FDIC offers guidance for de novos; OCC releases semiannual risk report

| 7/21/2017


Current financial reporting, governance, and risk management topics

From the Federal Financial Institution Regulators

Call Report Changes Proposed

The Federal Deposit Insurance Corp. (FDIC), the Federal Reserve Board (Fed), and the Office of the Comptroller of the Currency (OCC) on June 27, 2017, issued a joint notice and request for comment on burden-reducing revisions and certain other reporting changes to all three versions of the call report. These revisions are proposed to take effect March 31, 2018.

In addition to burden reduction, the agencies’ proposal includes two other revisions to the call report. The first proposal would revise the instructions by aligning the method for determining the past-due status of certain loans and other assets with an accepted industry standard. Under the current call report instructions, certain loans with payments scheduled monthly are to be reported as past due when the borrower is in arrears two or more monthly payments, which has been interpreted to mean that a loan is  past due if two monthly payments have not been received by the due date of the second monthly payment. Similarly, the call report instructions provide that other forms of credit are to be reported as past due when the customer has not made the minimum payment for two or more billing cycles. The current instructions also permit, at the institution’s option, that loans and leases with payments scheduled monthly may be reported as past due when one scheduled payment is due and unpaid for 30 days or more.

The proposal would revise the definition of ‘‘past due’’ to align with the Mortgage Bankers Association (MBA) method (a widely used industry standard) such that certain loans and forms of credit with scheduled monthly payments are reported as past due if a payment is not received by the end of the day immediately preceding the loan’s next payment due date. For example, if a monthly loan payment is due April 1 and no payment is received by the end of the day on April 30, which is the day immediately preceding the loan’s next payment due date, the loan would be considered 30 days past due for reporting purposes as of April 30. The change could result in reporting more loans past due than under the existing call report instructions.

The second proposal would revise portions of several call report schedules in response to changes in the accounting for investments in equity securities under the Financial Accounting Standards Board’s Accounting Standards Update (ASU) No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” These revisions are proposed to make the regulatory reporting consistent with the FASB’s accounting guidance in ASU 2016-01 that 1) revises the classification of equity securities such that available-for-sale equity securities are eliminated along with the related unrealized gains and losses, and those securities must be measured at fair value through net income unless an exception applies; and 2) revises the measurement of equity investments without readily determinable fair values to provide a practicability exception that those be measured at fair value (based on observable price changes) through net income rather than at cost (less impairment, if any).

Comments are due Aug. 28, 2017.

Fed Stress-Test Results Released

Results of stress tests mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) were released by the Fed on June 22, 2017. “Dodd-Frank Act Stress Test 2017: Supervisory Stress Test Methodology and Results” revealed that the largest U.S. banks collectively showed that they can withstand a severe economic downturn and continued to improve their capital positions.

“This year’s results show that, even during a severe recession, our large banks would remain well capitalized,” said Fed Governor Jerome Powell. “This would allow them to lend throughout the economic cycle, and support households and businesses when times are tough.”

Aggregate tier one capital ratios at the 34 firms subjected to the Fed’s stress-test program would fall from an actual 12.5 percent in the fourth quarter of 2016 to a minimum of 9.2 percent under the test’s most extreme hypothetical scenario. The “severely adverse” scenario includes 10 percent unemployment, falling Treasury rates, a 25 percent decline in home prices, and a 35 percent drop in commercial real estate prices.

Even with the hypothetical declines, capital levels at the banks still would be higher than they were following the financial crisis in 2008, when tier one capital ratios for the firms fell to about 5.5 percent at the end of that year.

“Semiannual Risk Perspective” Report for Spring 2017 Released

According to the OCC’s “Semiannual Risk Perspective” report released on July 7, 2017, the agency’s supervisory priorities for community and midsize banks are credit risk, compliance risk, and strategic risk. It’s main concerns for larger banks include compliance, governance, and operational risks. Information in the report is based on data for the year ending Dec. 31, 2016.

Compliance risk has been elevated due to ongoing concerns about Bank Secrecy Act compliance and new and evolving regulations including amendments to the Military Lending Act, the Truth in Lending Act and Real Estate Settlement Procedures Act (TILA-RESPA) integrated disclosures, and the Home Mortgage Disclosure Act.

For community and midsize banks, strategic risk remains high as those entities continue to deal with increased nonbank competition, merger trends, the persistent low-rate environment, and governance issues.

De Novo Charters Manual: Feedback Sought by FDIC

As the latest in a series of steps by the FDIC to encourage the chartering of de novo institutions, the FDIC on July 10, 2017, releasedDeposit Insurance Applications: Procedures Manual.” Although the manual was developed to assist FDIC staff as they evaluate and process deposit insurance applications, with its release, the FDIC is seeking feedback on how well the manual helps bank organizers understand the application process. Guidance in the manual covers the deposit insurance application process.

Comments are due Sept. 8, 2017.

Former Bank CEO Nominated to Lead OCC

The White House announced on June 6, 2017, that President Donald Trump nominated former bank CEO Joseph Otting to serve as comptroller of the currency. Otting is a former president and CEO of California-based OneWest Bank, where he worked closely with Treasury Secretary Steven Mnuchin.

Upon confirmation, Otting would replace acting Comptroller Keith Noreika, who has led the OCC since the end of former Comptroller Thomas Curry’s five-year term in April.

Banking Lawyer Nominated to Lead FDIC

President Trump on June 19, 2017, nominated James Clinger to serve as FDIC chair. According to the White House, Clinger has been nominated first to fill the long-vacant director position on the FDIC board and then to serve a five-year term as chair after Martin Gruenberg’s term ends in November.

Clinger has been chief counsel to the House Financial Services Committee for a decade. During the George W. Bush administration, he served as a deputy assistant attorney general, prior to which he was a staffer on the Financial Services Committee for another decade. He began his legal career in private practice.

From the Consumer Financial Protection Bureau (CFPB)

Changes to Prepaid Rule Proposed and Compliance Guide Issued

The CFPB on June 15, 2017, proposed several changes to its final rule on prepaid products and is seeking comments. Although finalized in 2016, the rule’s implementation has been delayed until April 1, 2018, and with the latest round of proposed changes, the bureau also is inviting comments about whether to delay the implementation date further based on time needed to comply.

Specifically, the bureau is proposing to revise the error resolution and limited liability provisions of the rule to clarify that “financial institutions would not be required to resolve errors or limit consumers’ liability on unverified prepaid accounts.” The CFPB proposal also would add a limited exception to the prepaid rule for credit card accounts linked to digital wallets that customers use to store funds, because the credit card accounts already are subject to Regulation Z. The bureau also proposed several minor clarifications and technical adjustments.

In addition, the CFPB released an updated compliance guide for small entities. The latest version reflects the delay of the effective date and several elements of additional guidance.

The proposal, “Amendments to Rules Concerning Prepaid Accounts Under the Electronic Fund Transfer Act (Regulation E) and the Truth in Lending Act (Regulation Z),” was posted in the Federal Register on June 29, 2017. Comments on the proposed rule are due Aug. 14, 2017.

Latest Round of TRID Amendments Finalized

The CFPB on July 6, 2017, finalized amendments to the TILA-RESPA integrated disclosure (TRID) rule. The 560-page final rule sets forth guidance, clarifications, and technical corrections on a broad range of topics and will take effect 60 days after publication in the Federal Register, with a mandatory compliance date of Oct. 1, 2018.

Included in the amendments are tolerance provisions for the disclosed total of payments, making the treatment consistent with pre-TRID practices and paralleling the TRID tolerances for disclosures of finance charges. The amendments also clarify exemptions from TRID requirements for certain housing assistance loans and extend the rule’s coverage to all cooperative units. Additionally, the rule expands the CFPB’s commentary to facilitate the sharing of disclosures with third parties, such as sellers and real estate brokers.

The rule also makes extensive technical corrections and clarifications on topics including affiliate charges, the calculating cash-to-close table, construction loan instructions, placement of decimal places and rounding, escrow account disclosures, escrow cancellation notices, expiration dates for the closing costs disclosed on the loan estimate, treatment of gift funds, payment ranges on the projected payments table, and informational updates to the loan estimate.

From the U.S. Department of the Treasury

Report on Core Principles of Financial Regulation Released

On June 12, 2017, the U.S. Department of the Treasury issued to President Donald J. Trump a report that examines the United States’ financial regulatory system and details executive actions and regulatory changes that can be immediately undertaken. This report, which is first in a series, identifies various requirements created by Dodd-Frank that the administration believes have adversely affected banking institutions and the financial regulatory system and could be subject to future rollback. The report notes that the requirements in Dodd-Frank “are overseen by multiple regulatory agencies with shared or joint rule-making responsibilities and overlapping mandates. This complicated oversight structure has raised the cost of compliance for the depository sector, particularly for mid-sized and community financial institutions. Moreover, the regulatory agencies often do not engage in sufficient coordination, so financial institutions often face duplication of efforts.”

Among other findings, the report highlights the following:
  • Community financial institutions, including banks and credit unions, are critically important to serving many Americans.
  • Simplification of capital, liquidity, and leverage rules would increase the flow of credit.
  • The U.S. must make sure its banks are globally competitive.
  • Improved market liquidity is critical for the U.S. economy.
  • The Consumer Financial Protection Bureau must be reformed.
  • Regulations need to be better tailored, more efficient, and more effective.
  • To improve accountability, Congress should review the organization and directives of the independent banking regulators.
The Treasury and the administration will work with Congress, independent regulators, the financial industry, and trade groups to carry out the recommendations detailed in the report by changing statutes, regulations, and supervisory guidance.

From the Financial Accounting Standards Board (FASB)

Accounting Guidance for Financial Instruments With Down Round Features Simplified

The FASB issued, on July 13, 2017, ASU 2017-11, “Earnings Per Share (Topic 260); Distinguishing Liabilities From Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments With Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests With a Scope Exception,” to address two separate issues.

Part 1 of the guidance addresses concerns with the complexity of accounting for certain financial instruments with down round features (for example, features that reduce the strike price of a financial instrument based on future equity offerings at a price less than the stated strike price). This ASU eliminates the requirement that an entity consider down round features when determining whether a financial instrument is indexed to its own stock under the liability or equity classification analysis, so that under the new guidance, an instrument with down round features will not be liability classified solely because of the down round features. Instead, for warrants and other freestanding equity classified financial instruments with down round features, companies that present earnings per share (EPS) will recognize the effect of a down round feature when it is triggered as a dividend and a reduction of income available to common shareholders in basic EPS.

Also, companies now will apply existing guidance for contingent beneficial conversion features (BCFs) to their convertible instruments with down round features (for example, debt or preferred stock convertible to common stock). Similar to warrants, down round features for convertible instruments (or BCFs) will be recorded only when the triggering event occurs, but unlike warrants, triggered BCFs will be recognized regardless of whether EPS is presented. BCFs are recorded as a discount to the convertible instrument with an offsetting credit to additional paid-in capital (APIC), and debt discounts are accreted to interest expense, while discounts to preferred stock are accreted to retained earnings and reported as a deemed dividend.

The ASU also requires disclosure of the conversion and exercise price change features (such as down round features) for equity-classified instruments. In the period that the down round feature is triggered, companies are required to disclose that fact and the value of the effect of the feature that has been triggered.

Part I provisions related to down round features are effective for public business entities (PBEs) for fiscal years beginning after Dec. 15, 2018, and interim periods within. For all other entities, Part I provisions are effective for fiscal years beginning after Dec. 15, 2019, and interim periods within fiscal years beginning after Dec. 15, 2020. Early adoption is permitted for all entities, including in an interim period.

Part II of the ASU addresses the 2003 effective date deferral of FASB Statement 150, “Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equity,” for mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests, which is memorialized in Accounting Standards Codification 480-10-65-1. Some find that content in the codification difficult to read and to navigate, so the board replaced the indefinite deferral with a scope exception. As such, there is no accounting impact.

Elimination of Certain Guidance for Bad Debt Reserves for Savings and Loans Proposed

The FASB, on June 27, 2017, issued a proposed ASU, “Technical Corrections and Improvements to Topic 942, Financial Services – Depository and Lending: Elimination of Certain Guidance for Bad Debt Reserves of Savings and Loans,” to eliminate obsolete accounting guidance on deferred taxes for bad debt reserves of savings and loans that arose after Dec. 31, 1987, and guidance in the Comptroller of the Currency’s Banking Circular, “Accounting for Net Deferred Tax Charges (Circular 202).” The FASB believes that these particular post-1987 bad debt reserves should have been recaptured by the relevant entities in full by 2008 and that the related guidance is no longer relevant.

No significant change in current practice is expected.

Comments are due Aug. 28, 2017.

Guidance on Related Parties and the Variable Interest Entity (VIE) Model Proposed

On June 22, 2017, the FASB issued a proposed ASU, “Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities,” that aims to improve VIE guidance for related-party matters that have arisen related to the consolidation guidance in ASU 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis.”

Currently, private companies can elect not to apply the VIE consolidation guidance for common control leasing arrangements provided by ASU 2014-07, “Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements.” This proposal expands that election beyond just leasing arrangements so that private entities could elect not to apply VIE consolidation guidance to any legal entities that are under common control as long as neither the parent nor the legal entity is a PBE.

The proposal would revise the analysis for determining whether a decision-making fee paid by a VIE is a variable interest such that indirect interests in a VIE held through related parties in common control arrangements would be considered on a proportional basis. This revision would be consistent with the analysis for determining whether a reporting entity in a related-party group is the primary beneficiary of a VIE by including indirect interests on a proportional basis (pursuant to amendments in ASU 2016-17).

Under the proposal, mandatory consolidation would be eliminated for circumstances in which related parties share power or when commonly controlled related parties, as a group, have the characteristics of a controlling financial interest but no reporting entity individually has a controlling financial interest. Instead, a reporting entity in the related-party group under common control or in a related-party shared-power situation would apply a set of four factors to assess its own decision-making power and whether it has a controlling financial interest in the VIE. In addition, when related parties under common control, as a group, have a controlling financial interest, the parent entity would consolidate the VIE unless a scope exception applies.

Comments are due Sept. 5, 2017.

From the Securities and Exchange Commission (SEC)

Confidential Review of Draft Registration Statements Offered to All Companies

In an announcement on June 29, 2017, the SEC said that beginning on July 10, 2017, the Division of Corporation Finance (Corp Fin) will allow all companies to submit draft registration statements for initial public offerings (IPOs) for nonpublic (or confidential) review. Certain foreign private issuers and emerging growth companies already enjoy this accommodation. A company will be permitted to submit registration statements to the SEC in order to start the SEC staff’s review of an IPO filing before the company announces to the public that it is pursuing an IPO.

From the American Institute of CPAs (AICPA)

New Framework for Valuation of Financial Instruments Proposed

On July 6, 2017, the AICPA released a proposed new valuation disclosure framework, which is designed for CPAs and financial professionals on the valuation of financial instruments and their underlying components, which historically have been difficult to value. The guidance is based on the principles of independence, objectivity, and consistency.

The AICPA released the proposed guidance in two exposure drafts:
The framework provides guidance on performance requirements, how to explain the characteristics of financial instruments, and disclosure of how these securities have been valued. The framework also defines parameters of documentation requirements, provides definitions of terms that may be unique to the framework, and presents references to accounting, audit, and valuation standards.

The application guidance establishes a minimum scope of work and documentation levels and addresses areas that often are misapplied or insufficiently supported or documented. This guidance provides valuation professionals with information on the amount of work, level of attention, and extent of documentation required when performing valuations for financial reporting purposes.

Comments are due Sept. 26, 2017.

From the Center for Audit Quality (CAQ)

New Tool for Audit Committees on Form AP Reporting Released

On June 20, 2017, the CAQ issued “Form AP – Auditor Reporting of Certain Audit Participants: A Tool for Audit Committees,” which can help audit committees participate in the dialogue about the role of audit participants and the new disclosures. The tool provides information on the importance of Form AP to audit committees and describes how Form AP may help them fulfill their responsibilities to evaluate and oversee the external auditor. The tool also provides example discussion points, questions, and considerations for the implication of these new disclosures including the impact on other employees within the company and on social media.

From the Institute of Internal Auditors (IIA)

Enhanced Audit Executive Center Resource Launched

The IIA launched a new Audit Executive Center (AEC) website on June 26, 2017. Designed for internal auditors, the website addresses technology, risk management, and culture and includes topics such as effective leadership, stakeholder relationships, internal audit intelligence, talent management, process excellence, and audit management.

The site’s Audit Intelligence Suite includes benchmarking reports to gauge audit function performance, skills assessments to evaluate team members’ proficiency, and surveys to gather stakeholder feedback. In addition, a Small Audit Function Resource Exchange is available for those with limited resources.

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