosure to address findings that a link exists between diverse boards and better financial performance and corporate governance. These proposed standards focus on clearer disclosures of a company’s board composition and increased information provided to investors that listed companies are considering diversity when selecting directors.

Under the proposal, most Nasdaq listed companies would be required to have, or explain why they do not have, at least two directors with diverse backgrounds. In accordance with the proposal, boards should include at least one woman and one LGBTQ person or person who is an underrepresented minority. All listed companies also will be required to disclose consistent and clear diversity statistics regarding their board of directors.

If the proposal is approved by the SEC, Nasdaq would become the first major U.S. stock exchange to require boardroom diversity. Companies would have up to one year to disclose board diversity statistics, and the board composition diversity requirement would need to be met within five years, depending on the size of the company.

Nasdaq’s proposed changes to exchange listing rules are subject to SEC review and a public comment period. Comments are due Jan. 4, 2021.

From the Public Company Accounting Oversight Board (PCAOB)

PCAOB presents at AICPA conference on SEC and PCAOB

The PCAOB provided its perspectives at the AICPA conference in three separate sessions:

  • The five members of the board engaged in a panel discussion. Topics included responses to COVID-19, improvements in audit quality, critical audit matters (CAMs), proposed changes to auditor independence, quality control feedback, China inspections, tailoring of 2021 inspections, and the board’s top focus areas for 2021.
  • Barbara Vanich, the PCAOB acting chief auditor, provided an update on PCAOB standard-setting activities including quality control systems, supervision of audits involving other auditors, audit evidence, and data and technology. Vanich also discussed COVID-19 audit resources, implementation reminders related to CAMs, and the new standards and amendments on estimates and specialists.
  • George Botic, director of the Division of Registration and Inspections, and Patrick Bryan, director of the Division of Enforcement and Investigations, each presented prepared remarks in a joint session. Botic and Bryan shared information on the PCAOB’s recent inspection observations, registration issues, and enforcement actions. Topics included effects of COVID-19 on audits, trends observed, and PCAOB efforts to optimize program efficiency and effectiveness.

PCAOB posts COVID-19 spotlight document

The PCAOB, on Dec. 2, 2020, postedStaff Observations and Reminders During the COVID-19 Pandemic.” This report offers lessons learned from recent PCAOB inspections of reviews of interim financial information and audits, and it provides important reminders for auditors to consider as they plan for and perform audits in the current pandemic environment. The reminders and key takeaways section includes insights into concerns over internal control over financial reporting, significant judgments and accounting estimates, and a reminder regarding the need for consideration of COVID-19 disclosures and risks.

From the Center for Audit Quality (CAQ)

CAQ reports on CAMS analysis

The CAQ released, on Dec. 3, 2020, a report, “Critical Audit Matters: A Year in Review,” providing data and analysis on the first year of including CAMs in auditor reports. The CAQ report revealed that CAMs for S&P 100 companies focused on some of the most complex accounting issues that require a high degree of judgment by the auditor and that the four most common areas were taxes, goodwill and intangibles, other contingent liabilities, and revenue. Additionally, the average number of CAMs included in the auditor reports for the S&P 100 companies was 1.98 CAMs per report.

CAQ releases perspectives on management review controls

On Nov. 18, 2020, the CAQ and the Financial Education & Research Foundation of Financial Executives International released “Perspectives on Management Review Controls: Challenges and Solutions” for preparers, auditors, and regulators. It includes information on issues surrounding the design, execution, and documentation of management review controls. Insights are based on interviews with audit engagement teams and accounting personnel that are involved in management review controls that include a significant degree of subjective management judgment. The report provides key findings, identifies challenges, and offers suggested actions for preparers, auditors, and regulators.

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