Accounting Update for Financial Institutions

Transcription

1 2013 CliftonLarsonAllen LLP Accounting Update for Financial Institutions September 16, :15 pm 4:15 pm 11

2 Topics 1. ALLL 2. TDRs 3. Acquired Loans 4. Other Real Estate Owned 5. Investments 6. Proposed Standards 2

3 Allowance for Loan Losses Credit quality indicators improving however. Yield and earnings pressure Increasing competition for limited good loans results in looser underwriting CRE risk remains elevated Difficult workouts Modifications, interest-only structures Risk Rating Accuracy Oil & gas, asset-based lending, leverage loans,commercial& industrial Farmland/Commodity Prices Home equity risk coming to the fore Reducing ALLL 3

4 Allowance for Loan Losses Current issues/topics of discussion include: 1. ALLL for a loan that becomes impaired 2. Use of unallocated 3. Use of ranges in loss estimates 4. Adjustment of historical loss periods 4

5 TDRs Initial assessment of a TDR 1. Financial reporting 2. Accrual vs Nonaccrual 3. Impairment calculation When do these initial assessments change? 5

6 Acquired Loans Segregation of loans by deterioration of credit quality 1. Insignificant deterioration Premium or discount accounted for as an adjustment to yield 2. Significant deterioration Follow FASB ASC (formerly SOP 03-3) 6

7 Acquired Loans Factors to consider when concluding on deterioration 1. Risk rating 2. Performing vs. non-performing 3. Document your thought process 4. Requests for additional financial statement disclosure 7

8 Acquired Loans Significant deterioration Pooling criteria 1. Similar credit risk 2. Other factor(s) Collateral Size Interest rate Origination date Term Geographic location 8

9 Other Real Estate Owned EITF Exposure draft issued on July 19, Addresses timing of transfers from loan to OREO 2. Addresses variance in current practices across the industry Terms such as in substance repossession, foreclosure, and physical possession are not defined in the current accounting guidance, which has led to different applications and interpretations of this standard. 9

10 Other Real Estate Owned A creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon one of the following occurring: the creditor obtaining legal title to the residential real estate property completion of a deed in lieu of foreclosure or similar legal agreement under which the borrower conveys all interest in the residential real estate property to the creditor to satisfy that loan, even though legal title may not yet have passed 10

11 Other Real Estate Owned Additional issues 1. Monitoring and updating fair value measurement 2. Look-back testing 3. Seller financed OREO transactions 11

12 Investments Current fair value issues Other than temporary impairment Interest rate component Credit component TRUPs impairment Equity vs. Debt instruments 12

13 Investments Third party pricing services Understand the pricing process Periodically test fair values Disclosure of policy Support for fair value hierarchy 13

14 Investments Transfers from AFS to HTM Securities classification shall be reassessed at each reporting date HTM to AFS introduces tainting concept, but AFS to HTM does not 14

15 Investments Transfers from AFS to HTM (continued) Halts further unrealized losses in a rising rate environment Additional considerations: Liquidity Possible manual processes for tracking and recording amortization Disclosure Significance of benefits 15

16 Financial Instruments Projects 1. Impairment 2. Recognition and Measurement 16

17 ALLL Expected Loss Model Weaknesses identified following the economic crisis Delayed recognition of credit losses under incurred loss model identified as a weakness in existing standards Complexity of multiple credit impairment models 17

18 ALLL Expected Loss Model Proposed Accounting Standards Update Financial Instruments-Credit Losses, issued December 20, 2012 Financial assets notaccounted for at fair value with changes in fair value reflected in net income with exposure to potential credit risk Examples applicable to financial institutions Loans Debt securities Loan commitments 18

19 ALLL Expected Loss Model Expected credit loss is an estimate of the present value of cash flows notexpected to be collected based on quantitative and qualitative information such as: 1. Past events 2. Historical loss experience 3. Current conditions 4. Borrower credit worthiness 5. Forecasts of expected credit losses* 6. Current point and forecast direction of economic cycle* 19

20 Estimating Expected Losses A practical expedient is available for collateral dependent financial assets A collateral dependent is a financial asset for which repayment is expected primarily or substantially through 1. Operation by the lender 2. Sale of the collateral 20

21 Estimating Expected Losses Calculation depends on reason for collateral dependence Sale of collateral Compare the amortized cost of the asset to the discounted fair value of the collateral, less expected selling costs Operation by lender Compare the amortized cost of the asset to the discounted fair value of the collateral 21

22 Purchased Credit-Impaired Purchased Credit-Impaired (PCI) Financial assets having experienced significant deterioration in credit quality subsequent to origination This differs from the current definition 22

23 Purchased Credit-Impaired Assets can be grouped (pooled) if they have shared risk characteristics at acquisition 1. Asset type 2. Risk rating 3. Past due status 4. Collateral type 5. Date of origination 6. Maturity 7. Industry 8. Debtor geography 9. Ratio of collateral value to commitment 23

24 Income Statement Impact Instruments carried at amortized cost Credit deterioration or improvement occurring during the period would be reflected in the income statement Instruments carried at fair value with changes in fair value reflected in other comprehensive income (FV OCI) Credit deterioration or improvement occurring during the period would be reflected in the income statement OR Practical expedient 24

25 Income Statement Impact Practical expedient for FV OCI Credit deterioration or improvement occurring during the period would be reflected in the income statement unless both of the following are true: 1. Fair value exceeds amortized cost 2. Expected credit losses are insignificant 25

26 Definitions 1. Ceasing accrual of interest 2. Resuming accrual of interest 3. Write offs 4. Recoveries 26

27 ALLL Expected Loss Model Presentation and disclosure requirements are similar to current disclosure requirements for loans, with some additions. For example: 1. Disclosures apply to all instruments within the scope of the proposed standard 2. Description of economic circumstances that caused changes to the allowance during the period 3. Reasons for significant changes in write offs 4. Rollforwardschedule of beginning to ending amortized cost for FV OCI assets 27

28 ALLL Smaller Institution Comments 1. Inability to accurately predict losses and lack of available data 2. Requires significant implementation cost 3. Regulators will utilize this as a tool to increase ALLL and decrease capital 4. Violates matching principle 5. Exclude smaller or non-public institutions 28

29 ALLL Smaller Institution Auditor Comments 1. Proposed model will be more challenging to support and audit 2. Life of loan losses aren t reasonable and supportable 3. Modify or exclude application to debt securities 4. Costs of additional disclosure requirements outweigh benefits 5. Eliminate TDR designation 29

30 ALLL Regulator Comments 1. Addresses the problem of too little, too late 2. Encourage convergence with IASB 3. Suggest practical expedients and transition periods for smaller institutions 4. Support application of nonaccrual and write-off provisions to non-regulated entities 5. Alternatives to TDR recognition and disclosure 30

31 Recognition and Measurement Project Proposed Accounting Standards Update Recognition and Measurement of Financial Assets and Financial Liabilities, issued February 14, 2013 The scope of the proposed ASU covers all assets and liabilities meeting the definition of a financial asset or liability with certain exclusions such as: Derivative instruments Insurance contracts Leases Pension obligations of employers or plans 31

32 Recognition and Measurement Project Classification and measurement of a financial asset is determined at the time of initial recognition based upon 1. Characteristics of the asset 2. Business model for managing the asset 32

33 Recognition and Measurement Project Initial measurement Fair Value Financial instruments subsequently measured at fair value with all changes in fair value recognized through the income statement (FV- NI) Transaction Price Financial instruments subsequently measured at fair value with all changes in fair value recognized through the Other Comprehensive Income (FV-OCI) Financial instruments subsequently measured at amortized cost 33

34 Recognition and Measurement Project Subsequent measurement - Assets 1. Amortized cost 2. Changes in fair value recognized through the Other Comprehensive Income (FV-OCI) 3. Changes in fair value recognized through the income statement (FV-NI) 34

35 Recognition and Measurement Project SPPI Test Do the contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest (SPPI) on the principal amount outstanding? Yes Perform business model assessment to determine amortized cost or FV-OCI No FV-NI 35

36 Recognition and Measurement Project Business Model Assessment Requires judgment Performed at a high level Considers matters such as: o Performance reporting o Management compensation o History of sales volume and frequency 36

37 Recognition and Measurement Project Business Model Assessment (continued) Amortized Cost -Objective is to hold the asset for collection of cash flows Changes in fair value recognized through the Other Comprehensive Income (FV-OCI) -Objective is to hold and manage the asset via a combination of collection of cash flows and selling of assets 37

38 Recognition and Measurement Project Changes in fair value recognized through the income statement (FV-NI) 1. Assets held for sale 2. Assets failing SPPI test 38

39 Definition of a Nonpublic Entity On August 7, 2013, the FASB issued a proposed Accounting Standards Update, Definition of a Public Business Entity: An Amendment to the Master Glossary. The comment period ends September 20, Establishes criteria for FASB, PCC and EITF to determine nonpublic entities for which it is appropriate to adjust financial reporting requirements. 39

40 Definition of a Nonpublic Entity What is a public business entity? 1. Entity required to file or furnish financial statements with the SEC 2. Entity which provides U.S. GAAP financial statements that are periodically made public via legal or regulatory requirement What is a nonpublic entity? 1. Consolidated subsidiary of a public company for purposes of standalone financial statements no included in an SEC filing by its parent or other registrant. 40

41 Definition of a Nonpublic Entity Applicability to NFPs and EBPs: Within the scope of Accounting Standards Codification Topics on plan accounting? Yes -excluded from the scope of the proposed guidance No nonpublic entity and FASB will determine applicability based on user needs and resources on a standard-bystandard basis 41

42 Revenue Recognition Impact on community banks is expected to be small, but relevant revenues and related costs in scope are: 1. Asset management fees 2. OREO 3. Interchange revenue 4. Loan underwriting 42

43 Leases Project Exposure draft released in August 2010 Too complex Disconnect between income statement recognition and economics Revised exposure draft released in May

44 Conclusion Questions? 44

45 Contact information Matt Birkelien Partner CliftonLarsonAllen LLP 9515 DeerecoRoad, Suite 500 Timonium, MD Mark Gillett Partner CliftonLarsonAllen LLP 9515 DeerecoRoad, Suite 500 Timonium, MD