Notes from the Field — the 2020 AICPA National Conference for Banks and Savings Institutions

By John Marsh September 30, 2020

I recently attended the 2020 AICPA National Conference for Banks and Savings Institutions. As you might expect, the COVID-19 pandemic was front and center during the conference. However, CECL continued to be prominent along with other topics such as economic forecasts, taxation and regulatory updates.

CECL OBSERVATIONS

Approximately 30% of financial institutions required to adopt CECL in Q1 had a 20% to 30% increase in their allowance for credit losses (ACL), while almost 35% had an increase of 30.01% to 50%.  During Q2 2020, the top 100 banks by assets increased their ACL coverage ratio by an average of 17% or more.

Key challenges noted in implementing CECL included:

• Effectiveness of models
  • Extreme economic circumstances challenged the effectiveness of many of the models built for CECL.
• Developing a reasonable and supportable forecast
  • The development of the forecast is the most challenging element of CECL. The COVID-19 pandemic significantly increased the uncertainty of the forecast.
• Rapidly changing economic conditions
  • Economic forecasts changed significantly throughout Q1 and into April.

ECONOMIC UPDATE

A summary of what was discussed by the economists presenting at the conference included the following:

• Unlike previous recessions, where unemployment typically peaks after the recession occurs, this time, job loss was immediate.
• Real GDP is expected to return to pre-pandemic levels in Q3 of 2021. As you might expect, the employment-to-population ratio fell to its lowest post-WWII level. Perhaps not surprisingly, leisure and hospitality saw the largest decreases in employment during the period January to August 2020 while financial services saw the lowest decrease.
• Transfer payments as a percent of personal income increased from 17% to 32% (peak) during the pandemic.
• Corporate business confidence has tempered, but corporate CEOs still have an expansionary outlook.
• Nearly 80% of National Association for Business Economics panelists suggested there is at least a one-in-four chance of a double-dip recession.
• The Federal Reserve policy shift has led to a record increase in excess reserves.
• Deposits and reserves for losses increased substantially in the second quarter.
• Continued strength in permits suggests further gains in construction over the coming months.
• New and existing home sales both jump past their prior peaks to the highest levels since the end of 2006.
• Home price growth is expected to stay strong in the near-term.

CYBERSECURITY

Presenters discussed several key aspects related to cybersecurity in the current environment.

The top cybersecurity threats over the past three years identified by survey respondents were:

• Phishing/malware
• Technical vulnerabilities
• Supply chain control deficiencies

Of note, consumer and financial services and the insurance sector had an increase in spending compared with previous years and other sectors. Access control remains a high-priority investment area with focus on privileged access management (PAM), biometrics, and identity-as-a-service (IDaaS) technologies. Data security is also a top priority.

Challenges to managing cybersecurity in 2020 include:

• Rapid IT changes and rising complexities
• Unavailability of skilled cyber professionals
• Business growth and expansion

Embedding cybersecurity into new products and services remains the top business issue cited with cybersecurity. Many organizations are prioritizing the adoption of the Zero Trust model. Zero Trust is a security concept centered on the belief that organizations should not automatically trust anything inside or outside its perimeters and instead must verify anything and everything trying to connect to its systems before granting access. Key drivers toward this model include:

• Complex IT environments
• Brand, reputational and regulatory concerns
• Increasing outsourcing of “core” services
• Increased need for workplace mobility and flexibility
• Push towards digital transformation
• Increased scale, complexity, and frequency of cyberattacks

SEC UPDATE – OFFICE OF THE CHIEF ACCOUNTANT (OCA)

COVID – 19

• The OCA will continue to not object to well-reasoned judgements related to COVID-19.
• Accounting areas highlighted in light of COVID-19 include, but are not limited to:
  • Fair value and impairment considerations
  • Leases
  • Debt modifications and restructurings
  • Hedging
  • Revenue recognition
  • Income taxes
  • Going concern
  • Subsequent events
  • Adoption of new accounting standards (e.g. the new credit losses standard)

Amendments to the Accelerated Filer and Large Accelerated Filer definition for 2020:

• Excludes from the accelerated filer and large accelerated filer definitions an issuer that is eligible to be a smaller reporting company and had annual revenues of less than $100 million in the most recent fiscal year.
• Those issuers that meet this requirement are no longer required to have an internal control over financial reporting (ICFR) auditor attestation included in the filing of their Forms 10-K, 20-F and 40-F. A check box has been added under the new rules to the annual reports on these forms to indicate whether an ICFR auditor attestation is included.

REGULATORY UPDATE

There were representatives from the Federal Reserve Board (FRB), the OCC and the FDIC presenting at the conference.

Observations about CECL included.

• Increased flexibility to react to changes and appropriately reserve now.
• Mitigated reliance solely on historical data and lagging indicators that may be inconsistent with expectation of loss.
• Aligned accounting and reporting with how financial institutions manage credit risk and their business.
• Improved quality and transparency of the discussions around the allowance.

The regulators support a scalable implementation of CECL for community banks.

The day one average impact of 53 OCC regulated banks from adoption of CECL was an increase in the ACL of $401 million or 34%.

The median ACL to loan ratio of CECL banks over $1 billion in assets at the end of Q2 was 1.36% compared to 1.11% for banks that continued to follow the incurred allowance for loan losses model. The ACL to loan ratio continued to increase in Q2 while incurred allowance for loan losses banks reported a decrease in the allowance for loan losses during Q2.

Community Bank Leverage Ratio (CBLR)

• As of Q2 2020, about 41% of all eligible institutions opted into the CBLR framework.
• Section 4012 of the CARES Act temporarily lowered the CBLR from 9% to 8%.

Main Street Lending Program

• For lenders, the SEC released its position on true sale accounting treatment for Main Street Lending Program transactions. The preclearance letter issued on September 11, 2020 stated that the SEC would not object to the conclusion that a financial institution has met the criteria of legal isolation necessary for sale accounting treatment under U.S. generally accepted accounting principles.

Loan Modifications

An interagency statement was issued on March 22, 2020 and updated April 7, 2020.  Subsequently, on August 3, 2020 an interagency statement on re-modifications was issued. The CARES Act passed on March 27, 2020.

The interagency statement provides that COVID-19 related loan modifications are not automatically considered TDRs – short-term modifications (less than six months) for borrowers current (less than 30 days past due) at inception of the modification program are not TDRs. Financial institutions are not expected to designate loans with deferrals granted due to COVID-19 as past due.

Section 4013 of the CARES Act states that financial institutions are not required to apply ASC 310-40 to the loan modification if the borrower was current (less than 30 days past-due) on December 31, 2019. Section 4013 applies to modifications occurring between March 1, 2020 and the earlier of (i) December 31, 2020, or (ii) the 60^th day after the end of the COVID-19 national emergency declared by the President.

Re-modifications that accumulate to more than six months and were modified under the interagency guidance would generally be considered a TDR. However, re-modifications that cumulatively exceed six months and were modified under and in accordance with Section 4013 of the CARES Act would not be required to be reported as TDRs.

As a reminder, with regard to accrual status, a financial institution should continue to refer to the applicable regulatory reporting instructions, as well as internal accounting policies, to determine whether a modified loan should be reported as a nonaccrual asset in regulatory reports.

Maintenance of an appropriate allowance for loan losses or allowance for credit losses remains a focal point of the regulators and as such financial institutions should consider all relevant and available information when assessing the collectability of cash flows, including changes in a borrower’s financial condition, collateral values, lending practices, and economic conditions as a result of the COVID-19 event. Borrowers facing identified financial difficulties as they near the end of the accommodation periods generally pose greater credit risk.

TAX ISSUES

The speaker discussed whether the 21% federal tax rate will survive. The speaker suggested that the answer would hinge on the political landscape and also had the view that the CARES Act stimulus spending will likely increase the pressure for some level of rate increase, even with a Republican Congress/administration.

Deferred tax assets and deferred tax liabilities on corporate balance sheets will be re-measured for the effect of any increase in the tax rate, with the offset being a decrease or increase in tax expense.

Tax planning will be applied in reverse to strategies applied in 2017 when the tax rate decreased – i.e. accelerate income and defer deductions. The goal of this planning is to increase the net deferred tax asset (or reduce the net deferred tax liability) that will be re-measured for the rate increase.

ACCOUNTING UPDATES

Speakers covered a variety of key accounting topics and updated attendees.

Transition from U.S Dollar LIBOR

Timeline – effective December 31, 2021 banks will no longer be obligated to make LIBOR submissions.

Accounting Standards Codification (ASC) 848, Reference Rate Reform (ASU 2020-04) provides optional relief related to contract modifications. The general principle of the relief is that contract modification due to reference rate reform is an event that does not require contract remeasurement or reassessment. It excludes contract modifications if changes are made to terms that are unrelated to the replacement of the reference rate. Specific modifications of contracts guidance includes loans (Topic 310), debt (Topic 470), leases (Topics 840/842), and the clearly and closely test (Topic 815).

ASC 848 provides optional relief for hedge accounting such as critical terms exceptions, expedients for excluded components, and specific expedients/exceptions for each of fair value and cash flow hedges. For all hedges, hedge accounting is preserved when contracts are modified. These are generally effective from March 12, 2020 to December 31, 2022. There is also a one-time election to sell or transfer (or both) debt securities that reference a rate affected by reference rate reform and classified as HTM before January 1, 2020.

Goodwill

Financial institutions with goodwill on their balance sheets are required to perform an annual impairment assessment. In addition, an interim impairment assessment in accordance with ASC 350-20-35-30 is required if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Of import, if a so called “triggering event” occurs in Q2, but improves in Q3, the financial institution still has a triggering event. Unusual market conditions may warrant special adjustments to the fair value calculation.

Mortgage Servicing Rights (MSR)

Market conditions changed significantly in 2020. Interest rate reductions and increases in delinquency risk have placed downward pressure on MSR values. An increase in impairments being recorded has been observed.

SUMMARY

The conference is worth attending. There were about 1,200 participants this year and the conference was held virtually.

Most of the discussion was around COVID-19 and related topics.  Several key accounting topics were covered that should be considered heading into year-end 2020 and then into 2021. To discuss these or any other banking topics, please contact Jeff Skaggs, our banking practice lead, or your BNN advisor at 800.244.7444.