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CECL: Reasonable and supportable? Be ready to be ALLL in

01.10.17

Recently, federal banking regulators released an interagency financial institution letter on CECL, in the form of a Q&A. Read it here. While there weren’t a lot of new insights into expectations examiners may have upon adoption, here is what we gleaned, and what you need to know, from the letter.

ALLL Documentation: More is better

Your management will be required to develop reasonable and supportable forecasts to determine an appropriate estimate for their allowance for loan and lease losses (ALLL). Institutions have always worked under the rule that accounting estimates need to be supported by evidence. Everyone knows both examiners and auditors LOVE documentation, but how much is necessary to prove whether the new CECL estimate is reasonable and supportable? The best answer I can give you is “more”.

And regardless of the exact model institutions develop, there will be significantly more decision points required with CECL than with the incurred loss model. At each point, both your management and your auditors will need to ask, “Why this path vs. another?” Defining those decision points and developing a process for documenting the path taken while also exploring alternatives is essential to build a model that estimates losses under both the letter and the spirit of the new rules. This is especially true when developing forecasts. We know you are not fortune tellers. Neither are we.

The challenge will be to document the sources used for forecasts, making the connections between that information and its effect on your loss data as clear as possible, so the model bases the loss estimate on your institution’s historical experience under conditions similar to those you’re forecasting, to the extent possible.

Software may make this easier… or harder.               

The leading allowance software applications allow for virtually instantaneous switching between different models, permitting users to test various assumptions in a painless environment. These applications feature collection points that enable users to document the basis for their decisions that become part of the final ALLL package. Take care to try and ensure that the support collected matches the decisions made and assumptions used.

Whether you use software or not there is a common set of essential controls to help ensure your ALLL calculation is supported. They are:

  • Documented review and recalculation of the ALLL estimate by a qualified individual(s) independent of the preparation of the calculation
  • Control over reports and spreadsheets that include data that feed into the overall calculation
  • Documentation supporting qualitative factors, including reasonableness of the resulting reserve amounts
  • Controls over loan ratings if they are a factor in your model
  • Controls over the timeliness of charge-offs

In the process of implementing the new CECL guidance it can be easy to focus all of your effort on the details of creating models, collecting data and getting to a reasonable number. Based on the regulators’ new Q&A document, you’ll also want to spend some time making sure the ALLL number is supportable.  

Next time, we’ll look at a lesser known section of the CECL guidance that could have a significantly negative impact on the size of the ALLL and capital as a result: off-balance-sheet credit exposures.

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Read this if you are a CFO or controller.

The Governmental Accounting Standards Board (GASB) recently provided much needed guidance for governmental organizations struggling to account for relief provided in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). In their Technical Bulletin No. 2020-1, Accounting and Financial Reporting Issues Related to the CARES Act and Coronavirus Diseases, GASB addressed a number of pressing recognition and presentation questions that you should be aware of when preparing financial statements. The following is a summary of the guidance:

  • Resources received under the Coronavirus Relief Fund (CRF) subject to restrictions should be recognized as voluntary nonexchange transactions, subject to eligibility rather than purpose restrictions. As such, the entity should recognize resources received from the CRF as liabilities until the applicable eligibility requirements are met, including the incurrence of eligible expenditures. When the eligibility requirements have been met, revenue should be recognized for CRF resources received.
  • Provisions of the CARES Act that address the entity’s loss of revenue should be considered an eligibility requirement for purposes of revenue recognition. 
  • Any possible amendments to the CARES Act issued subsequent to the statement of net position date but before the issuance of financial statements, even when enacted with retroactive provisions, do not represent conditions that existed as of the period-end being reported and should only be reported as a nonrecognized subsequent event.
  • With the exception of CARES Act funds provided through the Provider Relief Fund's Uninsured Program (operating revenues), funds received under the CARES Act are subsidies and should be reported as nonoperating revenues and presented as noncapital finance activities in the statement of cash flows.
  • Outflows of resources incurred in response to the coronavirus disease due to actions taken to slow the spread of the virus or the implementation of "stay-at-home" orders should not be reported as extraordinary items or special items.
  • In addition to the guidance provided with the Technical Bulletin, the GASB also provides a number of additional stakeholder resources that may be useful during this period on its website, including an Emergency Toolbox that provides guidance on donated assets, management’s discussion and analysis (MD&A), asset impairment, and many more. 

Please contact Robert Smalley if you have questions on the latest GASB updates.
 

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GASB releases guidance for organizations receiving relief from the CARES Act

Recently the Governmental Accounting Standards Board (GASB) finished its Governmental Accounting Research System (GARS), a full codification of governmental accounting standards. The completion of the project allows preparers easy access to accounting guidance from GASB. The overall project, starting from the codification of older pre-1989 Financial Accounting Standards Board (FASB) pronouncements in 2010, was focused on pulling together all authoritative guidance, similar to what FASB had done in 2009.

Here’s what we found interesting.

Poking around the GARS (Basic View is free) I was struck by a paragraph surrounded by a thick-lined box that read “The provisions of this Codification need not be applied to immaterial items.” If you have ever read a GASB or FASB pronouncement, you have seen a similar box. But probably, like me, you didn’t fully consider its potential benefits. Understanding this, GASB published an article on its website aimed at (in my opinion) prompting financial statement preparers to consider reducing disclosure for the many clearly insignificant items often included within governmental financial statements.

After issuing more than 80 pronouncements since its inception in 1984, including 19 in the last five years, GASB accounting requirements continue to grow. Many expect the pace to continue, with issues like leases accounting, potential revision of the financial reporting model, and comprehensive review of revenue and expense recognition accounting currently in process. With these additional accounting standards come more disclosure requirements.

With many still reeling from implementation of the disclosure heavy pension guidance, GASB is already under pressure from stakeholders with respect to information overload. Users of financial statements can be easily overwhelmed by the amount of detailed disclosure, often finding it difficult to identify and focus on the most significant issues for the entity. Balancing the perceived need to meet disclosure requirements with the need to highlight significant information can be a difficult task for preparers. Often preparers lean towards providing too much information in an effort to “make sure everything is in there that should be”. So, what can you do to ease the pain?

While the concept of materiality is not addressed specifically in the GASB standards, by working with your auditors there are a number of ways to reduce the overall length and complexity of the statements. We recommend reviewing your financial statements periodically with your auditor, focusing on the following types of questions:

  • On the face of the financial statements, are we breaking out items that are clearly inconsequential in nature and the amount?
  • Are there opportunities to combine items where appropriate?
  • In the notes to the financial statements are we providing excessive details about insignificant items?
  • Do we have an excess amount of historical disclosure from years past?
  • In the management’s discussion & analysis, is the analysis completed to an appropriate level? Is there discussion on items that are insignificant?

The spirit behind the box is that GASB was specifically thinking about material amounts and disclosures. It was not their intention to clutter the financials with what their article referred to as “nickel and dime” items. With more disclosure requirements on the way, now might be the time to think INSIDE the box.  

For more guidance on this and other GASB information, please contact Rob Smalley.

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Extra information for GASB organizations: How to lessen information overload

By now you have heard that the Financial Accounting Standards Board’s (FASB) answer to the criticism the incurred-loss model for accounting for the allowance for loan and lease losses faced during the financial crisis has been released in its final form. The Current Expected Credit Loss model (CECL), which was developed through an arduous (and sometimes contentious) process following the crisis, will bring substantial changes to the way community banks account for expected losses in their loan portfolios. 

Working closely with community banks in the years building up to final issuance, we recognized an uncomfortable level of uncertainty created by the ever-changing proposals and lack of concrete examples. Now that the guidance is final, we feel a strong sense of responsibility to provide our interpretations, thoughts and insights where we can. As the FASB has shown recently with its new revenue pronouncement, there is a good chance that updates to the guidance will occur as we move closer to the implementation dates. The banking regulators who have thus far been mostly silent on the guidance will also have their interpretations.

We find that with substantial new guidance breaking it down into bite size pieces can be the best approach to understanding and implementation. With that said, this is the first of a number of planned articles from BerryDunn to do just that.

Building your team

One of the first things your institution should do is create an implementation team. Building it now with staff from diverse backgrounds and experience including finance, lending and collections will bring significant rewards in the long run. This is also a good time to consider opportunities to include your auditor in the process. Ultimately, you will need them to perform audit procedures on your CECL allowance as part of your financial statement audit. That also means your model and the resulting estimate must be auditable. Including auditors in the early stages should also help your team think about implications the audit requirements may have for expectations related to retaining documentation and supporting assumptions. In addition, your auditor may be able to share observations based on how other institutions are implementing CECL that may be helpful for your team.  Auditors can do all this while maintaining independence if their services are structured properly.

When your team is assembled and is up-to-speed on the basics of what CECL is and isn’t, defining the team’s goals and creating a roadmap to get there will be your keys to success. And asking the right questions while creating the roadmap is a great place to start. 

Questions to consider:


What available method (under CECL) is the best fit for the institution?
We expect that largely most community institutions will start with a top-down approach using an adaption from their current loss-rate approach to reflect the change from the old incurred loss method to the “life of the loan” current expected credit loss method. We believe the following step-by-step model will be one practical approach that should fit most community banks and credit unions:

  1. Determine which loans for specific reserves are appropriate, much in the same manner as you’re likely doing now. The notion of “impaired” loans goes away with CECL; a loan should be evaluated specifically if the institution becomes aware of loan-specific information indicating it has an exposure to loss that differs from other loans it’s been pooled with. In practice, we think that’ll be largely the same loans that are currently being identified as impaired.
  2. Secondly, for the rest of the portfolio:
    1. Group loans by common characteristics – same as you are likely doing now. These groups can match your portfolio or class groupings used now in financial reporting, but can also be broken down further.
    2. For each group, create subgroups for each origination year. One of the disclosure requirements in the guidance suggests the current year and previous four years are the critical ones to focus on; anything older than five years could be combined together.
    3. For each subgroup:
      1. Establish economic and other relevant conditions for the average remaining term of loans in the subgroup. This will be a combination of forecasted conditions for the near future, probably based on the Fed’s three-year forecast, and long-term historical conditions for the remaining average loan term.
      2. Select an historical loss period that best approximates the conditions established in 2c(i).
      3. Determine average remaining lifetime losses for the historical loss period established in 2c(ii) for that loan type.
      4. Adjust the average determined in 2c(iii) for any current or expected conditions that you believe are different from this historical data. The regulators have indicated their expectation that these will likely be the types of items for which qualitative factors have been developed under the incurred loss model, or a subset thereof.

These adjustments should themselves be based on historical data, or peer historical data if institution-specific data isn’t available (for example, a new loan product); for example, a 25 basis point upward adjustment for actual and expected declines in real estate values beyond the average in the historical period in 2c(ii) should be supported by data that shows a 25 basis point increase in losses for this type of loan in previous periods in which real estate values had shown a similar decline.

What data do we need to start collecting?
The clock has started! The CECL model requires analysis of loss rates and environmental factors. Detailed loss-rate calculations for as far back as you can get is your goal. The next step after collecting the historical data on your losses is to document other factors that were in play during each period. You will also need to consider the factors that affected charge-off rates for different periods. Changes in overall economic conditions, underwriting (both risk and quality), the legal environment and other factors need to be documented and correlated to trends in charge-offs. Remember one of the first steps in preparing a CECL model is to decide which time period of losses best matches the current environment. Without considering the full picture, including the external forces in play, it will be impossible to select an appropriate time period.

How do we retain and access that data?
Many core providers restrict access to older loan level data, and in some cases historical information is readily available only for very short time periods. Knowing the restrictions on your older data will be key in planning for CECL. The model suggests that a starting point for considering historical data needs is to consider what time periods matter. This may vary for different types of loans.

Some core providers have started reaching out to their institutions to discuss CECL and options for collection of data through webinars and one-on-one meetings. Consider reaching out directly to your provider to see what options in terms of data collection, retention and reporting will be available to your team.

What is the next step?
Build a simple model so that your team can better grasp and discuss the fundamentals of CECL. This can serve to solidify the concept of “life of loan losses” vs. the incurred loss method, as well as get your task force focused on what is important in collecting data.

Now that you’ve got your team assembled and have begun to tackle these questions, it’s time to look at other factors to consider. In our next installment, we’ll take you through how to implement CECL for loans obtained in a merger or acquisition. In the meantime, please call us if you have any questions.

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CECL: Where to start

Read this if you paid wages for qualified sick and family leave in 2021.

The IRS has issued guidance to employers on year-end reporting for sick and family leave wages that were paid in 2021 to eligible employees under recent federal legislation.

IRS Notice 2021-53, issued on September 7, 2021, provides that employers must report “qualified leave wages” either on a 2021 Form W-2 or on a separate statement, including:

  • Qualified leave wages paid from January 1, 2021 through March 31, 2021 (Q1) under the Families First Coronavirus Response Act (FFCRA), as amended by the Consolidated Appropriations Act, 2021 (CAA).
  • Qualified leave wages paid from April 1, 2021 through September 30, 2021 (Q2 and Q3) under the American Rescue Plan Act of 2021 (ARPA).

The notice also explains how employees who are also self-employed should report such paid leave. This guidance builds on IRS Notice 2020-54, issued in July 2020, which explained the reporting requirements for 2020 qualified leave wages.

Employers should work with their IT department and/or payroll service provider as soon as possible to review the payroll system, earnings codes configuration and W-2 mapping to ensure that these paid leave wages are captured timely and accurately for year-end W-2 reporting.

FFCRA and ARPA tax credits background

In March 2020, the FFCRA imposed a federal mandate requiring eligible employers to provide paid sick and family leave from April 1, 2020 to December 31, 2020, up to specified limits, to employees unable to work due to certain COVID-related circumstances. The FFCRA provided fully refundable tax credits to cover the cost of the mandatory leave.

In December 2020, the CAA extended the FFCRA tax credits through March 31, 2021, for paid leave that would have met the FFCRA requirements (except that the leave was optional, not mandatory). The ARPA further extended the credits for paid leave through September 30, 2021, if the leave would have met the FFCRA requirements.

In addition to employer tax credits, under the CAA, a self-employed individual may claim refundable qualified sick and family leave equivalent credits if the individual was unable to work during Q1 due to certain COVID-related circumstances. The ARPA extended the availability of the credits for self-employed individuals through September 30, 2021. However, an eligible self-employed individual may have to reduce the qualified leave equivalent credits by some (or all) of the qualified leave wages the individual received as an employee from an employer.

Reporting requirements to claim the refundable tax credits

Eligible employers who claim the refundable tax credits under the FFCRA or ARPA must separately report qualified sick and family leave wages to their employees. Employers who forgo claiming such credits are not subject to the reporting requirements.

Qualified leave wages paid in 2021 under the FFCRA and ARPA must be reported in Box 1 of the employee’s 2021 Form W-2. Qualified leave wages that are Social Security wages or Medicare wages must be included in boxes 3 and 5, respectively. To the extent the qualified leave wages are compensation subject to the Railroad Retirement Tax Act (RRTA), they must also be included in box 14 under the appropriate RRTA reporting labels.

In addition, employers must report to the employee the following types and amounts of wages that were paid, with each amount separately reported either in box 14 of the 2021 Form W-2 or on a separate statement:

  • The total amount of qualified sick leave wages paid for reasons described in paragraphs (1), (2), or (3) of Section 5102(a) of the Emergency Paid Sick Leave Act (EPSLA)1  with respect to leave provided to employees during the period beginning on January 1, 2021, through March 31, 2021. The following, or similar language, must be used to label this amount: “Sick leave wages subject to the $511 per day limit paid for leave taken after December 31, 2020, and before April 1, 2021.”
  • The total amount of qualified sick leave wages paid for reasons described in paragraphs (4), (5), or (6) of Section 5102(a) of the EPSLA with respect to leave provided to employees during the period beginning on January 1, 2021, through March 31, 2021. The following, or similar language, must be used to label this amount: “Sick leave wages subject to the $200 per day limit paid for leave taken after December 31, 2020, and before April 1, 2021.”
  • The total amount of qualified family leave wages paid to the employee under the Emergency Family and Medical Leave Expansion Act (EFMLEA) with respect to leave provided to employees during the period beginning on January 1, 2021, through March 31, 2021. The following, or similar language, must be used to label this amount: “Emergency family leave wages paid for leave taken after December 31, 2020, and before April 1, 2021.”
  • The total amount of qualified sick leave wages paid for reasons described in paragraphs (1), (2), or (3) of Section 5102(a) of the EPSLA with respect to leave provided to employees during the period beginning on April 1, 2021, through September 30, 2021. The following, or similar language, must be used to label this amount: “Sick leave wages subject to the $511 per day limit paid for leave taken after March 31, 2021, and before October 1, 2021.”
  • The total amount of qualified sick leave wages paid for reasons described in paragraphs (4), (5), and (6) of Section 5102(a) of the EPSLA with respect to leave provided to employees during the period beginning on April 1, 2021, through September 30, 2021. The following, or similar language, must be used to label this amount: “Sick leave wages subject to the $200 per day limit paid for leave taken after March 31, 2021, and before October 1, 2021.”
  • The total amount of qualified family leave wages paid to the employee under the EFMLEA with respect to leave provided to employees during the period beginning on April 1, 2021, through September 30, 2021. The following, or similar language, must be used to label this amount: Emergency family leave wages paid for leave taken after March 31, 2021, and before October 1, 2021.”

If an employer chooses to provide a separate statement and the employee receives a paper 2021 Form W-2, then the statement must be included with the Form W-2 sent to the employee. If the employee receives an electronic 2021 Form W-2, then the statement must be provided in the same manner and at the same time as the Form W-2.

In addition to the above required information, the notice also suggests that employers provide additional information about qualified sick and family leave wages that explains that these wages may limit the amount of the qualified sick leave equivalent or qualified family leave equivalent credits to which the employee may be entitled with respect to any self-employment income.

For more information

If you have more questions, or have a specific question about your particular situation, please call us. We’re here to help.

 1Employees are eligible for qualified sick leave under EPSLA if the employee:

  • Was subject to a federal, state or local quarantine or isolation order related to COVID-19;
  • Had been advised by a health-care provider to self-quarantine due to concerns related to COVID-19;
  • Experienced symptoms of COVID-19 and was seeking a medical diagnosis;
  • Was caring for an individual who was subject to a quarantine order related to COVID-19, or had been advised by a health-care provider to self-quarantine due to concerns related to COVID-19;
  • Was caring for a son or daughter of such employee, if the school or place of care of the son or daughter had been closed, or the child-care provider of such son or daughter was unavailable, due to COVID-19; or
  • Was experiencing any other substantially similar condition specified by the Secretary of Health and Human Services.

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IRS guidance to employers: Year-end reporting requirements for qualified sick and family leave wages

Read this if you are a community bank.

The Federal Deposit Insurance Corporation (FDIC) recently issued its second quarter 2021 Quarterly Banking Profile. The report provides financial information based on Call Reports filed by 4,951 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community bank performance. In second quarter 2021, this section included the financial information of 4,490 FDIC-insured community banks. BerryDunn’s key takeaways from the community bank section of the report are as follows:

  • There was a $1.9 billion increase in quarterly net income from a year prior despite continued net interest margin (NIM) compression. This increase was mainly due to higher net interest income and lower provision expenses. Net interest income had increased $1.4 billion due to 1) lower interest expense, 2) higher commercial and industrial (C&I) loan interest income, and 3) loan fees earned through the payoff and forgiveness of Paycheck Protection Program (PPP) loans. Provision expense decreased $2.3 billion from second quarter 2020. However, it remained positive at $46.1 million. For non-community banks, provision expense was negative $10.8 billion for second quarter 2021.
  • Quarterly NIM declined 26 basis points from second quarter 2020 to 3.25%. The average yield on earning assets fell 57 basis points to 3.57% while the average funding cost fell 31 basis points to 0.32%. Both of which are record lows.
  • Net operating revenue (net interest income plus non-interest income) increased by $1.6 billion from second quarter 2020, a 6.5% increase. This increase is attributable to higher revenue from service charges on deposit accounts (increased $134.8 million, or 23.5%, during the year ending second quarter 2021) and an increase in “all other noninterest income,” including, but not limited to, bankcard and credit card interchange fees, income and fees from wire transfers, and income and fees from automated teller machines (up $203.6 million, or 9.3%, during the year ending second quarter 2021).
  • Non-interest expense increased 7.8% from second quarter 2020. This increase was mainly attributable to salary and benefit expenses, which saw an increase of $688.2 million (7.8%). That being said, average assets per employee increased 8.4% from second quarter 2020. Non-interest expense as a percentage of average assets declined 18 basis points from second quarter 2020.
  • Noncurrent loan balances (loans 90 days or more past due or in nonaccrual status) declined by $894.6 million, or 7.1%, from first quarter 2021. The noncurrent rate improved 5 basis points to 0.68% from first quarter 2021.
  • The coverage ratio (allowance for loan and lease losses as a percentage of loans that are 90 days or more past due or in nonaccrual status) increased 39.8 percentage points year-over-year to 191.7%, a record high, due to declines in noncurrent loans. This ratio is well above the financial crisis average of 64.5%. The coverage ratio for community banks is 15.4 percentage points above the coverage ratio for non-community banks.
  • Eighty-eight community banks had adopted current expected credit loss (CECL) accounting as of second quarter. Community bank CECL adopters reported negative provision expense of $208.3 million in the second quarter compared to positive $254.5 million for community banks that have not yet adopted CECL.
  • Net charge-offs declined 8 basis points from second quarter 2020 to 0.05%. The net charge-off rate for consumer loans declined most among major loan categories, having decreased 51 basis points.
  • Trends in loans and leases showed a slight decrease from first quarter 2021, decreasing by 0.5%. This decrease was mainly seen in the C&I loan category, which was driven by a $38.3 billion decrease in PPP loan balances. The decrease in PPP loans was driven by the payoff and forgiveness of such loans. Despite the decrease in loans quarter-over-quarter, total loans and leases increased by $5.7 billion (0.3%) from second quarter 2020. The majority of growth was seen in commercial real estate portfolios (up $61.7 billion, or 8.9%), which helped to offset the decline in C&I, agricultural production, and 1-4 family mortgage loans during the year.
  • Two-thirds of community banks reported an increase in deposit volume during the second quarter. Growth in deposits above the insurance limit, $250,000, increased by $47.8 billion, or 4.7%, while alternative funding sources, such as brokered deposits, declined by $3.8 billion, or 6.7%, from first quarter 2021. 
  • The average community bank leverage ratio (CBLR) for the 1,789 banks that elected to use the CBLR framework was 11%.
  • The number of community banks declined by 38 to 4,490 from first quarter 2021. This change includes two new community banks, 12 banks transitioning from community to non-community banks, one bank transitioning from non-community to community bank, 27 community bank mergers or consolidations, and two community bank self-liquidations.

Second quarter 2021 was another strong quarter for community banks, as evidenced by the increase in year-over-year quarterly net income of 28.7% ($1.9 billion). However, tightening NIMs will force community banks to find creative ways to increase their NIM, grow their earning asset bases, or find ways to continue to increase non-interest income to maintain current net income levels. Some community banks have already started dedicating more time to non-traditional income streams, as evidenced by a 4.3% year-over-year increase in quarterly non-interest income. The importance of the efficiency ratio (non-interest expense as a percentage of total revenue) is also magnified as community banks attempt to manage their non-interest expenses in light of declining NIMs. Banks appear to be strongly focusing on non-interest expense management, as seen by the 18 basis point decline from second quarter 2020 in non-interest expense as a percentage of average assets, although inflated balance sheets may have something to do with the decrease in the percentage.

Furthermore, much uncertainty still exists. For instance, although significant charge-offs have not yet materialized, the financial picture for many borrowers remains uncertain. And, payment deferrals have made some credit quality indicators, such as past due status, less reliable. Payment deferrals for many borrowers are coming to a halt. So, the true financial picture of these borrowers may start to come into focus. The ability of community banks to maintain relationships with their borrowers and remain apprised of the results of their borrowers’ operations has never been more important. This monitoring will become increasingly important as we transition into a post-pandemic economy. For seasonal borrowers, current indications, such as the most recent results from the Federal Reserve’s Beige Book, show that economic activity was relatively strong over the summer of 2021. However, supply chain pressures and labor shortages could put a damper on the uptick in economic activity for these borrowers, making a successful transition into the “off-season” months that much more important. 

Also, as offices start to open, employers will start to reassess their office needs. Many employers have either created or revised remote working policies due to changing employee behavior. If remote working schedules persist, whether it be full-time or hybrid, the demand for office space may decline, causing instability for commercial real estate borrowers. Recent inflation concerns have also created uncertainty surrounding future Federal Reserve monetary policy. If an increase in the federal funds target rate is used to combat inflation, community banks could see their NIMs in another transitory stage.

As always, please don’t hesitate to reach out to BerryDunn’s Financial Services team if you have any questions.

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FDIC Issues its Second Quarter 2021 Quarterly Banking Profile

Read this if you are a plan sponsor of employee benefit plans.

This article is the ninth in a series to help employee benefit plan fiduciaries better understand their responsibilities and manage the risks of non-compliance with Employee Retirement Income Security Act (ERISA) requirements. You can read the previous articles here

Employee benefit plan loan basics 

If your plan’s adoption agreement is set up to allow loans, participants can borrow against their account balance. Some participants may find this an attractive option as the interest they pay on the loan is returned to their retirement account as opposed to other loans where the interest is paid to the lender. 

Additionally, while interest is charged at the market rate, it may be lower than other options available to the participant, such as a credit card or other unsecured debt. Unlike hardship distributions, there are no restrictions on the circumstances under which a participant may take a loan. A potential downside is that if the borrower defaults on the loan or ends their employment and cannot repay the loan in full, it converts from a loan to a deemed distribution, potentially incurring taxes and penalties.

If a participant decides that an employee benefit plan loan is their best option, they will apply for the loan through your plan administrator. Loans are limited in both size and quantity. Participants may take loans up to 50% of their vested account balance with a maximum loan of $50,000. The provisions of a plan determine how many loans an employee may have at once; however, the combined loan balances cannot exceed 50% of the employee’s vested balance or $50,000. Furthermore, the $50,000 loan maximum must also consider payments made on loans within the previous 12 months.

Repayment of employee benefit plan loans

Repayment of employee benefit plan loans may be done through after tax payroll contributions, making it a relatively easy process for the participant. If a plan sponsor elects to provide this repayment option, they must ensure that repayments are remitted to the plan in a timely manner, just as they must with other employee funded contributions. The term of the loan is typically limited to five years and must be repaid in at least quarterly installments. However, a loan can be extended to as long as thirty years if specified within the plan’s loan policy. If the loan term is for longer than five years, the loan proceeds must be used to purchase a primary residence.

Like any source of debt, there are pros and cons to taking out an employee benefit plan loan, and it remains an important option for participants to understand. The benefits include the ease of applying for such a loan and loan interest that is then added to the participant’s retirement account balance. Potential pitfalls include lost earnings during the loan period and the risk of the loan becoming a deemed distribution if the participant is unable to repay within the allotted time. 

If you would like more information, or have specific questions about your specific situation, please contact our Employee Benefits Audit team.

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Retirement plan loans: A brief review

Read this if you are at a financial institution that uses FedLine® Solutions.

In response to an evolving security threat landscape, the Federal Reserve Bank has implemented a Security and Resiliency Assurance Program (“Assurance Program”). Financial institutions that use FedLine® Solutions will need to take action before year-end to comply with Assurance Program requirements. Here’s what you need to know.

Required assessment to be completed annually

Financial institutions are already required to implement, maintain, and assess technical and procedural security controls to safeguard their FedLine® connections. Starting in 2021, financial institutions must conduct an assessment of their compliance with the Federal Reserve Bank's FedLine® security requirements and submit an attestation that they have completed the assessment. The deadline for submitting the first attestation is December 31, 2021. Moving forward, this assessment and attestation must be completed annually.

This assessment can be performed internally by an independent internal department/function such as an internal audit or compliance department. The Federal Reserve Bank may, in its discretion, require the assessment be conducted or reviewed by an independent third party. End User Authorization Contacts (EUAC) for each organization were sent an Assurance Program kick-off packet with requirements and instructions in January 2021 to assist with the process. 

Immediate action 

Evaluate the requirements for your financial institution’s Assurance Program assessment as soon as possible. Planning for the 2021 assessment should be well underway. If you would like to discuss the Assurance Program requirements or you’ve been notified that your financial institution needs an independent third party review, contact us today.

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The Federal Reserve's FedLine® Solutions Security and Resiliency Assurance Program

Read this if you have a blended workforce with both in-office employees and remote workers.

It is hard to believe it has been nearly a year and a half since we started our remote work journey. At the time, many thought the move to working remotely would be short term. Then, a couple of weeks turned into a month, a month into another month, another month into a year and, some employers are now finally considering re-opening their offices.

Back in April 2020, we provided some internal control challenges, and potential solutions, faced by working in a remote environment. These challenges included exercising appropriate tone at the top, maintaining appropriate segregation of duties, and ensuring timely review, amongst others. Although these challenges still exist, there are new considerations to address as we transition into (hopefully) a post-pandemic world.

Blended workforces

As we mentioned in that article, since people have now been forced to work in a remote environment, they will be more apt to continue to do so. For some employees, the perks of ditching that long commute outweighs the free coffee they receive in the office. Employers have a decision to make—do we allow our employees the option to continue to work from home or, do we require employees to work from the office, as was standard pre-pandemic? Now that employees have exhibited the ability to work from home efficiently and effectively, it may be difficult to move all employees back into the office. Requiring all employees to return to the office could result in employees seeking employment elsewhere, and the option to work remotely is a selling point for many recruiters. Furthermore, disallowing remote work could cause employees to feel distrusted or undervalued, possibly leading to less efficient and effective work.

However, remote work comes with many challenges. Although video chat has been instrumental in navigating the remote work environment, it still has limitations. Nothing can beat in-person conversations and the relationships they help build. Nearly every video chat has a purpose, and unfortunately, you can’t just “run” into somebody in a video chat as you can in the office. Building camaraderie and instilling your company’s culture is difficult in a remote environment. And, if your workforce is blended, with some working in the office while others work remotely, building culture may be even more difficult than if your entire workforce was remote. Employees in the office may be less apt to communicate with remote colleagues. If you have a task you wish to delegate, you may think of giving the assignment to someone in the office prior to thinking of your remote co-workers that may be just as able and willing to complete the assignment. It will be important to ensure all employees are provided with equal opportunities, no matter of where they work.

Remote work policy

Regardless of your company’s decision to allow employees to work remotely or not, we recommend developing a remote work policy addressing expected behaviors. When developing such a policy, consider:

  •  Will the policy’s provisions apply to the entire company or will there be different provisions by department? If the latter, consider what the implications may be on employee morale.
  • Will there be a minimum amount of days per week that must be spent in the office?
  • If employees are allowed to work remotely, do they need to work a set schedule or can the frequency, and which days they work remotely, change from week to week?
  • Who should the employee communicate their decision to? How will this information then be shared company-wide?
  • How do remote employees address document destruction? If they are handling sensitive and confidential documents, how should they dispose of these documents?
  • Similarly, what are the expectations for protecting sensitive and confidential information at home?
  • Are employees allowed to hook up company-provided equipment to personal devices, such as personal printers?
  • If an employee is customer/client facing, what are the expectations for dress code and backgrounds for video chat meetings?
  • What will staff development look like for individuals working remotely? Alternatively, what will their involvement look like in onboarding/developing new employees?
  • What are the expectations for meetings? Will all meetings be set up in a manner that accommodates in-person and remote attendees? Are there meetings where in-person attendance is mandatory?

The importance of these considerations will likely differ from company to company. Some of these considerations may be addressed in other, already existing policies.

Are your internal controls “blended workforce” ready?

If your company plans to allow employees to work remotely, you will need to assess if your internal controls make sense for both in-office and remote employees. Typically, internal controls are written in a manner irrespective of where the employee resides. However, there may be situations that require an internal control be re-worked to accommodate in-office and remote employees. For instance, do you have an internal control that references a specific report that can only be run in-office? If the control owner plans to transition to a hybrid work schedule, does the frequency of the internal control need to change to reflect the employee’s new schedule? Alternatively, does it make sense to transition this internal control to someone else that will be in the office more frequently?

Internal control accommodations

The transition to a remote environment was expeditious and many thought the remote environment would be over quickly. As a result, there may have been modifications to internal controls that were made out of necessity, although they were not ideal from an internal control standpoint. The rationale for these accommodations may have been the expectation that the remote environment would be short-lived. Although these accommodations may have made sense for a short amount of time, and posed little to no additional risk to your company, the longer these accommodations remained in effect, the greater the chance for unintended consequences. 

We recommend reviewing your internal controls and creating a log of any internal control accommodations that were made due to the pandemic. Some of these modifications may continue to make sense and, after operating under the new internal control for an extended period of time, may even be preferable to the previous internal control. However, for those modifications that do appear to have increased control risk, control owners should assess if the length of the pandemic could have resulted in inadequately designed internal controls. And, if so, what could the consequences of these poorly designed internal controls have been to the company?

Internal control vs. process

While reviewing your company’s internal controls, it will also be a good time to ensure your internal control descriptions actually describe an internal control rather than simply a process. Although having well-documented processes for your company’s various transaction cycles is important, a good internal control description should already incorporate the process within it. Think of your internal control descriptions as writing a story—the “process” provides background information on the characters and setting, while the “internal control” is the story’s plot.

For example: The Accounting Manager downloads the market values from the investment portfolio accounting system and enters the market values into the general ledger on a monthly basis. Once the journal entry is entered, the Accounting Manager provides the market value report and a copy of the journal entry to the Controller.

Although a savvy reader may be able to identify where the internal control points are within this process, it could easily be modified to explicitly include discussion of the actual internal controls. The text in bold below represents modifications to the original:

The Accounting Manager downloads the market values from the investment portfolio accounting system and enters the market values into the general ledger on a monthly basis. Once the journal entry is entered, the Accounting Manager provides the market value report and a copy of the journal entry to the Controller via email. This email serves as documentation of preparation of the journal entry by the Accounting Manager. The Controller then reviews the market value report against the journal entry for accuracy. Once approved, the Controller posts the journal entry and replies to the email to indicate their review and approval. The Accounting Manager saves the email chain as auditable evidence.

The text additions in bold font help provide a complete story. A new employee could easily read this description and understand what they need to do, and how to appropriately document it. Most importantly, the internal control is both in-office and remote environment friendly.

Transitioning back to the office has resulted in a mixture of excitement and anxiety. Routine office norms, such as shaking hands and having a spontaneous meeting over a cup of coffee need to be relearned. Likewise, policies and internal controls need to be revisited to address the changing landscape. The more proactive your company can be, the better positioned it will be to accommodate its employees’ demands, while also maximizing the effectiveness of its internal controls. Please contact David Stone or Dan Vogt if any questions arise.

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May the "blended workforce be with you": Policy and internal control considerations for a new era

Read this if you are a plan sponsor of employee benefit plans.

This article is the eighth in a series to help employee benefit plan fiduciaries better understand their responsibilities and manage the risks of non-compliance with Employee Retirement Income Security Act (ERISA) requirements. You can read the previous articles here

The Department of Labor regulations regarding service provider fee disclosures clarify that plan fiduciaries are responsible for assessing the reasonableness of fees charged to plans in relation to services performed. 

Before a plan fiduciary is able to assess the reasonableness of plan fees, the fiduciary has to receive required fee disclosures from their covered service provider. A covered service provider is considered a party that enters into an agreement with a covered plan to provide certain services. The range of services provided generally include recordkeeping services, investment adviser services, accounting services, auditing services, actuarial services, appraisals, banking, consulting, legal services, third party administration services, or valuation services provided to the plan.

In general, the covered service providers are required to provide the plan fiduciary a disclosure of the following information:

  • All expected services and fees, and
  • All direct and indirect compensation
    • Direct compensation are fees paid to the service providers from the plan
    • Indirect compensation are fees paid to the service providers from sources other than the plan, the plan sponsor, the covered service provider, or an affiliate 

Once the service provider fee disclosures are received, the responsible plan fiduciary must assess the reasonableness of the fees in relation to the services provided. There are numerous ways a plan fiduciary can determine if the fees are reasonable. The following are some of the most common ways to determine if the plan expenses are reasonable:

  • Complete a Request for Proposal (RFP) or Request for Information (RFI) process that compares at least two vendors.
  • Complete a plan “benchmarking” project. The responsible plan fiduciary can have an independent organization compare the fees charged to the plan to plans of similar size and characteristics. Failure to determine the reasonableness of the fees charged can result in a prohibited transaction. The responsible plan fiduciary should determine and document whether the fees are reasonable. Documentation should also include the steps taken to make this determination.

It is important to remember that failure to assess the reasonableness of the service provider fees can result in a prohibited transaction. Documentation of the assessment process, including steps taken to make a determination on fee reasonableness, is the best way to avoid having a prohibited transaction.

If you have any questions while assessing your service providers’ fees, please contact our Employee Benefits Audit team.
 

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Service provider fee disclosures: Understanding the process