The 2013 Banking Conference: Working Toward Greater Transparency and Accountability

By Baker Newman Noyes December 2, 2013

In mid-September, the American Institute of Certified Public Accountants (AICPA) held its annual National Conference on Banks and Savings Institutions in National Harbor, Maryland. With more than 1,000 attendees, 45 sessions and 69 speakers, the conference delivered comprehensive discussions on current economic, accounting, regulatory, auditing and financial reporting issues.  Speakers included prestigious economists, and officials from standard setting bodies and regulatory agencies. While this article does not capture all topics discussed, it will highlight the conference’s common themes and hot topics which revolve around the need for the banking industry to improve its credibility through improvements to transparency and accountability.

Douglas Duncan, Fannie Mae’s Chief Economist, gave a presentation titled “Transition to Normal” focusing on the general macroeconomic environment, credit conditions, and the real estate market. Overall, he feels the economy is continuing to underperform, but is improving, and housing, while still not robust, has gained firm footing. Homebuilding is forecasted to reach “normal” levels in 2016 with increases in house prices being driven by supply and not demand. Duncan also expressed concerns about the federal fiscal imbalances that will weigh on the economy due to higher taxes, less spending, weaker growth, and higher inflation. Additionally, he is concerned about weakening consumer spending rates (the growth rate between 1980 and 2007 was 3.4%; it is currently at 1.5%), the below par capital expenditure growth, and the dampening of consumers’ confidence in the housing market. Although interest rates remain low from a historical perspective, the relatively recent rate increases have weakened refinance activity as anticipated.

One theme of the conference was that the proposed Current Expected Credit Loss (CECL) model is supported by the standard setting bodies and regulators because they believe weaknesses in the current model became apparent during the recent economic recession. Regulators feel that most investors support CECL, but that preparers generally do not, because of their concern with projecting losses beyond a reasonably foreseeable period, and that CECL does not reflect the economics of lending. Thomas Curry, Comptroller of the Currency, and Kathy Murphy, the Chief Accountant at the Office of the Comptroller of the Currency, both noted that based on studies performed, allowances are expected to increase between 30% and 50% upon implementation of CECL. The two largest challenges are going to be: (1) the ability to develop reasonable and supportable forecasts that include general economic conditions, the direction of the economic cycle, changes in underwriting and collateral values, and (2) the ability to estimate what loan balances are going to be for hard-to-determine loan products. For example, mortgages and home-equity lines-of-credit may need a separate model due to long loan life, advances, prepayments, etc.

Kathy Murphy advised that banks should continue to improve their documentation relating to qualitative and environmental factors’ impact on the allowance for loan losses, particularly in light of the fact that balances are trending down and “releases” continue. Murphy noted that documentation should include a description of each factor, management’s analysis of how each factor changed over time, which loan group’s loss estimates have been adjusted, the amount by which loss estimates have been adjusted, an explanation of how management estimates the impact and other available data supporting the reasonableness of the adjustments.

The Financial Accounting Standard Board’s (FASB) proposal on lease accounting, whereby essentially all leases with terms greater than one year will be recorded on the balance sheet, is moving forward and is currently in redeliberations. Regulators are in support of the proposal even though the May 2013 exposure draft has been heavily criticized as being too complex, partially due to a potentially difficult implementation of the Type A and Type B classifications. The current thought is that 2017 would be the earliest implementation.  Robert Storch, Chief Accountant of the Federal Deposit Insurance Corporation (FDIC), noted that a lease’s “right-to-use” asset will be a tangible asset for capital ratio purposes unless the FASB explicitly says that it is an intangible asset. Lawrence Smith, a FASB Board Member, indicated such assets will be classified as “other assets” vs. “intangibles.” The FDIC will assess the rule changes’ impact on capital ratios once the information becomes available.

Robert Storch also discussed the Committee of Sponsoring Organizations of the Treadway Commission’s (COSO) internal control framework. Part 363 of FDIC’s regulations identifies COSO’s internal control integrated framework as a suitable and available framework for assessing the effectiveness of internal control over financial reporting. In response to changes in business and operating environments, including increased complexity and changes in technology, COSO issued an updated version of its framework. The revision retains the core definition and the basics of the 1992 version, but now explicitly speaks to seventeen principles for assessing whether the five components of COSO (control environment, risk assessment, control activities, information and communication, and monitoring) are present and functioning. The revision also contains “points of focus” to assist management in designing, implementing, and maintaining the seventeen principles. COSO will make the original 1992 framework available through December 15, 2014, after which it will consider the 1992 framework superseded by the 2013 framework.

Basel III, which is intended to improve both the quality and quantity of capital, was a common topic discussed at the conference. The key changes reflected in Basel III include: (1) increased Tier 1 capital requirements, (2) introduction of common equity Tier 1 capital and a capital conservation buffer (the “buffer”), (3) requirements for greater risk weights on certain assets (such as commercial real estate), and (4) establishment of limits on deferred tax assets and mortgage servicing rights as a percentage of capital. The main concerns around Basel III which were echoed by many at the conference are over the risk weightings and the “buffer” which is designed to limit capital distributions and discretionary bonuses to executive officers for banks that do not meet certain capital ratios. Jeffrey Geer, Deputy Chief Accountant of the OCC, discussed that the final ruling reflects some important changes from the previous proposal to respond to concerns. Specifically, risk weightings for residential real estate loans remained unchanged from the current rule, banks can make a one-time election to either include or exclude components of accumulated other comprehensive income in regulatory capital, and trust preferred securities will generally be grandfathered in Tier 1 capital. Geer also indicated that if the Basel III rules were implemented today, approximately 95% of banks would be in compliance.

The above themes and issues in aggregate definitely will challenge banks and preparers to implement the accounting and regulatory changes; however, they could help the industry improve its credibility by providing greater transparency and accountability.

If you would like to discuss any of these please contact your BNN advisor at 800.244.7444.