Special message from Mike Percy, Managing Partner, Financial Services
Dear FIEB readers,
Fall is officially here, as of yesterday, and brings the conference season and all things pumpkin. Like many of you, I wonder where the time has gone. I continue to hope this message finds you, your friends, your family, and your colleagues safe.
Two of the largest conferences for our industry are hosted by the American Institute of Certified Public Accountants (AICPA). Last week was the 45th annual AICPA National Conference on Banks and Savings Institutions with total attendance of 1,254, all participating online. We have included here our takeaways from the conference on COVID-19, loan modifications, the Paycheck Protection Program (PPP), Main Street Lending, London Interbank Offered Rate (LIBOR), and use of estimates.
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2020 AICPA Conference on Credit Unions
Oct. 19-21, 2020
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Given this continuing unusual environment, we once again have organized this month’s Financial Institutions Executive Briefing to focus on the most critical issues and will strive to keep you updated as events unfold.
AICPA holds Banking Conference
The 45th annual AICPA National Conference on Banks and Savings Institutions, which was held virtually Sept. 14-16, 2020, covered accounting and auditing topics relevant to financial institutions. Similar to recent years, the current expected credit loss (CECL) standard was a focal point. However, accounting and financial reporting effects of the COVID-19 pandemic also were discussed at length. Here are highlights from this year’s conference.
Selected COVID-19 takeaways:
- Dr. Marci Rossell, former chief economist at CNBC, said she believes that the COVID-19 pandemic will permanently change how Americans will live, work, and play.
- Securities and Exchange Commission (SEC) Corp Fin Associate Chief Accountant Stephanie Sullivan noted that issuers should convey “through the eyes of management” as much information as possible on significant pandemic-related operational and financial challenges faced by the institution.
- Office of the Comptroller of the Currency (OCC) acting Chief Accountant Jeffrey Geer remarked that bank examiners will be focused on the reasonableness of management’s response to the pandemic. As new information becomes available, banks should consider the impact of the pandemic on longer-term business strategy.
On loan modifications made in response to the pandemic:
- Per Geer, examiners will not criticize institutions for working with borrowers in a safe and sound manner, even if those loans ultimately develop weaknesses or are subsequently downgraded. However, examiners will be focused on whether the bank is making accurate and timely assessments of asset quality.
- Federal Deposit Insurance Corp. (FDIC) Chief Accountant John Rieger noted that, with respect to pandemic-related loan modifications not accounted for as TDRs under regulatory or CARES Act guidance, institutions still must ensure that interest accrual and allowance for credit losses/allowance for loan and lease losses allocations are appropriate and all credit monitoring criteria are considered.
- During the Community Banks Hot Topics session, panelists commented that institutions can use the CARES Act Section 4013 for any qualifying loan modification, regardless of whether the loan was modified previously under Section 4013 or the IAS. As a reminder, the ability to qualify for a loan modification under the CARES Act requires an objective evaluation of whether the criteria are met.
On the SBA’s Paycheck Protection Program:
- At both the Mid-Size Bank Chief Accounting Officers (CAO) Panel and the Community Banks Hot Topics sessions, panelists discussed fee recognition on forgiven PPP loans. Panelists noted net unamortized fees will be recognized into income when cash is received from the SBA. Given the lack of history and pooled risk characteristics, estimating prepayments on PPP loans would be a challenge.
- Rieger verified that PPP loans confirmed by the SBA as eligible for forgiveness should continue to be accounted for as loans until the obligation has been settled in full by the SBA.
- Sullivan commented that it is inappropriate to present non-GAAP metrics that adjust earnings to exclude the impact of CECL. However, she said the SEC does not object to institutions disclosing “pre-provision net revenue,” as the metric is grounded in bank regulatory reporting.
- The Financial Accounting Standards Board (FASB) noted that the unfunded commitment expense geography is not addressed in the standard, which means the expense can be with provision or noninterest expense.
On the Federal Reserve’s Main Street Lending Program:
- The SEC discussed a consultation in response to a preclearance consultation submitted from the ABA and eight accounting firms (including Crowe). The SEC noted its nonobjection that financial institutions have a reasonable basis to conclude that, if requested, a true sale opinion could be obtained specifically related to the legal isolation requirement.
On London Interbank Offered Rate (LIBOR) transition:
- Federal Reserve Board (Fed) Chief Accountant Lara Lylozian commented that institutions should expect to see an increase in supervisory activities during 2020 and 2021 that focus on evaluating LIBOR transition preparedness, particularly for institutions with significant LIBOR exposure or less developed transition processes.
On auditing estimates:
- PCAOB Chief Auditor Megan Zietsman noted that assumptions based on past experiences or management expectations may not be indicative of future events.
FDIC issues “Quarterly Banking Profile” for second quarter 2020
The FDIC issued, on Aug. 25, 2020, its “Quarterly Banking Profile” covering the second quarter of 2020. According to the report, FDIC-insured banks and savings institutions reported $18.8 billion in net income for the second quarter, a 70% decrease from a year ago. The decrease in net income is attributable to the continuing uncertain economic environment, which has resulted in an increase in provision expenses.
The report provides these additional statistics:
- Net interest income decreased $7.6 billion (5.4%) from a year earlier to $131.5 billion. The average net interest margin decreased to 2.81% in the second quarter from 3.39% a year ago.
- Community banks earned $6.63 billion during the second quarter, up 3.2% from the same period last year.
- Total loans and leases increased $33.9 billion (0.3%) from the previous quarter.
- Net charge-offs increased by $2.8 billion (22.2%) from a year ago, and the average net charge-off rate increased from 0.50% to 0.57%.
- From the previous quarter, noncurrent loans (those 90 days or more past due) increased by 15 basis points to 1.08%.
The total number of FDIC-insured commercial banks and savings associations declined to 5,066 from 5,116 for the previous quarter. The number of institutions on the problem bank list fell to 52, one new bank was chartered, 47 banks were absorbed by mergers, and one bank failed.
NCUA issues second quarter 2020 performance data
On Sept. 3, 2020, 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 2020. Highlights include:
- The number of federally insured credit unions declined from 5,308 in the second quarter of 2019 to 5,164 in the second quarter of 2020 (3,232 federal credit unions and 1,932 federally insured, state-chartered credit unions).
- Total assets in federally insured credit unions rose by $229 billion (15.1%) over the year to $1.75 trillion.
- Net income at an annual rate was $9.4 billion, down $5 billion (34.6%) from the previous year.
- The return on average assets decreased significantly from 97 to 57 basis points compared to a year ago.
- The credit union system’s net worth ratio decreased from 11.27% last year to 10.46%.
Agencies issue three final rules related to previously issued interim final rules on capital
On Aug. 26, 2020, the Fed, FDIC, and OCC issued three final rules to adopt interim final rules issued earlier in 2020. All final rules were identical or substantially similar to the interim final rules. The rules are as follows:
- A rule to temporarily lower the community bank leverage ratio to 8%. Community banks may elect to use the 8% leverage ratio through the end of the year, and the ratio will increase gradually back to 9% by Jan. 1, 2022. The final rule is effective Oct. 1, 2020.
- A rule to make automatic restrictions on capital distributions more gradual if a bank’s capital levels decline below certain levels. The final rule is effective Jan. 1, 2021.
- A rule to provide certain institutions the option to mitigate the estimated capital effects of the CECL standard for two years. The final rule will be effective immediately upon publication in the Federal Register.
Treasury releases study on CECL and regulatory capital
The U.S. Department of the Treasury issued a study, “The Current Expected Credit Loss Accounting Standard and Financial Institution Regulatory Capital,” dated Sept. 15, 2020.
The study is in response to a legislative package of spending bills (H.R. 1158 and H.R. 1865) funding the federal government through Sept. 30, 2020, that was passed in late 2019 and signed by the president on Dec. 20, 2019. The accompanying conference report included a directive to Treasury to conduct a study, in consultation with the federal financial institution regulators, of the impact of the CECL standard on capital requirements for financial institutions. Congress chose to focus this study on capital requirements rather than a broader economic impact. The report was due within 270 days of the date of enactment of the act.
The study notes, “A definitive assessment of the impact of CECL on regulatory capital is not currently feasible, in light of the state of CECL implementation across financial institutions and current market dynamics. Drawing conclusions right now regarding CECL’s impact since its initial implementation in early 2020 is challenging because CECL has not been fully implemented by all entities, and numerous market factors relating to the COVID-19 global pandemic (including government responses) have affected the economy, financial institutions, and borrowing and lending dynamics .”
The 29-page study includes an executive summary, background, implications for regulatory capital, the key areas of debate, and recommendations. The high-level recommendations include:
- “The prudential regulators should continue to monitor the effects of CECL on regulatory capital and financial institution lending practices, and calibrate capital requirements, as necessary.
- “The prudential regulators should monitor the use and impact of transitional relief granted, and extend or amend the relief, as necessary.
- “FASB should further study CECL’s anticipated benefits.
- “FASB should expand its efforts to consult and coordinate with the prudential regulators to understand – and take into account when considering any potential amendments to CECL – the regulatory effects of CECL on financial institutions.
- “FASB should, in consultation with relevant stakeholders, explore the costs and benefits of further aligning the timing of the accounting recognition of fee revenues associated with financial assets under GAAP with the earlier accounting recognition of potential credit losses under CECL.
- “FASB, together with the prudential regulators, should examine the application of CECL to smaller lenders.”
Treasury notes it will continue to actively monitor implementation and consult with stakeholders, including the federal financial institution regulators, FASB, and the SEC.
CFPB issues report on COVID-19 impact on consumer credit
On Aug. 31, 2020, the Consumer Financial Protection Bureau (CFPB) issued a report, “The Early Effects of the COVID-19 Pandemic on Consumer Credit.” The report found that, despite spikes in unemployment, delinquencies have not increased significantly since the start of the COVID-19 pandemic. A few highlights from the report:
- New delinquencies fell between March and June 2020.
- Overall, payment assistance from lenders increased, particularly for mortgage and student loans. There was also an increase in payment assistance for auto loans and credit cards, which previously had seen almost no assistance.
- Credit card closures due to inactivity increased, and more credit line increases for existing accounts were suspended.
CFPB proposes new category of qualified mortgages
The CFPB, on Aug. 18, 2020, issued a notice of proposed rulemaking to create a new category of qualified mortgages (QMs) called “seasoned QMs.” Under the proposed rules, a covered transaction would receive a safe harbor from ability to repay liability at the end of the 36-month seasoning period as a seasoned QM if certain requirements are satisfied, including:
- The loan is a first-lien, fixed-rate transaction.
- The loan had no more than two 30-day delinquencies and no delinquencies of 60 or more days within the seasoning period.
- The loan was held in the creditor’s portfolio during the seasoning period.
- The creditor considered and verified the consumer’s debt-to-income ratio at origination.
Agencies issue statements on BSA enforcement
On Aug. 13, 2020, two statements relating to Bank Secrecy Act (BSA) enforcement were issued, one by the Financial Crimes Enforcement Network (FinCEN) and one jointly by the Fed, FDIC, NCUA, and OCC.
The FinCEN statement clarifies the agency’s approach to enforcing BSA requirements. The statement also outlines actions available when BSA violations are identified and notes the factors considered when determining the appropriate action. Possible actions range from no action to criminal referral.
The statement from the federal banking agencies clarifies that isolated or technical violations generally do not result in enforcement actions. Furthermore, the statement addresses how the agencies evaluate violations of the pillars of BSA/anti-money laundering compliance, including how customer due diligence requirements are incorporated as part of the internal controls pillar.
Agencies issue guidance on due diligence requirements for PEP accounts
On Aug. 21, 2020, the Fed, FDIC, FinCEN, NCUA, and OCC issued a joint statement clarifying due diligence requirements for customers identified as politically exposed persons (PEPs), indicating that the level of due diligence should be commensurate with the risks posed by the relationship. Risk factors to consider include transaction volumes, account balances, known legitimate sources of funds, and types of products and services used.
The statement also clarifies that while financial institutions must adopt risk-based customer due diligence procedures, no supervisory expectation exists for banks to have additional due diligence requirements for PEP customers.
Federally chartered banks and thrifts may provide custody for crypto assets
On July 22, 2020, the OCC published a letter clarifying that national banks and federal savings associations may provide crypto asset custody services. In the letter, the OCC notes that such custody services, including holding unique cryptographic keys, are a modern form of traditional bank activities related to custody services.
In an OCC news release, acting Comptroller of the Currency Brian P. Brooks said, “From safe-deposit boxes to virtual vaults, we must ensure banks can meet the financial services needs of their customers today. This opinion clarifies that banks can continue satisfying their customers’ needs for safeguarding their most valuable assets, which today for tens of millions of Americans includes cryptocurrency.” The opinion applies to national banks and federal savings associations of all sizes and is consistent with a number of states that have authorized banks or trust companies to provide similar functions.
Financial regulators host a webinar on PPP loan forgiveness
On Sept. 3, 2020, the financial regulators held an ask-the-regulators webinar, “Loan Forgiveness and Other Matters Relative to the Paycheck Protection Program.” The webinar, which is available for replay, focused on the Small Business Administration (SBA) and Treasury interim final rule, “Business Loan Program Temporary Changes; Paycheck Protection Program – Requirements – Loan Forgiveness,” that was issued on May 22. The significant points of the forgiveness process include:
- Borrower completes loan forgiveness application (SBA Form 3508 or lender equivalent).
- Lender reviews the application and makes a decision regarding loan forgiveness.
- Lender has 60 days from receipt of a complete application to issue a decision to SBA.
- If lender determines borrower is entitled to forgiveness of some or all of the amount applied for, lender must request payment from SBA at the time the lender issues its decision to SBA.
- SBA will, subject to any review, remit the appropriate forgiveness amount to the lender, plus any interest accrued through the date of payment, not later than 90 days after the lender issues its decision to SBA.
- Lender accounts for the loan as an interest-bearing loan through receipt of payment from the borrower or the SBA. Payments received from the borrower or the SBA prior to the maturity of the loan are considered prepayments.
AICPA issues additional guidance for PPP lenders
The AICPA and its Depository Institutions Expert Panel released Technical Question and Answer (TQA) 2130.45 to help financial institutions and other lenders appropriately account for the PPP loans that they distributed. The TQA addresses how a lender should account for the portion of a PPP loan that is eligible for forgiveness during the settlement process, including the time period after the lender’s determination that the borrower is eligible for forgiveness and through the receipt of payment from the SBA.
FDIC updates FAQ on PPP
Through Aug. 31, 2020, the FDIC updated its frequently asked questions on the SBA’s PPP, including the FAQs on accounting and regulatory reporting. The FDIC updated its responses that originally conflicted with AICPA guidance. The original answer to “How should institutions account for PPP loan forgiveness when notification of forgiveness is provided or a portion of the loan is transferred to the SBA?” was removed and replaced with this answer:
For regulatory reporting purposes, PPP loans should continue to be accounted for as loan receivables recognizing payments from the borrower or the SBA. Payments received from the borrower or the SBA prior to the maturity of the loan, other than required payments of principal and interest, are considered prepayments of the loan. Based on the premise that the SBA is considered one of the counterparties, or co-borrower, to the loan agreement in a PPP loan, if the borrower provides the institution and SBA with documentation supporting that it has met the condition of forgiveness, payments received from the SBA should be accounted and reported similar to payments received from the borrower. Accordingly, payments received prior to the loan’s maturity from the borrower or the SBA, either full or partial, should be accounted and reported as a prepayment. Unamortized loan origination fees should be accounted for in accordance with [Accounting Standards Codification] ASC Subtopic 310-20, Receivables – Nonrefundable Fees and Other Costs.
SBA updates PPP summary information
The SBA released an updated PPP report summarizing details of the program through Aug. 8, 2020, the date PPP closed to new loan applications. The report provides details on the number of loans to date; total dollar amounts of loans; lender information including number, size, and segments; loans by state and industry; loans by size; and top PPP lenders. The amount of funding remaining under the program was $133,987,798,876 based on approvals through Aug. 8, 2020.
SEC weighs in on Main Street Lending Program
On Sept. 11, 2020, the staff from the SEC’s Office of the Chief Accountant informed the American Bankers Association (ABA) and a group of large accounting firms of its nonobjection to the ABA’s consultation on their analysis of the legal isolation condition in ASC 860-10-40-5(a) related to the MSLP. The ABA’s consultation sought to understand if each participating bank can satisfy the legal isolation condition for each MSLP facility without the receipt of individual legal isolation opinions given several unique factors surrounding the MSLP.
Representatives from the Crowe national office participated in the call and understand that banks executing sales of loan participations with the special-purpose vehicles established by the Federal Reserve Bank of Boston under the MSLP can reach a conclusion that the legal isolation condition is met as the bank has a reasonable basis to conclude that appropriate legal opinion(s) would be given if requested. The SEC also addressed this consultation during remarks on Sept. 14 at the AICPA National Conference on Banks and Savings Institutions.
The MSLP preclearance consultation is limited solely to the legal isolation condition for the MSLP, meaning all other conditions required to achieve sale under ASC 860 need to be evaluated by the bank. The SEC staff noted that this view is unique to the MSLP, includes certain assumptions, and should not be analogized in other fact patterns.
Fed continues to update FAQs
The Fed updated the MSLP frequently asked questions document on Aug. 24, 2020, to provide additional guidance on the program as well as other topics. The Fed added questions and answers addressing terms and conditions as well as certifications and covenants.
On Sept. 4, 2020, the Fed also updated its Main Street for Nonprofit Organizations frequently asked questions.
Understanding the accounting for pandemic-related loan modifications (CARES Act and the IAS)
Over the past several months, banks and credit unions have responded to the COVID-19 pandemic by working with their borrowers on alleviating potential cash flow concerns through modifying, and often deferring, payment terms on existing loans. The volume of modified loans is unprecedented; many organizations have modified 20% to 30% of their loan portfolio since late March.
Although the guidance in Section 4013 of the Coronavirus Aid, Relief and Economic Security Act (CARES Act) and the “Interagency Statement [IAS] on Loan Modifications by Financial Institutions Working With Customers Affected by the Coronavirus” (revised in April 2020) share many similarities, a fundamental difference exists between the two. A loan modification that qualifies for and is accounted for under Section 4013 is exempt from troubled debt restructuring (TDR) requirements. The guidance in the IAS includes no such thing. Loan modifications that meet the criteria under the IAS are presumed to not meet the “financial difficulty” prong of ASC 310-40. These loans, in effect, were presumed to be evaluated under existing TDR rules and did not meet the criteria for TDR recognition. The IAS did not suspend GAAP, although Section 4013 did.
Crowe has received a number of questions on how to consider the interaction between the IAS and Section 4013 on subsequent modifications. For example, can a loan be modified first under IAS guidance and then subsequently modified under the provisions of the CARES Act? The Sept. 14-16, 2020, AICPA National Conference on Banks and Savings Institutions addressed this as well.
The simple answer to this question is yes. An institution that wishes to elect to account for loan modifications under CARES Act Section 4013 may do so at any time and for any qualifying loan, regardless of whether the loan was modified previously during the COVID-19 crisis. The regulatory agencies note in the Aug. 3 “Joint Statement on Additional Loan Accommodations Related to COVID-19,” which addresses loans nearing the end of relief period, that “an additional loan modification could also be eligible under section 4013.”
The OCC has published a reference guide, “TDR Designation and COVID-19 Loan Modifications: Section 4013 of the CARES Act and OCC Bulletin 2020-35.”
SEC updates statistical disclosures for banking registrants
On Sept. 11, 2020, the SEC adopted a final rule, “Update of Statistical Disclosures for Bank and Savings and Loan Registrants,” to modernize statistical disclosures of banking registrants currently provided in Industry Guide 3, “Statistical Disclosure by Bank Holding Companies.” The final rule rescinds Guide 3 and relocates required disclosures to new Subpart 1400 of Regulation S-K.
The rule clarifies, for both domestic and foreign registrants, that banks and savings and loan registrants are subject to Subpart 1400 and, with minor exceptions, matches the periods required for statistical disclosures to the annual and interim periods presented in the financial statements. The final rule carries over many current Guide 3 disclosures to Subpart 1400; however, it also eliminates certain Guide 3 disclosure topics (for example, return on equity and assets and short-term borrowings) and makes minor changes to Article 9 of Regulation S-X.
Significant disclosure changes include, among others, weighted average yield of debt security investments by maturity, maturity analysis of the loan portfolio, certain credit ratios and the factors that explain material changes in the ratios, and the addition of certain disaggregated uninsured deposit disclosures.
The final rule is effective 30 days after publication in the Federal Register and will apply to years ended on or after Dec. 15, 2021. Early compliance will be permitted provided the final rules are applied in their entirety from the date of early compliance.
SEC adopts amendments to modernize Regulation S-K disclosures
The SEC, on Aug. 26, 2020, adopted amendments to update the description of business (item 101), legal proceedings (item 103), and risk factor (item 105) disclosures required under Regulation S-K. Incorporating changes in the capital markets and the economy, the amendments also reflect the SEC’s commitment to a principles-based, registrant-specific approach to disclosure and are intended to improve the readability of disclosure documents and to discourage repetition and reduce the disclosure of information that is not material.
Among other changes to Items 101, 103, and 105, the amendments include the following:
- Item 101. Clarifying and expanding the principles-based approach; adding disclosure topics such as human capital resources, including any material human capital measures or objectives that management focuses on in managing the business; and emphasizing regulatory compliance by including material government regulations
- Item 103. Specifically stating that required information about material legal proceedings may be provided through hyperlinks or cross-references to legal proceedings disclosure located elsewhere in the document
- Item 105. Requiring a summary disclosure if risk factors exceed 15 pages, changing the required disclosure standard from “most significant” to “material” factors, and requiring risk factors to be organized under relevant headings
The amendments are effective 30 days after publication in the Federal Register.
SEC modernizes definition of accredited investor
On Aug. 26, 2020, the SEC adopted amendments to the accredited investor definition, which is one of the principal tests for determining who is eligible to participate in private capital markets. Previously, individual investors who did not meet specific income or net worth tests, regardless of their financial sophistication, were not provided the opportunity to invest in private markets. These amendments update and improve the definition to better identify institutional and individual investors that have the knowledge and expertise to participate in private markets.
The amendments include defined measures of professional knowledge, experience, or certifications in addition to the existing tests for income or net worth that allow for qualification as an accredited investor. Qualifying individuals now will include those who have certain professional certifications and designations and a “knowledgeable employee” of a private fund for the purpose of investing in that fund. The amendments also increase the list of entities that may qualify as accredited investors.
The amendments are effective 60 days after publication in the Federal Register.
SEC updates guidance on expiring confidential treatment orders
On Sept. 9, 2020, the SEC’s Division of Corporation Finance (Corp Fin) released an update to CF Disclosure Guidance: Topic No. 7. The new guidance describes the three options available to companies whose confidential treatment orders are expiring, including refiling the unredacted information, extending the confidential period, and transitioning to compliance with the requirements under Regulation S-X item 601(b)(1) and other parallel rules.
PCAOB announces 2020 Forums on Auditing in the Small Business Environment and on Auditing Broker-Dealers
On Sept. 9, 2020, the PCAOB announced that the 2020 forums for auditors of small businesses and auditors of broker-dealers will be recorded due to the COVID-19 pandemic and posted on its website. The recordings, which will include perspectives from the PCAOB and the Financial Industry Regulatory Authority, will be available starting Oct. 19, 2020.