The Financial Institutions Executive Briefing offers updates on financial reporting, governance, and risk management topics from Crowe. In each issue of this electronic newsletter, you will find abstracts of recent standard-setting activities and regulatory developments affecting financial institutions.
Statement on Risks in CRE Lending IssuedThe Board of Governors of the Federal Reserve System (Fed), Federal Deposit Insurance Corp. (FDIC), and Office of the Comptroller of the Currency (OCC) on Dec. 18, 2015, issued a “Statement on Prudent Risk Management for Commercial Real Estate Lending” describing recent supervisory findings related to commercial real estate (CRE) loan underwriting and CRE risk management practices that cause concern. In addition, the statement is a reminder of existing regulatory guidance on CRE concentration risk.
According to the statement, CRE markets are growing rapidly and banks’ CRE concentration levels are rising due to the strength of the market and the quality of CRE assets. However, the agencies have observed looser underwriting standards for CRE loans, including “less-restrictive loan covenants, extended maturities, longer interest-only payment periods, and limited guarantor requirements,” as well as more frequent exceptions to underwriting policies and “insufficient monitoring” of market conditions.
The agencies caution, “Historical evidence demonstrates that financial institutions with weak risk management and high CRE credit concentrations are exposed to a greater risk of loss and failure.” In contrast, financial institutions that have been successful during more difficult economic cycles have acted in a manner consistent with supervisory expectations by doing such things as maintaining adequate loan policies and underwriting standards, following appropriate lending strategies, conducting robust analyses of ability to repay, stress testing their CRE loan portfolio, and keeping their board informed.
The agencies also state that during 2016 reviews, supervisors will “pay special attention” to CRE lending and risks associated with such lending.
Revisiting Appraisal Threshold and Possible Basel III Relief Discussed by RegulatorsAt the Dec. 2, 2015, Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) outreach meeting held in Arlington, Virginia, FDIC Chairman Martin Gruenberg described the FDIC’s current and planned actions to address the EGRPRA comments received.
“Based largely on comments we have received during these outreach sessions, we have formed an interagency working group to review the appropriateness of dollar thresholds for transactions requiring appraisals and other requirements of the interagency appraisal regulations,” Gruenberg said.
Gruenberg described actions by the FDIC to clarify the process of applying for deposit insurance and how the agency handles requests for exceptions to limits on dividends paid by S-corporation banks. He closed his speech with a look to the future: “We will continue to look for other ways to reduce or eliminate outdated or unnecessary requirements as we move forward with this review.”
At the same event, Fed Governor Daniel Tarullo discussed the possibility of changing the Basel III capital calculations and reporting requirements to minimize the burden on highly capitalized community banks, as many commenters have pushed for such a change. Tarullo said, “I believe that it is possible to develop a simpler set of capital requirements for smaller banks that will be consistent both with the safety and soundness aims of prudential regulation and with our statutory obligations such as the Collins Amendment.”
After the outreach meeting, the fourth and final request for comments on outdated and burdensome rules under the EGRPRA process was published in the Federal Register on Dec. 23, 2015. Comments are due March 22, 2016.
Risk Assessment System Guidance UpdatedOn Dec. 3, 2015, the OCC updated its “Comptroller’s Handbook” to include new guidance about its risk assessment system (RAS), clarify several concepts and definitions, and provide further guidance for examiners.
The updated guidance addresses the following:
- Clarifies the relationship between the RAS and the Uniform Financial Institutions Rating System (CAMELS)
- Revises the “banking risk” definition to be the same for all risk categories and expands the risk concept to include its impact on a bank’s current or projected financial condition or resilience
- Creates a new category of “insufficient” for the quality of risk management assessment
- Adds quantitative and qualitative requirements for assessing strategic and reputational risk
Report Released on Rising Underwriting and CyberriskThe OCC released its “Semiannual Risk Perspective” report on Dec. 16, 2015, based on data as of June 30, 2015. The OCC noted an increase in threats from credit risk and cyberrisk and that it will make those areas a focus in the coming months. The report also identifies strategic risk, compliance risk, and interest-rate risk as stable but still areas of concern.
The OCC reports that the continued low-interest-rate environment has contributed to slow growth and low rates of return for banks, pushing many banks to reassess risk tolerance and increase their pursuit for yield. Concurrently, the industry has seen an easing of credit underwriting standards as banks strive to remain competitive, most noticeably in high-growth loan segments such as commercial and industrial, indirect auto loans, and multifamily commercial real estate. The OCC warns that these practices could result in the industry being less prepared to absorb shocks or handle future economic uncertainties.
Cybercrime continues to evolve and represent a threat to the financial industry. Many banks are adopting new preventive technologies or partnering with vendors to protect themselves from fraud; however, the report warns that risk management and control practices might not be keeping pace with the quick changes in these areas, creating additional operational risk for all banks.
Large Bank Guidelines on Recovery Planning ProposedOn Dec. 17, 2015, the OCC issued “Notice of Proposed Rulemaking: Guidelines Establishing Standards for Recovery Planning by Certain Large Insured National Banks, Insured Federal Savings Associations, and Insured Federal Branches,” which proposes guidelines on recovery planning for the financial institutions it regulates with assets of more than $50 billion. The guidelines are not intended to apply to community banks. The proposed guidelines would be included as an appendix to the OCC’s safety and soundness regulations and be enforceable by statute.
In accordance with the proposed guidelines, each covered bank would be expected to develop and maintain a recovery plan suitable for its own risk profile, size, activities, and complexity. The recovery plan would be expected to include the following:
- An overview of the bank
- Qualitative and quantitative stress triggers for when the recovery plan would be implemented
- The range of recovery options for each trigger and how they would be implemented
- Assessments of how each option would affect the covered bank
- Escalation procedures
- Reports to management and the board
- Communications procedures
Comments are due Feb. 16, 2016.
Guidance on Capital Planning Expectations IssuedOn Dec. 21, 2015, the Fed released guidance that consolidates capital planning expectations for large financial institutions (those with total consolidated assets of $250 billion or more) and explains differences in those expectations based on firm size and complexity, with additional guidance for firms with assets between $50 billion and $250 billion to reflect their lower risk profile and less complex operations.
According to the guidance, senior management of the largest firms should review the capital planning process quarterly, whereas management of smaller institutions should review it at least semiannually. Additionally, the Fed expects larger firms to have a more formal risk identification process and to use quantitative approaches supported by expert judgment for risk management; smaller firms can have a less formal risk identification process and use either qualitative or quantitative risk measurement approaches.
The guidance is effective for the 2016 Comprehensive Capital Analysis and Review cycle.
Compliance Examination Manual UpdatedThe FDIC, on Dec. 4, 2015, updated its “Compliance Examination Manual” with new guidance and examples for examiners conducting compliance and Community Reinvestment Act examinations. The revisions include new sample templates of examination reports and evaluations for a hypothetical bank evaluated under the Intermediate Small Bank test, new guidance about the Matters Requiring Board Attention section of the Report of Examination, guidance on understanding the impact of consumer harm on supervisory and examination activities, and a series of questions to help examiners determine specific areas of focus for a bank’s examination activities. The guide also includes revised exam procedures pertaining to the new Truth in Lending Act – Real Estate Settlement Procedures Act integrated disclosures.
Regulatory Expectations on Credit Loss Accounting Issued by Basel CommitteeOn Dec. 18, 2015, the Basel Committee on Banking Supervision released “Guidance on Credit Risk and Accounting for Expected Credit Losses,” which provides credit risk and expected credit loss accounting guidance intended to set common worldwide regulatory expectations for loan loss accounting, including the current expected credit loss (CECL) model from the Financial Accounting Standards Board (FASB). Use of forward-looking information; grouping of credit exposures; and linkage of accounting, credit, and capital management systems are among the significant regulatory expectations in the document. The guidance does not present regulatory capital requirements on expected loss provisioning under the Basel capital framework but does detail how the expected credit loss accounting model should interact with a bank’s overall credit risk practices and regulatory framework.
In response to recommendations, the guidance highlights that implementation will be based on the size, complexity, and materiality of an organization’s banking products. It is anticipated that further U.S.-based guidance would be proposed by the federal banking agencies soon after FASB’s CECL model is issued, which is expected in the first quarter of 2016.
December Issue of “The NCUA Report” PublishedThe National Credit Union Administration (NCUA) posted the December 2015 issue of “The NCUA Report” on Dec. 15, 2015. This latest issue includes a column from the NCUA board chairman, articles from various NCUA offices on the NCUA’s initiatives, and information on supervisory, regulatory, and compliance issues that are relevant to all federally insured credit unions.
Articles in this month’s report include:
- “Proposed Rule on Field of Membership Offers Regulatory Relief, Growth Opportunities”
- “Chairman’s Corner: Future of Credit Unions Depends on Viable Membership Fields”
- Vice Chairman Rick Metsger’s perspective: “Members: The Heart and Soul of Every Credit Union”
- Board Member J. Mark McWatters’ perspective: “Exam Appeals: Credit Unions Deserve a Better Process”
- “Board Actions: Two-Year Budget Approved With Smallest Percentage Increase Since 2007”
- “Greater Flexibility Means Credit Union Boards Have to Be Engaged”
- “Help Keep Your Members Safe This Holiday Season”
HMDA Compliance Guide and Resources ReleasedThe CFPB has released several resources to help banks and other entities understand their obligations under the Home Mortgage Disclosure Act (HMDA) and Regulation C. The new resources include a compliance guide addressing the changes to the HMDA rule issued in October 2015, data reporting instructions, and charts designed to assist institutions in determining whether they are covered by Regulation C.
Monthly Report on Consumer Complaints IssuedThe CFPB released its latest “Monthly Complaint Report” on Dec. 22, 2015. The report details consumer complaint volume by product, state, and company; highlights money transfers in its product spotlight section; and presents a geographically focused section on complaints in Georgia and the Atlanta metro area.
According to the report, the CFPB has handled more than 770,000 complaints as of Dec. 1, 2015. Complaints for November 2015 decreased approximately 12 percent from the previous month. Consistent with October 2015 data, the most-complained-about financial product or service was debt collection, representing approximately 30 percent of complaints submitted for November 2015. The second-most-complained-about financial product or service was mortgages, accounting for approximately 19 percent of complaints, and the third-most-complained-about financial product or service was credit reporting, accounting for approximately 18 percent of complaints.
In the money transfers spotlight section, the report identifies the following as the most common complaints:
- Consumers victimized by fraud (42 percent of the total population of 5,100 complaints)
- Problems transferring money
- Inadequate customer service
- Issues resolving errors including long delays and unclear rights
Roundtable Planned on Current Expected Credit Loss Model
On Feb. 4, 2016, the FASB will host a public meeting with community bank preparers, including representatives from the Independent Community Bankers of America and the American Bankers Association; auditors; and regulators. The focus of the roundtable is to discuss the FASB’s project on credit losses, which is part of its financial instruments project. The meeting is intended to give stakeholders the opportunity to engage in a constructive dialogue about their concerns about complexity in measuring credit losses on financial assets. The meeting, which is scheduled 12:30-3:30 p.m. Eastern, will be available to view by webcast or in person.
New Guidance Issued on the Recognition and Measurement of Financial InstrumentsThe FASB issued on Jan. 5, 2016, Accounting Standards Update (ASU) No. 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” completing part one of three of its financial instruments project. This ASU will have some implications for financial institutions, albeit far less impact than the two proposed updates that led to the ASU would have had.
Two of the changes, both viewed as positive by financial institutions, may be adopted early for financial statements not yet issued:
- Liabilities using the fair value option. Under current generally accepted accounting principles (GAAP), the change in fair value resulting from instrument-specific credit risk is presented in earnings, which has an interesting result. As an entity’s own creditworthiness declines, income is recorded because the value of the liability declines. Under the ASU, those changes now will be recorded in other comprehensive income instead of earnings, which is consistent with regulatory capital treatment.
- Disclosures of fair value of financial instruments (ASC Topic 825, “Financial Instruments,” formerly known as FASB Statement No. 107, “Disclosures About Fair Value of Financial Instruments”). In an effort to provide relief, the FASB is dropping this requirement for nonpublic business entities.
In addition, the ASU incorporates the following new requirements:
- Equity investments (other than those accounted for under the equity method of accounting or those that result in consolidation of the investee) are to be measured at fair value with fair value changes recognized in net income, which means the available-for-sale (AFS) category is eliminated for equity investments.
- For equity investments that do not have readily determinable fair values, the FASB is changing the measurement to be carried at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The ASU also simplifies the impairment assessment by moving to a one-step qualitative assessment.
- Currently there is diversity in practice on whether deferred tax assets (DTAs) on AFS securities should be evaluated for a valuation allowance separately (given that management has control over the realizability because the securities can be sold) or evaluated in combination with other DTAs. In the final ASU, the FASB has chosen the latter.
- Financial assets and financial liabilities are to be presented by measurement category and form of financial asset on the balance sheet or in accompanying notes to the financial statements.
The new guidance is effective for PBEs for fiscal years beginning after Dec. 15, 2017, including interim periods within those fiscal years, which is the first quarter of 2018 for calendar year-ends. For non-PBEs, the guidance becomes effective for fiscal years beginning after Dec. 15, 2018, and for interim periods within fiscal years beginning after Dec. 15, 2019, which is Dec. 31, 2019, for calendar year-ends.
New Guidance on FAST Act Published
The SEC Division of Corporation Finance (Corp Fin) staff has issued guidance on the recently enacted Fixing America’s Surface Transportation Act (FAST Act), which was signed into law Dec. 4, 2015. The FAST Act incorporates several amendments to the federal securities laws, some of which must be implemented by SEC rule-making or study; others are self-executing. Corp Fin’s SEC staff announcement provides a summary of the specific provisions within the legislation that affect the securities laws. The announcement highlights the following provisions:
- Improving access to capital for emerging growth companies
- Disclosure modernization and simplification
- Reforming access for investments in startup enterprises
- Small company simple registration
- Holding company registration threshold equalization
Rules Proposed for Resource Extraction IssuersThe SEC voted, on Dec. 11, 2015, to propose rules under which resource extraction issuers would have to disclose payments made to the U.S. federal government or foreign governments for the commercial development of oil, natural gas, or minerals. As mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), the proposed rules are meant to promote transparency about payments related to resource extraction, thereby advancing U.S. policy interests.
An issuer required to file annual reports with the SEC under the Securities Exchange Act would be required under the proposed rules to disclose payments made to the U.S. federal government or a foreign government and also would have to disclose payments made by a subsidiary or entity controlled by the issuer. The disclosure would be made at the project level and would be filed publicly with the SEC annually on Form SD.
Comments on the proposal are due Jan. 25, 2016. Reply comments, which can address only issues raised during the initial comment period, are due Feb. 16, 2016.
Investment Management Priorities Discussed by SEC DirectorIn his speech at the Investment Company Institute 2015 Securities Law Developments Conference held on Dec. 16, 2015, in Washington, D.C., SEC Director David Grim discussed rule-making initiatives for the Division of Investment Management for 2016, specifically highlighting consideration of recommendations that (1) the SEC require registered investment advisers to create and maintain transition plans to be used in the event of a major disruption in their business and (2) the SEC propose new requirements for stress testing by large investment advisers and investment companies as required by Dodd-Frank.
Grim also spoke about the division’s disclosure review process and noted, “Through the disclosure review process, staff identifies new and recurring issues that may result in policy guidance and rulemaking. In its review of investment company disclosures, our Disclosure Review and Accounting Office staff continues to be particularly focused on a number [of] areas, including, fees, investment strategies, and industry trends such as the use of derivatives by funds and changes to existing variable annuity products.”
Rules Proposed on Use of Derivatives by Registered Investment Companies and Business Development CompaniesOn Dec. 11, 2015, the SEC issued for public comment a proposed rule, “Use of Derivatives by Registered Investment Companies and Business Development Companies,” which is targeted to improve regulation of the use of derivatives by registered investment companies – including mutual funds, exchange-traded funds, and closed-end funds – as well as by business development companies. Rule 18f-4, included in the proposal, is a new exemptive rule under the Investment Company Act of 1940 that addresses the investor protection concerns underlying Section 18 of the act and offers a more comprehensive approach to the regulation of funds’ use of derivatives. The proposed rule would permit covered companies to enter into derivatives transactions and financial commitment transactions (as defined in the proposed rule) notwithstanding the restrictions on senior securities issuances under Section 18 of the act, provided that the funds comply with the proposed rule’s conditions.
Comments are due March 28, 2016.
Accredited Investor Definition Staff Report IssuedSEC staff issued “Report on the Review of the Definition of ‘Accredited Investor'” on Dec. 18, 2015. As required under Dodd-Frank, the SEC is to review the definition of “accredited investor” as it relates to natural persons every four years to determine whether the definition should be modified or adjusted. This report, prepared by the staff from the Divisions of Corporation Finance and Economic and Risk Analysis, represents the first such review.
The report details the definition’s history and evaluates comments on the definition from public commenters, the Investor Advisory Committee, and the Advisory Committee on Small and Emerging Companies. The report presents alternative approaches to defining an accredited investor, includes staff recommendations for potential changes to the current definition, and analyzes the impact suggested changes may have on accredited investors.
The SEC is seeking comments on the definition and on the staff recommendations contained in the report.
Public Comment Sought on Transfer Agent RulesThe SEC voted on Dec. 22, 2015, to issue an advance notice of proposed rule-making addressing new requirements for transfer agents as well as a concept release requesting comment on the SEC’s broader review of transfer agent regulation. Together, the advance notice and concept release present a summary of the history of the national clearance and settlement system, describe transfer agents’ role within that system, and explain the sources and status of the SEC’s transfer agent rules.
Within the advance notice, the SEC lists areas in which it intends to propose specific rules or rule amendments. Areas identified in the notice include requirements for registration and annual reporting, funds and securities safeguarding, antifraud requirements related to the issuance and transfer of restricted securities, and cybersecurity and IT.
With the objective of providing information for the SEC’s consideration of additional rule-making, the concept release seeks comments on issues including book entry securities processing, bank and broker-dealer record keeping for beneficial owners, issuer plan administration, outsourcing and the role of transfer agents to mutual funds, and crowdfunding.
Comments are due within 60 days after publication in the Federal Register.
Compliance Outreach Program Registration OpenThe SEC, Financial Industry Regulatory Authority, and the Municipal Securities Rulemaking Board will be holding a Compliance Outreach Program for Municipal Advisors in Philadelphia on Feb. 3, 2016. It also will be streamed live on the SEC website. Registration currently is open. The program will give municipal adviser professionals an arena for discussions with regulators about recent exam findings, regulatory issues, and compliance practices.
Opportunity Announced to Test File in Preparation for Crowdfunding OfferingsThe SEC staff issued, on Dec. 18, 2015, an announcement, “Opportunity for Companies to Test File in Preparation for Crowdfunding Offerings,” which provides that companies immediately may begin test filings of the new Form C, which details certain disclosures about crowdfunding offerings under new SEC crowdfunding rules that will take effect on May 16, 2016. The new rules will permit companies to offer and sell securities through crowdfunding. Such companies must file Form C on the SEC's Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system.
Through Feb. 29, 2016, filers will be able to submit test filings on the new form, which should be clearly marked as “test” filings. Such test filings are intended to help prospective issuers gain familiarity with the filing process before the new regulations are effective. “Live” filings are not permitted and will be rejected by the system until the rules are effective. SEC staff will not review test filings or evaluate them for compliance with the rules, and the test filings will not be available for public viewing. In addition, they should not include any confidential or personally identifiable information.
Rules Adopted on Naming the Engagement Partner and Firms Participating in the Audit
The PCAOB adopted, on Dec. 15, 2015, new rules to provide investors with more information about participants in public company audits. In accordance with the new rules, auditors will be required to file a new PCAOB Form AP, “Auditor Reporting of Certain Audit Participants,” for each issuer audit. Information to be disclosed includes:
- Engagement partner name
- Names, locations, and extent of participation of other accounting firms that took part in the audit and whose work constituted 5 percent or more of the total audit hours
- Number and aggregate extent of participation of all other accounting firms that took part in the audit whose individual participation was less than 5 percent of the total audit hours
The rules are subject to SEC approval, and if approved, the disclosure requirement for the engagement partner name would be effective for auditor’s reports issued on or after Jan. 31, 2017, or three months after SEC approval of the final rules, whichever is later. The requirement to disclose other audit firms participating in the audit would be effective for reports issued on or after June 30, 2017.
Report Issued on CBOK Study of Competencies Required of Internal AuditorsThe IIA Research Foundation released a report with the results of the Common Body of Knowledge (CBOK) 2015 Global Practitioner Survey. The report, “Mapping Your Career: Competencies Necessary for Internal Audit Excellence,” finds that internal auditors generally are secure in their grasp of professional ethics and their abilities to communicate, persuade, and collaborate.
In addition, the report finds that survey respondents are least confident in their knowledge of the IIA’s International Professional Practices Framework and technical expertise. The report includes a form for conducting a self-assessment of core competency and offers strategies to strengthen weaker competencies.
The report is based on data collected from more than 14,500 internal audit practitioners in 166 countries who responded to the CBOK study, the largest ongoing study of internal audit practitioners and their stakeholders.
Internal Control Certificate Program AnnouncedOn Dec. 16, 2015, COSO announced its Internal Control Certificate Program, which is designed to provide financial professionals, including internal auditors and CPAs, the opportunity to develop a confidence in the internal control system, learn from experts, share experiences with peers, and earn a professional certificate in the 2013 COSO Internal Control – Integrated Framework.
The program combines self-paced learning and a hands-on workshop designed to go through the framework from beginning to end using real-world scenarios and examples to help participants understand the principles-based approach of the framework and how to identify and analyze risks. An online examination follows. Candidates who complete the training and the exam will receive an official COSO certificate as evidence of their ability to design and implement an effective system of internal control using the framework.
The program will be offered only through COSO’s five sponsoring organizations: American Accounting Association, American Institute of CPAs, Financial Executives International, IMA – The Association of Accountants and Financial Professionals in Business, and the IIA.