Financial Institutions Executive Briefing 5-20-2016

| 5/20/2016


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

Key Concerns of Regulatory Burden and Financial Technology Discussed

At the April 8, 2016, meeting of the Community Depository Institutions Advisory Council of the Board of Governors of the Federal Reserve System (Fed), members of the council raised concerns over the challenging and demanding regulatory landscape facing community banks. According to the council, the increased regulatory burden is affecting banks’ ability to serve their customers and has resulted in many banks exiting entire lines of business because of increasing compliance costs or heightened risk exposure. The council identified several examples of the regulatory challenges banks face, including the complex Basel III capital rules, the Truth in Lending Act (TILA) and Real Estate Settlement Procedures Act (RESPA) integrated disclosure requirements, and qualified mortgage rules. The council also mentioned areas, such as small-business lending and mortgage servicing, that are likely to face greater regulatory scrutiny in the future.

Although the council acknowledged that many institutions have adapted to the new rules and regulations, it warned that shadow banks and the largely unregulated financial technology sector could pose a serious competitive threat in the future. The council also pointed out that consumers face a greater risk when using financial services offered by nonbank providers.

“Financial institutions are subject to extensive consumer protection regulations, capital requirements, and stringent rules regarding consumer privacy and data security,” the council said. “Nonfinancial institutions offering payment services do not provide the same level of consumer protection or systemic strength.” The council suggested that the Fed take a leadership role to formalize a structure for policy discussion and action plan development.

Final Rule on How Small Banks Are Assessed for Deposit Insurance Approved

The Federal Deposit Insurance Corp. (FDIC) approved, on April 26, 2016, a final rule that amends how small banks (those with assets less than $10 billion) are assessed for deposit insurance.

For small banks that have been FDIC insured for at least five years, the final rule updates the data and the FDIC’s method for determining risk-based assessments in an effort to better reflect risks and to ensure that banks that take on greater risks pay more for deposit insurance than their less-risk-taking counterparts.

“This rule will allow future assessments to better differentiate riskier banks from safer banks,” FDIC Chair Martin J. Gruenberg said. “Using the FDIC’s experience during the recent financial crisis, this rule will better allocate the costs of maintaining a strong Deposit Insurance Fund. Taken together with the overall decline in rates approved by the Board in 2011 that will occur once the reserve ratio reaches 1.15 percent, more than 93 percent of small banks will pay lower assessment rates.”

The FDIC expects that the aggregate assessment revenue collected from established small banks under the final rule will be approximately the same as it would have been before the final rule. The FDIC also has revised the online assessment calculator to reflect the final rule, thereby providing institutions with a tool to estimate their assessment rates under the final rule.

The final rule will be used to determine assessment rates for small banks beginning the quarter after the Deposit Insurance Fund reserve ratio reaches 1.15 percent, but no earlier than the third quarter of 2016.

De Novo Banks Time Period Rescinded

On April 6, 2016, at the FDIC Community Banking Conference in Arlington, Virginia, Gruenberg announced that the FDIC will reduce the period of heightened supervisory monitoring for newly chartered community banks from seven years to three years to promote the creation of de novo banks.

“The 7-year period was established during the financial crisis in response to the disproportionate number of de novo institutions that were experiencing difficulties or failing,” Gruenberg said. He added, “In the current environment, and in light of strengthened, forward-looking supervision, it is appropriate to go back to the 3-year period.”

Gruenberg also announced that the FDIC plans to hold future outreach meetings to provide more information on the de novo application and approval process and that the FDIC is developing a handbook to guide prospective bank startups through the review process.

Also on April 6, the FDIC issued supplemental guidance for proposed depository institutions applying for FDIC insurance. The guidance also explains the FDIC’s expectations for organizations when developing business plans. The questions and answers expand on guidance originally issued in November 2014.

Off-Site Reviews of Electronic Loan Records Introduced

On April 19, 2016, the Fed announced that all state member banks and U.S. branches and agencies of foreign banking organizations with assets of less than $50 billion may choose to have the Fed examiners review loan files off-site during target or full-scope examinations. This will be offered as an option to such banks provided they can transmit readable and comprehensive loan information securely. This change in procedures to off-site loan file review is expected to streamline the exam process and reduce the burden that the on-site portion of examinations places on the day-to-day operations of community banks. Loan file information provided electronically will be handled in accordance with existing security policies and practices of the Fed.

Revised Executive Incentive Compensation Proposal Released

The Fed, Office of the Comptroller of the Currency (OCC), FDIC, National Credit Union Administration (NCUA), Federal Housing Finance Agency, and U.S. Securities and Exchange Commission jointly released, on May 2, 2016, a proposed revision to the incentive-based compensation arrangements rule, as required under Section 956 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). This would revise the proposed rule published in the Federal Register on April 14, 2011, about incentive-based payment arrangements. The proposal would prohibit incentive-based compensation arrangements for executives who encourage excessive risk-taking behavior.

The proposed rule would apply to all financial institutions with assets of more than $1 billion, and it would divide institutions into three levels based on overall asset size. Under the rule, level one institutions (those with $250 billion or more in assets) would be subject to the most stringent requirements, while level two institutions (those with $50 billion to $250 billion in assets) and level three institutions (those with assets between $1 billion and $50 billion) would be subject to the rule in different forms.

Both level one and level two institutions would be required to defer a percentage of qualifying incentive-based compensation for executives and significant risk takers for a specified amount of time. Level one institutions would be required to defer 60 percent for executives and 50 percent for significant risk takers for a minimum of four years, and level two institutions would be required to defer 50 percent for senior executives and 40 percent for significant risk takers for a period of at least three years. Regulators would have discretion over requirements for level three institutions.

In accordance with the revised proposal, institutions also would be required to maintain a record of senior executives and significant risk takers and disclose the incentive-based compensation arrangements of those individuals. Additionally, the proposed rule includes a claw-back provision that would allow a covered institution to recover vested incentive-based compensation if the executive or risk taker engaged in behavior that was found to have hurt the institution.

Comments are due July 22, 2016.

Net Stable Funding Ratio Requirement Proposed

On May 3, 2016, the FDIC, OCC, and Fed jointly proposed a rule that would implement the U.S. version of the net stable funding ratio, a long-term liquidity measurement included in the Basel III liquidity standards. This ratio measures structural funding and is designed to ensure that covered firms maintain a stable funding profile over time.

The net stable funding ratio requirement would apply to banking institutions with total assets of more than $250 billion or $10 billion or more in on-balance sheet foreign exposures. The proposal also would include a modified ratio for certain bank holding companies with assets of $50 billion or more.

The proposed net stable funding ratio would consist of the amount of available stable funding over a year divided by the institution’s required stable funding, with the numerator required to equal or exceed the denominator. Detailed descriptions of what would count toward available and required stable funding are provided in the proposal. Additionally, institutions would be required to publicly disclose their net stable funding ratio quarterly using a standard template, and if a bank’s ratio should fall under 1 at any point, it would be required to notify regulators and develop a remediation plan. The requirement would be applicable beginning on Jan. 1, 2018.

The proposal also would amend certain definitions in the liquidity coverage ratio rule and would equalize the way national banks and state-chartered banks treat fiduciary deposits in their calculations of high-quality liquid assets.

Comments are due Aug. 5, 2016.

New Consumer Compliance Rating System Proposed

The Federal Financial Institutions Examination Council (FFEIC), whose members include representatives from the Fed, FDIC, NCUA, OCC, State Liaison Committee, and Consumer Financial Protection Bureau, released on April 29, 2016, a proposal for public comment on a revised uniform interagency consumer compliance rating system. The proposed changes are intended to address regulatory, supervisory, technological, and market changes since the current system was introduced in 1980. The revisions are designed to more fully align the rating system with the FFIEC agencies’ current risk-based, tailored examination approaches. One significant change is the adoption of risk-based supervision focused on institutions’ compliance management systems, compared to the transaction testing that was common in the 1980s. The proposed new rating system would apply to all institutions.

The new model would retain the 1-through-5 rating scale, and ratings would be based primarily on the adequacy of an institution’s compliance management systems. As identified in the proposal, institutions would be assessed in three categories: board and management oversight, compliance program, and violations of law and consumer harm. The proposed changes were not developed with the objective of setting new or higher supervisory expectations for financial institutions and are expected to represent no additional regulatory burden.

Comments will be due within 60 days after publication of the proposal in the Federal Register.

From the Consumer Financial Protection Bureau (CFPB)

Monthly Complaint Report Issued

The CFPB, on April 26, 2016, issued its latest “Monthly Complaint Report” on consumer complaints. This month’s report details consumer complaint volume by product, state, and company; highlights mortgage complaints in its product spotlight section; and presents a geographically focused section on complaints in California.

According to this month’s report, the CFPB has received more than 859,900 complaints since July 2011 across all financial products, with mortgage complaints accounting for approximately 223,100, making it the second most complained-about product after debt collection, which had approximately 227,300 complaints. The majority of reported mortgage complaints related to “problems when you are unable to pay” (51 percent) and “making payments” (31 percent).

From the Financial Accounting Standards Board (FASB)

Vote Taken to Proceed With Final Standard on Credit Losses

On April 27, 2016, the FASB voted to proceed with the new accounting standard on credit losses, using the expected credit loss (CECL) model, on loans and other financial assets. The final Accounting Standards Update (ASU) is expected to be published in June 2016.

The FASB had initially answered the millionaire-dollar question for the effective dates in early November when it expected to have the standard finalized in December. Given the elapsed time, the FASB took the opportunity to re-evaluate its prior decision and decided to defer the original effective dates by one year to the following:

  • For public business entities (PBEs) that meet the definition of an SEC filer, the standard will be effective for fiscal years (and interim periods within those fiscal years) beginning after Dec.15, 2019. For calendar year-end SEC filers, it is effective for March 31, 2020, interim financial statements.
  • For other PBEs, the standard will be effective for fiscal years beginning after Dec. 15, 2020, including interim periods within those fiscal years. For calendar year-end PBEs that are not SEC filers, it is effective for March 31, 2021, interim financial statements.
  • For non-PBEs, the standard will be effective for annual periods beginning after Dec. 15, 2020, and interim periods within fiscal years beginning after Dec. 15, 2021. For calendar year-end entities that are not PBEs, it is effective for Dec. 31, 2021, annual financial statements.
  • Early adoption will be permitted for fiscal years beginning after Dec. 15, 2018, including interim periods within those fiscal years.
In addition, the FASB voted to provide practical and transitional relief for disclosing vintages. PBEs that are not SEC filers will be able to elect a practical expedient in transition to disclose only three years of the required vintage information in the year of adoption and four years in the year after adoption, and all other entities will not be required to disaggregate credit indicators by year of origination.

For more information, see the April 27, 2016, Crowe article “FASB Votes to Proceed With CECL and Delays Effective Dates by One Year.”

Change in Goodwill Proposed

The FASB issued a proposed ASU, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment,” on May 12, 2016, as a part of a two-phase project to address concerns about the cost and complexity of the subsequent accounting for goodwill for PBEs. The proposed amendments would remove the second step from the goodwill impairment test. Under current generally accepted accounting principles (GAAP), step two includes determining the implied fair value of goodwill and comparing it to the carrying amount of goodwill. Under the proposal, entities would compare the fair value of a reporting unit to its carrying amount and record impairment for the amount by which the carrying amount exceeds the fair value. Entities still would have the option to apply a qualitative assessment of a reporting unit to determine if a quantitative impairment test is required.

The FASB also proposed removing the requirements that reporting units with zero or negative carrying amounts perform a qualitative assessment, and if they fail that qualitative test, to perform step two. Therefore, the same impairment tests would apply to all reporting units.

Comments are due July 11, 2016.

Changes to the Statement of Cash Flows Proposed

The FASB issued a proposed ASU, “Statement of Cash Flows (Topic 230): Restricted Cash,” on April 28, 2016, to address the diversity in practice in the presentation of changes in restricted cash on the statement of cash flows.

The proposed amendments would require a statement of cash flows to explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Restricted cash and restricted cash equivalent amounts would be included with cash and cash equivalents when reconciling a statement of cash flow’s beginning-of-period and end-of-period totals.

Comments are due June 27, 2016.

Technical Corrections and Improvements Proposed

The FASB, on April 21, 2016, issued a proposed ASU, “Technical Corrections and Improvements,” to clarify, correct errors to, or make minor improvements to the FASB Accounting Standards Codification.

The proposed changes include simplifications and minor improvements to topics on insurance; troubled debt restructuring; financial instruments; property, plant, and equipment – real estate sales; fair value measurement; and transfers and servicing – sales of financial assets. In some cases, the modifications would remove certain definitions from the master glossary or revise definitions to be more consistent among topics; in other cases the amendments would provide clarification of considerations in the analysis of applicable transactions.

Comments are due July 5, 2016.

From the Securities and Exchange Commission (SEC)

New Guidance on Non-GAAP Measures Released

On May 17, 2016, the SEC’s Division of Corporation Finance (Corp Fin) released updated Compliance and Disclosure Interpretations (C&DIs) related to non-GAAP financial measures that define certain non-GAAP measures and presentations of measures that can be misleading, including these:
  • Adjustments such as “a performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business” (see question 100.01)
  • Inconsistencies in the calculation of a non-GAAP measure from period to period (see question 100.02) or inconsistencies in the treatment of gains and losses that are similar in nature (see question 100.03)
  • Non-GAAP measures that use “individually tailored” accounting principles, such as a non-GAAP policy that accelerates the recognition of revenue when it should be deferred under GAAP (see question 100.04)
  • Non-GAAP performance measures that look like liquidity measures and are presented on a per share basis, even if management does not present the measure as a liquidity measure (see question 102.05)
  • Explicit examples of prohibited presentations that more prominently present the non-GAAP measure than the comparable GAAP measure (see question 102.10)
The updated C&DIs also include examples of how tax effects for both non-GAAP liquidity measures and performance measures should be included in a non-GAAP measure (see question 102.11).

Non-GAAP Measures and Other Topics Discussed by SEC Deputy Chief Accountant

Deputy Chief Accountant Wesley Bricker spoke at the 2016 Baruch College Financial Reporting Conference on May 5, 2016. He emphasized several areas of focus for the SEC. His remarks highlighted the SEC’s emphasis on non-GAAP reporting measures, transition period activities for major accounting standards (revenue recognition, leasing, and financial instruments), and PCAOB activities. The full text of the speech is available online.

Amendments Adopted to Implement JOBS Act and FAST Act Changes for Exchange Act Registration Requirements

On May 3, 2016, the SEC approved amendments to revise its final rules related to the registration thresholds, registration termination, and suspension of reporting under Section 12(g) of the Securities Exchange Act of 1934 (Exchange Act) to implement provisions of the Jumpstart Our Business Startups Act (JOBS Act) and the Fixing America’s Surface Transportation Act (FAST Act). Changes include these:
  • To reflect the new thresholds established by the JOBS Act and the FAST Act, Exchange Act Rules 12g-1 through 12g-4 and 12h-3 have been amended, and reporting obligations under Section 15(d) have been suspended.
  • For purposes of Exchange Act Section 12(g)(1), the definition of “accredited investor” in Securities Act of 1933 (Securities Act) Rule 501(a) applies to determinations as to which record holders are accredited investors. The accredited investor determination will be made as of the last day of an issuer’s year.
  • The definition of “held of record” has been amended so that, when determining whether an issuer must register a class of equity securities with the SEC under Exchange Act Section 12(g)(1), the issuer may exclude securities held by persons who received them under an employee compensation plan in transactions exempt from, or not subject to, Securities Act Section 5 registration requirements and, in certain circumstances, held by persons who received them in exchange for securities received under an employee compensation plan.
Additionally, the SEC has established a nonexclusive safe harbor for determining holders of record:
  • “An issuer may deem a person to have received the securities under an employee compensation plan if the plan and the person who received the securities under the plan met conditions of Securities Act Rule 701(c).
  • “An issuer may, solely for the purposes of Section 12(g), deem the securities to have been issued in a transaction exempt from, or not subject to, the registration requirements of Section 5 of the Securities Act if the issuer had a reasonable belief at the time of the issuance that the securities were issued in such a transaction.”
An issuer that is not a bank, bank holding company, or savings and loan holding company must, as a result of changes to the JOBS Act and FAST Act, register a class of equity securities under the Exchange Act if it has total assets of more than $10 million and the securities are “held of record” either by 2,000 persons or by 500 persons who are not accredited investors. An issuer that is a bank, bank holding company, or savings and loan holding company must register a class of equity securities if it has total assets of more than $10 million and the securities are “held of record” by 2,000 or more persons.

The rules will be effective 30 days after publication in the Federal Register.

Business Conduct Standards Adopted for Security-Based Swap Dealers and Major Security-Based Swap Participants

On April 13, 2016, the SEC voted to adopt final rules to implement business conduct standards and chief compliance officer requirements for security-based swap dealers and major security-based swap participants (security-based swap entities). Adopted under Title VII of Dodd-Frank, the rules put forth a number of provisions designed to increase transparency, inform customer decision-making, and strengthen standards of professional conduct.

In accordance with the final rules, security-based swap entities must communicate with potential counterparties in a fair and balanced manner, disclose material information (including material risks, characteristics, incentives, and conflicts of interest) about the security-based swap, and follow other professional standards of conduct. Additionally, the rules establish requirements for supervision and chief compliance officers and address the cross-border application of these requirements and the potential availability of substituted compliance.

The final rules are effective June 27, 2016.

Online Tool Offered to Help Companies Estimate Registration Fees

The SEC announced, on April 18, 2016, the release of an online tool, the Registration Fee Estimator, to assist companies with more accurately calculating registration fees for certain form submissions to the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system. The tool is designed to decrease the need for corrections to fee calculations. It works for the most common filings companies use to register initial public offerings, debt offerings, asset-backed securities, closed-end mutual funds, limited partnerships, and small-business investment companies.

Filers can use the tool to estimate filing fees and find guidance on completing the related fee tables. They will continue to be responsible for paying all required fees and correctly including all required information in their filings.

The new tool is available on the SEC website.

Public Comment Sought on Plan to Create a Consolidated Audit Trail

On April 27, 2016, the SEC voted to publish for public comment a proposed national market system (NMS) plan to establish a comprehensive database designed to allow regulators to efficiently track all U.S. equity and options market trading activity. The plan for this consolidated audit trail (CAT) database was submitted jointly by the self-regulatory organizations as required by Rule 613 of Regulation NMS.

The proposed plan describes the approaches that self-regulatory organizations and broker-dealers would use to record and report information, including customer identity, to create an array of data elements that collectively provide the complete life cycle of all orders and transactions in the U.S. equity and options markets. The proposal also specifies how the CAT data would be preserved to protect its accuracy and integrity and maintain security.

Comments will be due within 60 days after publication of the proposed plan in the Federal Register.

Guidance on Regulation AB Updated

The staff in the Corp Fin issued updates, on April 28, 2016, to its C&DIs, Regulation AB. This update relates to the filing of asset-level disclosures on Form ABS-EE and addresses several questions about such filings. Within its answers, Corp Fin provides guidance on certain aspects of the SEC’s final rules on asset-backed securities, including prospectus information requirements, determination of the most recent reporting period, and other performance-related information reporting requirements.

From the Public Company Accounting Oversight Board (PCAOB)

Report on Compliance With Standard on Audit Committee Communications Published

The PCAOB, on April 5, 2016, published a report, “Inspection Observations Related to PCAOB Rules and Auditing Standards on Communications With Audit Committees,” which discusses registered audit firms’ initial implementation of and compliance with PCAOB Auditing Standard No. 16, “Communications With Audit Committees” (AS 16).

The report covers the 2014 and preliminary 2015 PCAOB inspection results. It reveals that in 93 percent of the applicable audits inspected in 2014, no failures to comply with the requirements were identified, and preliminary results from the 2015 inspections were similar. PCAOB inspectors found that most firms inspected in 2014 had incorporated AS 16 requirements into their audits, introduced relevant practice aids, or provided partner and staff training.

Standard to Enhance the Auditor’s Report to Include Critical Audit Matters Re-proposed

On May 11, 2016, the PCAOB re-exposed a proposal, “The Auditor’s Report on an Audit of Financial Statements When the Auditor Expresses an Unqualified Opinion,” to add critical audit matters (CAMs) to the auditor’s report. The revised proposal retains the pass-fail model in the existing auditor’s report but would add CAMs and make other improvements to the report. The PCAOB refined its prior proposal by limiting the source of CAMs to those communicated or required to be communicated to the audit committee, introducing a materiality component to the CAM definition, and adding a requirement that the auditors describe how the CAM was addressed. Generally, the proposal will apply to audits conducted under PCAOB standards; however, unlike the 2013 proposal, the requirements will not apply to the audits of 1) brokers and dealers, 2) investment companies other than business development companies, and 3) employee stock purchase, savings, and other similar plans.

Comments are due Aug. 15, 2016.

From the Institute of Internal Auditors (IIA)

Report on Building Audit Department Skills Published

The IIA published, on April 28, 2016, a report based on results of the Common Body of Knowledge (CBOK) 2015 Global Internal Audit Practitioner Survey, “The Top 7 Skills CAEs Want: Building the Right Mix of Talent for Your Organization.”

Chief audit executives (CAEs) identified the top skills that they require in candidates: analytic and critical thinking skills as well as communication skills. In addition, the report discloses that CAEs believe that these five specific skills are necessary for internal audit activities:
  • Accounting
  • Risk management assurance
  • Information technology
  • Industry-specific knowledge
  • Data mining and analytics
The report discusses these skills and how they fit into internal audit, and it offers some talent management strategies that can be used to develop an audit staff that has these critical skills.

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Sydney Garmong
Sydney Garmong
Office Managing Partner, Washington, D.C.