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.
From the Federal Financial Institution Regulators
“Quarterly Banking Profile” for Fourth-Quarter 2014 Issued
The Federal Deposit Insurance Corp. (FDIC) published on Feb. 24, 2015, its “Quarterly Banking Profile” for the fourth quarter of 2014. The profile provides an early comprehensive summary of financial results for all FDIC-insured institutions. Highlights include these findings:
- FDIC-insured banks and savings institutions earned $36.9 billion in the fourth quarter of 2014, down 7.3 percent from the industry’s earnings a year before. The drop in earnings was driven primarily by an increase in noninterest expenses due to legal costs at a few large banks and declining noninterest income due to reduced mortgage activity.
- During the fourth quarter, community banks earned $4.8 billion, up 27.7 percent from the same period in 2013.
- For 2014, the industry’s net income slipped 1.1 percent to $152.7 billion, the first full-year decline in five years.
- The average industrywide return on assets fell to 0.96 percent from 1.09 percent a year earlier, the first time in two years the figure has landed below 1 percent.
- Noninterest income fell 0.3 percent since the fourth quarter of 2013, while net interest income increased 1 percent.
- Banks set aside $8.2 billion in provisions for loan losses, up 12 percent from a year earlier. This marks the second consecutive quarter that the industry has reported a year-over-year increase in loss provisions.
- Asset quality indicators continued to improve. Insured banks and thrifts charged off $9.9 billion in uncollectible loans during the quarter, down 18.3 percent ($2.2 billion) from a year earlier.
- During the fourth quarter, noncurrent loans and leases fell $9.2 billion (5.4 percent). The percentage declined to 1.96 percent, which was the lowest level since the end of the first quarter of 2008 (1.73 percent).
- The number of institutions on the FDIC’s problem bank list dropped from 329 to 291, the 15th consecutive quarter that the number declined. In addition, the Deposit Insurance Fund balance rose to $62.8 billion during the quarter.
December 2014 Data on Credit Union Performance Released
On March 2, 2015, the National Credit Union Administration (NCUA) reported December 2014 figures based on call report data submitted to and compiled by the agency for the quarter. These are highlights for federally insured credit unions for the quarter:
- The number of federally insured credit unions fell by 77 from the third quarter to 6,273 at the end of the fourth quarter. This was a decline of 1.2 percent in the quarter and 4.3 percent for the year.
- Total assets reached $1.12 trillion, which represents growth by $60 billion, or 5.7 percent, for the year.
- Return on average assets was 80 basis points, a slight decline from the previous quarter but two basis points higher than at the end of 2013.
- Outstanding loan balances reached $712.3 billion, which represents growth of 10.4 percent since the end of 2013 and was the largest percentage increase since 2005.
- The delinquency ratio fell to 0.85 percent from 1.01 percent at the end of 2013. The net charge-off ratio remained at 49 basis points year-to-date, a decline of seven basis points from the end of 2013.
- The aggregate net worth ratio was up 20 basis points from the end of 2013 to 10.97 percent at the end of the fourth quarter.
Cybersecurity and Bank Infrastructure Vulnerabilities Discussed
At the Clearing House’s Operational Risk Colloquium on Feb. 11, 2015, Office of the Comptroller of the Currency (OCC) Deputy Comptroller for Operational Risk Beth Dugan spoke to an industry audience regarding financial institutions’ need to become more resilient to attacks in this time of increasing technological interconnectedness and motivated cybercriminals.
In her speech, Dugan discussed bankers’ need to expand their notion of business continuity to include not only natural disasters or power outages but also cyberattacks. “Physical threats still matter, but interconnectedness, new concentrations in service providers – including financial market infrastructure firms – and the changing nature of cyber threats call for new and creative thinking about resiliency,” she said.
Dugan also noted that banks should re-examine their disruption scenarios, board-level strategic planning, and risk oversight processes to ensure they reflect today’s threats.
Concentrated, Correlated Risks Warning Issued
While speaking at the Global Association of Risk Professionals conference on Feb. 25, 2015, OCC Deputy Comptroller for Supervision Risk Management Darrin Benhart warned that bankers should be alert to concentration and correlation risks while ensuring that they do not allow past performance to determine future activities. Benhart shared that to recognize evolving concentrations, bank managers and boards regularly must review concentrations in their portfolios.
To emphasize the importance of managing correlated risks, Benhart provided the example of falling oil prices by describing that the decline in oil prices affects not just oil producers but also oilfield service firms and commercial and residential real estate in oil patches. He said, “It is easy to focus on the obvious risk, but sound risk management also needs to think broadly about other, sometimes more nuanced correlated risks.”
Changes to Regulatory Capital Reporting Approved
The Federal Financial Institutions Examination Council has approved revisions to Schedules RC-R (“Regulatory Capital”) and RC-L (“Derivatives and Off-Balance Sheet Items”) in the call report based on the final Basel III regulatory capital rules. The revised RC-R would continue aligning the call report with Basel III, with specific changes to reporting requirements for risk-weighted assets. The new RC-L will require all institutions to report the amount of securities borrowed or lent.
Additionally, the final regulatory capital rules give nonadvanced approach institutions the option to exclude accumulated other comprehensive income (AOCI) from their Basel III regulatory capital calculations; however, the election to exclude AOCI, or opt out, is a one-time election that must be made on the March 31, 2015, call report. The opt-out will be in Part I of call report schedule RC-R, line item 3a.
Capital Calculator for Securitization Exposures Released
The Federal Reserve (Fed), the FDIC, and the OCC announced on Feb. 13, 2015, the development and release of a tool to help banks calculate the capital levels required for their securitization exposures under Basel III. The tool is designed to facilitate the calculations for banks that use the agencies’ Simplified Supervisory Formula Approach, which applies relatively higher requirements to riskier junior tranches that are the first to absorb losses, and relatively lower capital requirements to more senior tranches.
$100 Million Threshold for Regulatory Relief Proposed by NCUA Board
At a meeting on Feb. 19, 2015, the NCUA board approved a proposed rule (Part 791) and policy statement to update the definition of a “small entity” under the Regulatory Flexibility Act to include federally insured credit unions with assets of up to $100 million – an increase from the current ceiling of $50 million. Under this proposed rule, 745 more credit unions would receive special consideration for reduced regulatory compliance requirements or exemptions in future NCUA rulemakings, and approximately 4,900 federally insured credit unions would receive special consideration for regulatory relief under the proposed definition of “small entity.” Additionally, this higher threshold commits the board to specifically review the economic impact on small credit unions during future rulemakings.
NCUA Small-Business Lending Resource Center Launched
The NCUA on Feb. 20, 2015, launched a new online resource for credit unions. The Small Business Lending Resources page provides information about the NCUA’s member business lending rules and regulations, supervisory guidance, links to the Small Business Administration’s loan programs, and related articles from “The NCUA Report.”
NCUA Board Chairman Debbie Matz said, “This new online portal provides valuable information on how credit unions can prudently lend to their small business members and tap into SBA’s lending programs. I encourage all credit unions to explore this resource.”
Second Phase of EGRPRA Review Commenced
On Feb. 13, 2015, the Fed, FDIC, and OCC issued a notice of regulatory review and request for the second round of comments in the decennial Economic Growth and Regulatory Paperwork Reduction Act of 1996 (EGRPRA) review cycle, as mandated by Congress in order to identify outdated, unnecessary, or burdensome bank regulations.
The second phase of the review covers regulations related to banking operations, capital, and the Community Reinvestment Act; however, the agencies narrowed the potential regulatory relief by specifically excluding Consumer Finance Protection Bureau and Financial Crime Enforcement Network rules, as well as any rules related to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) or Basel III.
Comments on this phase are due May 14, 2015.
Updated Deposit Account-Based Credit Guidance Released
The OCC issued on March 6, 2015, the “Deposit-Related Credit” booklet to be included in the “Comptroller’s Handbook” to replace the previously issued “Deposit-Related Consumer Credit” booklet. The updated booklet:
- Provides guidance on consumer credit offerings related to deposit accounts and incorporates recent guidance on overdraft protection and deposit advances
- Provides information on third-party relationships, due diligence, and appropriate capital for deposit-based credit
- Describes OCC examination procedures used to assess a bank’s deposit-related credit products and services
From the Financial Accounting Standards Board (FASB)
Improved Consolidation Guidance for Legal Entities Issued
In order to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (for example, collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions), the FASB issued on Feb. 18, 2015, Accounting Standards Update (ASU) No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis.” The ASU focuses on the evaluation for determining whether certain legal entities should be consolidated. Current generally accepted accounting principles (GAAP) require a qualitative evaluation of power over and economics from a variable interest entity (VIE) to determine whether it should be consolidated. For some, the outcome has been consolidation of a VIE that resulted in less useful information about the financial position and operating results of the reporting entity.
A second objective of the new ASU is to simplify. There are currently two models for VIE consolidation and two models for voting interests (partnership) consolidation. By eliminating the specialized guidance for limited partnerships in the voting interest model and the VIE model applied by certain investment companies, the ASU reduces the number of models.
The new standard improves current GAAP in these ways:
- It emphasizes loss risk when determining a controlling financial interest. When certain criteria are met, an entity may no longer have to consolidate a legal entity based solely on its fee arrangement.
- It reduces the frequency of related-party guidance application when determining a controlling financial interest in a VIE.
- It revises consolidation conclusions in several industries that typically use VIEs or limited partnerships.
For public companies, the ASU will be effective for periods beginning after Dec. 15, 2015. For private companies, it will be effective for annual periods beginning after Dec. 15, 2016, and for interim periods beginning after Dec. 15, 2017. Early adoption is permitted, including adoption in an interim period.
Exposure Draft on Hybrid Financial Instruments Disclosures Issued
On Feb. 24, 2015, the FASB issued a proposed ASU, “Derivatives and Hedging (Topic 815): Disclosures About Hybrid Financial Instruments With Bifurcated Embedded Derivatives,” which is intended to provide more useful information to users about hybrid financial instruments that contain bifurcated embedded derivatives. The proposed ASU would require disclosure of the carrying amount, measurement attribute, and line item within the balance sheet and income statement in which each bifurcated embedded derivative and its related host contract appear.
The amendments would be applied on a prospective basis to hybrid financial instruments with bifurcated embedded derivatives that existed as of the beginning of the fiscal year for which the proposed amendments are effective.
Comments are due April 30, 2015.
Changes to Disclosure Guidance Regarding Uncertain Tax Positions for Private Entities Pending
The American Institute of Certified Public Accountants (AICPA) intends to amend Technical Practice Aid (TPA) 5250.15, “Application of Certain FASB Interpretation No. 48 (codified in FASB ASC 740-10) Disclosure Requirements to Nonpublic Entities That Do Not Have Uncertain Tax Positions,” to revise a previously communicated interpretation. In the past, the AICPA concluded that in situations where a nonpublic entity does not have any uncertain tax positions the ASC 740-10-50-15(e) requirement to disclose the number of years that remain open subject to tax examination was still applicable and thus required to be disclosed.
The FASB and the Private Company Council discussed the interpretation at a recent meeting, where the FASB indicated that it did not intend to require disclosure of open tax examination years when a nonpublic entity does not have any uncertain tax positions. This view is described specifically in the basis for conclusions of ASU 2009-06. The AICPA is in the process of amending the TPA, and the FASB has indicated it will provide clarification to the codification in its next round of technical corrections.
From Harvard University
Impact of Regulations on Community Banks Shown in New Study
Researchers at Harvard Kennedy School published a new study, “The State and Fate of Community Banking,” analyzing the constricting effects of Dodd-Frank regulations and other rules on community bank activities and their share of the market. The researchers found that community banks lost only 6 percent of market share during the years of the financial crisis; however, that rate has increased to 12 percent since the enactment of Dodd-Frank. The researchers attribute that decline in market share to a pullback by community banks in several lending categories due in large part to regulatory burden. During the same time frame, community bank consolidation accelerated; however, the report expressed concern that such consolidation might be due to inappropriately designed regulation and inadequate regulatory coordination. The report concludes by describing policies that could promote a more competitive banking sector.
From the Center for Audit Quality (CAQ)
Report Published on Best Practices for Strengthening Relationships in Auditing
The CAQ and The Institute of Internal Auditors on March 10, 2015, jointly published “Intersecting Roles: Fostering Effective Working Relationships Among External Audit, Internal Audit, and the Audit Committee,” summarizing points from a series of 2014 roundtable meetings. The report highlights that stronger communications and cooperation among these stakeholders during the financial statement auditing process can help avoid potential tensions and improve risk management.
The report further describes best practices and strategies for addressing challenges especially in three areas:
- A more productive and efficient external audit process within the confines of regulatory requirements
- Improved communication between internal and external auditors to build better working relationships
- Introduction of enterprise risk management to an organization