Current financial reporting, governance, and risk management topics
The Federal Deposit Insurance Corp. (FDIC) issued, on Sept. 5, 2019, its “Quarterly Banking Profile” covering the second quarter of 2019. According to the report, FDIC-insured banks and savings institutions reported $62.6 billion in net income for the second quarter, a 4.1% increase from a year ago. The increase in net income was attributable mainly to higher net interest income and an increase in realized gains on securities. Net interest income increased $4.9 billion (3.7%) from a year earlier to $139 billion.
The report provides these additional statistics:
- The average net interest margin decreased slightly to 3.39% in the second quarter from 3.42% for the first quarter.
- Community banks earned $6.9 billion during the second quarter, up 8.1% from the same period last year.
- Total loans and leases increased 4.5% from a year ago.
- Net charge-offs increased by 9.3% from a year ago; however, the average net charge-off rate remained unchanged (0.50%) as compared to last quarter. Noncurrent loans (those 90 days or more past due) declined by 4.8% from the previous quarter.
The total number of FDIC-insured commercial banks and savings associations declined to 5,303 from 5,362 for the previous quarter. The number of institutions on the problem bank list fell to 56, five new banks were chartered, 60 banks were absorbed by mergers, and one bank failed.
On Sept. 4, 2019, the National Credit Union Administration (NCUA) reported quarterly figures for federally insured credit unions based on call report data submitted to and compiled by the agency for the second quarter of 2019. Highlights include:
- The number of federally insured credit unions declined from 5,480 in the second quarter of 2018 to 5,308 in the second quarter of 2019 (3,335 federal credit unions and 1,973 federally insured, state-chartered credit unions).
- Total assets in federally insured credit unions rose by $91 billion (6.3%) over the year to $1.52 trillion.
- Net income at an annual rate was $14.4 billion, up $1.7 billion (13.5%) from the previous year.
- The return on average assets increased from 90 to 97 basis points compared to a year ago.
- The credit union system’s net worth ratio increased slightly from 11.01% last year to 11.27%.
The FDIC and the Office of the Comptroller of the Currency (OCC), on Aug. 20, 2019, approved an interagency final rule that includes changes to the Volcker rule, which generally prohibits banking entities from engaging in proprietary trading and from owning or controlling hedge funds or private equity funds. The final rule is aimed at tailoring and simplifying the Volcker rule to allow banking entities to more efficiently provide financial services. Among other changes, the final rule includes:
- Basing compliance requirements on the size of a firm’s trading assets and liabilities, with the strictest requirements applied to banking entities with the most significant trading activity
- Redefining the rebuttable presumption for instruments under the short-term intent prong to state that instruments held for 60 days or longer are not covered
- Defining that banking entities that trade within internal risk limits set under the final rule’s conditions are engaged in permissible market making or underwriting activity
- Simplifying the applicable criteria for the hedging exemption from the proprietary trading prohibition
- Streamlining the information required to be reported to the agencies on trading activity
The rule is pending approval by the Federal Reserve Board, the Securities and Exchange Commission, and the Commodity Futures Trading Commission. Once approved by all of the participating agencies, the final rule will be published in the Federal Register and will be effective on Jan. 1, 2020, with a compliance date of Jan. 1, 2021.
The Basel Committee on Banking Supervision issued, on Aug. 14, 2019, answers to seven FAQs addressing the new standardized approach for operational risk capital, which was included in the Basel III standards finalized in December 2017. The FAQs address treatment of nonperforming loans in the business indicator, timeline for exclusion and inclusion of loss and business indicator items after divestiture or deconsolidation and acquisition or merger, conversion of losses from foreign subsidiaries into local currency, treatment of refunds due to overbilling, and treatment of losses from outsourced activities.
On Aug. 20, 2019, the FDIC approved a final rule increasing the threshold at which bank directors or other management officials are prohibited from serving at more than one depository institution or holding company. Currently, a management official of a depository organization with total assets greater than $2.5 billion (or any affiliate of such an organization) may not serve at the same time as a management official of an unaffiliated depository organization with total assets greater than $1.5 billion (or any affiliate of such an organization), regardless of the location of the two depository organizations. The final rule raises both total assets thresholds to $10 billion.
In Financial Institution Letter 47-2019, issued on Aug. 27, 2019, the FDIC announced the addition of a new section to its Risk Management Manual of Examinations Policies. The new section, “Risk-Focused, Forward-Looking Safety and Soundness Supervision,” includes the FDIC’s examination philosophy and methods, provides transparency to the FDIC’s examination practices, and reinforces the expectations placed on FDIC supervisory staff to conduct risk-focused, forward-looking supervision. The new section also highlights the importance of clear communication and risk tailoring during the examination process under the risk-focused approach.
The Federal Financial Institutions Examination Council (FFIEC), on Aug. 28, 2019, released a statement recommending a standardized approach to cybersecurity preparedness. The FFIEC identified available standardized tools for institutions, including the FFIEC Cybersecurity Assessment Tool, the National Institute of Standards and Technology Cybersecurity Framework, the Financial Services Sector Coordinating Council Cybersecurity Profile, and the Center for Internet Security Critical Security Controls.
On Aug. 21, 2019, FinCEN issued an advisory to financial institutions to alert them to illicit financial schemes related to the trafficking of fentanyl and other synthetic opioids. The advisory is intended to help banks detect and report suspicious and illicit activity that might be enabling the ongoing opioid crisis.
The advisory focuses on the primary typologies and red flags of this drug trafficking activity and notes that fentanyl trafficking in the U.S. primarily follows one of two routes: direct purchase of fentanyl from China or cross-border trafficking from Mexico. The main funding methods for these trafficking patterns include purchases from a foreign source using a money services business (MSB), bank transfer, or online payment processor; purchases from a foreign source using convertible virtual currency such as bitcoin; and purchases from a U.S. source using an MSB, online payment processor, virtual currency, or person-to-person sale.
The FASB, on Sept. 5, 2019, issued a proposed Accounting Standards Update (ASU), “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting,” that would provide temporary optional guidance to ease the potential burden in accounting for, or recognizing the potentially burdensome effects of, global capital market transition away from the London Interbank Offered Rate (LIBOR) as a reference rate. The proposed ASU includes optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships affected by reference rate reform and would apply only to contracts or hedging relationships that reference LIBOR or another reference rate expected to be discontinued.
Among other optional expedients, the proposed guidance includes these:
- "1. Modifications of contracts within the scopes of Topic 310, Receivables, and Topic 470, Debt, would be accounted for by prospectively adjusting the effective interest rate in the agreement.
"2. Modifications of contracts within the scope of Topic 842, Leases, would be accounted for as a continuation of the existing contract with no reassessments or remeasurements that otherwise would be required under that Topic.
"3. Modifications of contracts would not require a reassessment under Subtopic 815-15, Derivatives and Hedging – Embedded Derivatives, of whether an embedded derivative should be accounted for as a separate instrument.”
For other topics and subtopics in the Accounting Standards Codification (ASC), entities would be allowed to consider contract modifications due to reference rate reform to be a continuation of those contracts and would be permitted to not reassess previous determinations.
When elected, the optional expedients would be applied consistently for all contracts or transactions.
The amendments also would provide exceptions to Topic 815, “Derivatives,” guidance related to changes to the critical terms of an existing hedging relationship that come as a result of reference rate reform. The proposal identifies changes that would not result in the dedesignation of the hedging relationship if certain criteria are met.
The proposed guidance would be in effect for only a limited time as it is designed to assist entities through the transition period and not apply to contract modifications made and hedging relationships entered into or evaluated after Dec. 31, 2022.
Comments are due Oct. 7, 2019.
On Aug. 21, 2019, the SEC released clarification guidance addressing proxy voting responsibilities for investment advisers. In addition to other topics, the guidance covers the ability of investment advisers and their clients to establish a variety of voting arrangements and matters to consider when they use proxy advisory firm services.
In addition, the SEC provides interpretative guidance on the applicability of the federal proxy rules to proxy voting advice and notes that proxy voting advice provided by proxy advisory firms generally constitutes a “solicitation” under the federal proxy rules. Related guidance about the application of the proxy antifraud rule to proxy voting advice is included.
The guidance and interpretation are effective as of Sept. 10, 2019.
The PCAOBissued, on Aug. 22, 2019, four staff guidance documents to provide information on the new estimates and specialists audit requirements prior to the effective date of fiscal years ending on or after Dec. 15, 2020. These documents detail aspects of the new standard and improvements made to integrate the risk assessment requirements when auditing accounting estimates, including fair value measurements. The documents also describe features of the new requirements that apply when auditors use the work of specialists and when they use the work of a company specialist as audit evidence.
The four staff guidance documents are:
- “Auditing Accounting Estimates”
- “Auditing the Fair Value of Financial Instruments”
- “Supervising or Using the Work of an Auditor’s Specialist”
- “Using the Work of a Company’s Specialist"
On Aug. 20, 2019, the PCAOB released its annual report on 2018 inspections of broker-dealer auditors. The report includes observations from inspections during 2018, insights into applicable standards, and examples of effective procedures. The report highlights that the percentage of deficiencies for audit and attestation engagements remained high and that continued improvement is needed. The PCAOB believes that auditors could achieve significant positive impact on audit quality if they:
- Focus on improving their quality control systems
- Increase their knowledge and understanding of PCAOB standard
- Focus on improving their testing of internal controls when employing controls-reliance audit strategies and for examination engagements
The PCAOB also noted this report should help broker-dealer owners and audit committees or equivalents as they oversee the work of their auditors.
On Sept. 9, 2019, the AICPA issued a practice aid, “Allowance for Credit Losses – Audit Considerations,” to help auditors as they communicate with management and audit committees on ASC 326, “Financial Instruments – Credit Losses.” The practice aid addresses considerations in auditing the allowance for credit losses related to loans under ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” Key areas within the auditing process include:
- Gaining an understanding of the entity
- Assessing risks
- Identifying audit-relevant controls
- Crafting an audit response
- Performing audit procedures
- Evaluating audit results and disclosure considerations
The publication is aimed primarily at auditors, but it also will help lenders preparing to implement ASU 2016-13. The practice aid, part of a broader AICPA initiative, will be included in the AICPA Credit Losses A&A Guide planned for release in 2020.
On Aug. 15, 2019, the AICPA’s Financial Reporting Executive Committee (FinREC) issued three new working drafts that provide guidance on implementation issues related to ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”
The drafts focus on depository and lending institutions and include:
- Issue #21: Advances of Taxes and Insurance
- Issue #23: Zero Expected Credit Losses Factors for Financial Assets Secured by Collateral
- Issue #28: Scope Exception for Loans and Receivables Between Entities Under Common Control
The working drafts will be included in the AICPA Allowance for Credit Losses – Audit and Accounting Guide upon issuance.
Comments are due Oct. 15, 2019.
The AICPA’s Auditing Standards Board (ASB) issued, on Aug. 22, 2019, a proposed Statement on Auditing Standards (SAS), “Auditing Accounting Estimates and Related Disclosures.” The proposed SAS makes the AICPA’s standard conform with that of the International Auditing and Assurance Standards Board, with language changes to follow usage in the U.S. The proposed SAS, if adopted as proposed, would supersede SAS 122, “Statements on Auditing Standards: Clarification and Recodification,” as amended, Section 540, “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures” (AU-C Section 540). The ASB also incorporated elements of the PCAOB’s recently adopted Auditing Standard 2501.
Among other items, the proposed SAS:
- Explains the nature of estimation uncertainty
- Provides guidance on scalability of the requirements
- Requires separate assessment of inherent risk and control risk
- Provides enhanced risk assessment requirements tailored to estimates
- Requires that further audit procedures must respond to the reasons for the assessed risks of material misstatement
- Discusses the exercise of professional skepticism and how it is affected by the auditor’s evaluation of inherent risk factors
The effective date for audits of financial statements would be for periods ending on or after Dec. 15, 2022.
Comments are due Nov. 22, 2019.