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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.
 

Article
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.

Article
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 file taxes with the IRS for yourself or other individuals.

To protect yourself from identity thieves filing fraudulent tax returns in your name, the IRS recommends using Identity Protection PINs. Available to anyone who can verify their identity online, by phone, or in person, these PINs provide extra security against tax fraud related to stolen social security numbers of Tax ID numbers.

According to the Security Summit—a group of experts from the IRS, state tax agencies, and the US tax industry—the IP PIN is the number one security tool currently available to taxpayers from the IRS.

The simplest way to obtain a PIN is on the IRS website’s Get an IP PIN page. There, you can create an account or log in to your existing IRS account and verify your identity by uploading an identity document such as a driver’s license, state ID, or passport. Then, you must take a “selfie” with your phone or your computer’s webcam as the final step in the verification process.

Important things to know about the IRS IP PIN:

  • You must set up the IP PIN yourself; your tax professional cannot set one up on your behalf.
  • Once set up, you should only share the PIN with your trusted tax prep provider.
  • The IP PIN is valid for one calendar year; you must obtain a new IP PIN each year.
  • The IRS will never call, email or text a request for the IP PIN.
  • The 6-digit IP PIN should be entered onto your electronic tax return when prompted by the software product or onto a paper return next to the signature line.

If you cannot verify your identity online, you have options:

  • Taxpayers with an income of $72,000 or less who are unable to verify their identity online can obtain an IP PIN for the next filing season by filing Form 15227. The IRS will validate the taxpayer’s identity through a phone call.
  • Those with an income more than $72,000, or any taxpayer who cannot verify their identity online or by phone, can make an appointment at a Taxpayer Assistance Center and bring a photo ID and an additional identity document to validate their identity. They’ll then receive the IP PIN by US mail within three weeks.
  • For more information about IRS Identity Protection PINs and to get your IP PIN online, visit the IRS website.

If you have questions about your specific situation, please contact our Tax Consulting and Compliance team. We’re here to help.

Article
The IRS Identity Protection PIN: What is it and why do you need one?

Read this if you are at a financial institution with employees working remotely.

Working remotely is not a new concept. Over the past 20 years, technology enhancements have increased the ability for employees to connect remotely and perform many job functions without ever leaving their homes. When the COVID-19 pandemic began in early 2020, working remotely became a necessity for essential businesses like financial institutions to provide safe environments for both employees and customers and remain open.

One of the benefits of an increase in working from home during the pandemic is that it provided financial institutions and other businesses an opportunity to learn how to perform essential job functions and manage teams from a distance. In addition, many organizations experienced indirect benefits, including a more flexible work environment, higher job satisfaction, increased productivity, and improved employee retention. Now that employees are being asked to return to the office, many financial institutions are considering if a permanent work-from-home arrangement is possible. 

What you need to know

For starters, financial institutions need to know where their employees are providing services. Is it across state lines or across the country? What if you have two or more employees who want to work out of state—and they are all different states? What are the tax implications? Are there legal concerns?

Nexus

Nexus is the connection that taxpayers have with a state that permits the state to assess various types of taxes, including income tax. Nexus rules vary from state to state, but generally a business with nexus in a state is required to register with the Secretary of State/Department of Revenue, file tax returns, and pay various taxes to the state. 

Employees working in a "different state" (a state which income tax returns are not already being filed) may create nexus to that state for tax purposes. Even if your financial institution has only one employee working in a state and otherwise has no other connection to the state, there may be tax implications. Some states have established nexus waivers because of the pandemic, providing relief to some businesses and employees who have temporary work-from-home arrangements. These waivers, however, will soon expire or have expired already. 

The following details should be considered before offering out-of-state remote employee work arrangements.

State income tax filing requirements

  • If your financial institution has an employee working remotely from a different state, the financial institution has created physical presence nexus in that state. Once nexus has been established, the financial institution may be subject to state and local income taxes, gross receipts taxes, unique taxes specific to financial institution, or franchise taxes. When it comes to taxing a financial institution, not all states assess tax in the same manner. 
  • After nexus has been established, your financial institution will also need to understand how the state apportions wages in determining income tax liability to the state. One example is a factor approach: Total payroll paid to employees working in the state divided by total payroll paid to all employees. In a simplified example, the fraction would be multiplied by taxable income resulting in amount of taxable income in that state. One employee in a state is not likely to create a significant income tax liability to the state, however, many states have minimum tax liabilities and other fees—some more significant than others—which should also be considered along with additional administrative costs. 

State tax withholding

  • Employees will need to pay personal state income tax based on their primary state of residence as well as the state in which they work. If your financial institution's remote employee is performing most of their work from home in a different state than the financial institution, and travels to the financial institution for occasional meetings or in-person days, this could result in the employee having a personal state income tax liability in both states. It may be necessary for your financial institution to track the employee’s location and properly withhold state income taxes from the employee’s pay based on the state that the employee is providing services. 
  • Failure to properly withhold state income taxes could create a liability for both the employee and the employer including penalties and interest. Proper policies should be in place regarding the responsibility of tracking where employees are performing their work may mitigate these concerns. You should encourage your employees to work with their individual tax advisors on state tax issues as each employee's tax filing position is unique (we generally advise against providing tax advice to your employees). 

Unemployment taxes and workers’ compensation

  • Unemployment is typically paid to the state in which an employee has their permanent place of work. Your financial institution should review the state’s unemployment rules to determine if the financial institution is required to collect and remit unemployment tax to a state that it has employees. If your employee is working in a different state on a temporary basis or due to the pandemic, we believe there is no need for unemployment to change from the state where the financial institution is located.
  • Workers’ compensation is also typically paid to the state in which the employee is permanently assigned. If the out-of-state work arrangement is temporary, we do not feel you need to change your workers’ compensation. However, if the out-of-state arrangement from home becomes permanent, you may need to change your policy. Some states require employers to have a minimum number of employees in the state before requiring a workers’ compensation policy in that state. We recommend working with BerryDunn’s employee benefits experts on state rules and discussing with your insurance carrier.

Personal property and other taxes

  • Employees working from home are often provided furniture and equipment for their remote office set up. Financial institutions should consider whether they want to provide these items without retaining ownership to the property, as owning property in another state could result in the financial institution needing to file and remit personal property taxes to the state. It also would be considered a best practice to develop a policy that provides consistency among all remote employees, regardless of their location. 
  • Sales and use tax implications and other special or unique state and local taxes should be researched and understood prior to entering any state to determine the impact on existing products and services which may be offered to out of state customers who reside or relocate out of state. We will provide more information about the state tax issues related to providing services in a future installment of this state tax series. 

Other considerations

  • We recommend you discuss with your financial institution's attorney regarding the need to file a business license or update the financial institution's charter as these are legal matters. Here are some topics to consider as you have these discussions:
    • Your financial institution may be required to register with the state department of revenue/taxation
    • Registering as a foreign corporation is often necessary to access the legal system
    • Your financial institution may want to consider whether other regulatory licenses may be needed, such as insurance broker or license for trust services
  • Health insurance and other employee benefit plans should be reviewed to ensure that a remote employee eligible to receive benefits still qualifies and receives the same level of coverage that is available to in-state employees. 

In summary, even one employee working out of state could create additional compliance costs and exposure to a state’s laws and regulations. You may be wondering how risky it is to have only one employee located in a state, and how likely is it that the state would make the connection to your out-of-state financial institution.

While  the risk may seem low, states are always looking to generate additional tax revenue, and many have the ability to cross check internal systems. Withholding and remitting state income taxes on behalf of an employee is likely going to require your financial institution to register with a state's income tax withholding agency. The state will then be aware of your financial institution’s connection to its state as the financial institution’s EIN will be in the system for payroll purposes. While the exposure may still be low, the state may start looking for an income tax filing and at least payment of minimum tax. Failure to file in a state means that the statute of limitations for the financial institution’s exposure to that state will not start.

The risks shouldn’t necessarily prevent your financial institution from allowing employees to work from home, and as many financial institutions want to offer more flexible work arrangements given what has been learned in recent years, it is possible to minimize tax risk and remain compliant with proper planning and awareness. 

For more information

To discuss your specific tax situation and state compliance risks, please contact the BerryDunn Financial Services team. We’re here to help.

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State tax issues impacting your financial institution part one: Remote employees

Read this if you are a Chief Financial Officer or Controller at a financial institution.

Back in April, we wrote about recently released Accounting Standards Update (ASU) No. 2022-02, Financial Instruments – Credit Losses (Topic 326). Here, we are going to look at the standard in more depth. 

One of the most notable items this ASU addresses, is that it eliminates the often tedious troubled debt restructuring (TDR) accounting and disclosure requirements. Accounting for loan modifications will now be maintained under extant US generally accepted accounting principles, specifically Accounting Standards Codification (ASC) 310-20-35-9 through 35-11. However, rather than eliminate loan modification disclosure requirements altogether, the Financial Accounting Standards Board (FASB) created some new requirements, inspired by voluntary disclosures many financial institutions made during the coronavirus pandemic. 

Rather than disclosing information on TDRs, financial institutions will now be required to disclose information on loan modifications that were in the form of principal forgiveness, an interest rate reduction, an other-than-insignificant payment delay, or a term extension (or a combination thereof) made to debtors experiencing financial difficulty. These disclosures must be made regardless of whether a modification to a debtor experiencing financial difficulty results in a new loan or not. 

ASC 310-10-50-42 through 50-44 establishes these new disclosure requirements, and ASC 310-10-55-12A provides an example of the required disclosures. 

New Loan Modification Disclosure Requirements

Financial institutions have long had internal controls surrounding the determination of TDRs given the impact such restructurings can have on the allowance for credit losses and financial statement disclosures. Banks may find they are able to leverage those controls to satisfy the new modification disclosures, with only minor adjustments. Similar to previous TDR determinations, the above disclosures are only required for modifications to debtors experiencing financial difficulty. Therefore, financial institutions will need to have a process —or defined set of parameters—in place to determine debtor “financial difficulty”, thus triggering the need for modification disclosure. Banks may also find that the specific data gathered for preparation of these new disclosures will change, but should be readily available, with (hopefully) only minor manipulation required.

ASU No. 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years—the same effective date for those who have not yet adopted ASU No. 2016-13, more commonly referred to as CECL (Current Expected Credit Loss). As always, if you have any questions as to how this new ASU may impact your financial institution, please reach out to BerryDunn’s Financial Services team or submit a question via our Ask the Advisor feature.

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New loan modification disclosure requirements: A deeper dive

Read this if you are a depository institution.

Environmental, Social, and Governance (ESG) matters are all the rage right now. From new disclosures to personal, professional, investor, and social media pressures, ESG presents itself as a vast topic, encompassing many facets of an organization. It can be daunting to even know where to begin ESG efforts. 

ESG issues seem pervasive and may be best thought of as residing on a spectrum, with some industries further along this spectrum than others. However, each industry can make its own mark, with initiatives that can propel it along the ESG spectrum. Even within one industry, individual organizations may have their own initiatives and areas of focus. Equal importance does not need be given to the E, the S, and the G, and some industries may be better equipped to address one of these pillars over the others. We would like to share what we believe to be four areas of opportunity for banks as they think about ESG, their customers, and their employees.

Credit decisions

Many financial institutions currently base credit decisions on an array of financial metrics of the prospective borrower. Their reviews include financial forecasts, historical financial results, collateral values, etc., all with the intent of predicting if the prospective borrower will be able to repay the credit. Given the increasing regulatory and social pressure regarding ESG, bankers should be aware of how ESG requirements and industry initiatives could impact a borrower’s financial condition. For instance, consider the following:

  • Where does the prospective borrower reside on the ESG spectrum, collectively and individually (the separate E, the S, and the G spectrums)? 
  • If they are a carbon-intensive company, what additional risks does that pose to the relationship, if any? (E)
    • Are there pending regulations (or fines) that could significantly impact their operations?
    • Although their finances may be strong currently, are there alternative products or services that are seen as “greener” that may jeopardize future profits and cash flows?
    • If the company plans to become less carbon-intensive, either voluntarily or out of necessity, are there significant costs anticipated to be incurred during this transition?
  • Do they have, or anticipate, community investment initiatives? (S)
  • Are they viewed as a reputable company in their respective communities? (S)
  • Is there adequate Board and execute management oversight? (G)

ESG-specific products

Financial institutions can reward borrowers for their stewardship. This concept is not new, as “green bonds” have been around for years to incentivize climate and environmental projects. Some financial institutions, such as TD Bank and Barclays, offer preferred interest rates to ESG-conscious borrowers, such as those that purchase houses that meet certain energy efficiency ratings. Financial institutions could further expand on this idea and offer loans earmarked for certain ESG-related purposes, such as development of low-carbon manufacturing techniques or investment in the company’s workforce. Such products can be a great way to position your financial institution as an ESG leader in the community and assist borrowers on their ESG journey. 

Financial institutions can act as a connector for like-minded parties

Financial institutions are in a unique position, as aside from the borrower themselves, a financial institution likely knows the most about the borrower’s business. Financial institutions may become aware of customers further along their ESG journeys and could help connect those resources to other customers who may want to know and learn more. Customers are increasingly looking for more from their financial institution outside of traditional banking services. Given their unique position, financial institutions are best equipped to act as a connector for like-minded parties. 

Customers and employees may want their supply chain/employer to be ESG conscious

Customers, whether they be individuals or businesses, and employees are increasingly considering the actions of potential vendors and employers before partnering with them. Likely a result of their own ESG mission, customers are starting to realize that, even if they feel as if they are ESG conscious, it is their responsibility to also hold their vendors accountable. Therefore, customers may elect to go to another financial institution that is more ESG conscious even if your financial institution offers a better product. Employees are also factoring this into employment decisions. Employees want to feel as if they are part of a larger mission. Focusing on ESG could give your financial institution a competitive advantage.

When considering ESG matters, some believe they are faced with two mutually exclusive decisions: (1) what makes the most sense financially, and (2) what will propel our organization further along the ESG spectrum? What some leading companies have found, however, is that by focusing first on where they lie on the ESG spectrum and defining where they want to be in the future helps clarify future decision-making so that cost and ESG progress are aligned rather than opposing forces. As always, BerryDunn’s Financial Services team is here to help.

Article
Propelling along the ESG spectrum: Four considerations for your financial institution

What the C-Suite should know about CECL and change management

Read this if you are at a financial institution. 

Some institutions are managing CECL implementation as a significant enterprise project, while others have assigned it to just one or two people. While these approaches may yield technical compliance, leadership may find they fail to realize any strategic benefits. In this article, Dan Vogt, Principal in BerryDunn’s Management and IT Consulting Practice, and Susan Weber, Senior Manager and CECL expert in BerryDunn’s Financial Services Practice, outline key actions leaders can take now to ensure CECL adoption success.  

Call it empathy, or just the need to take a break from the tactical and check in on the human experience, but on a recent call, I paused the typical readiness questions to ask, “How’s the mood around CECL adoption – what’s it been like getting others in the organization involved?” The three-word reply was simple, but powerful: “Kicking and screaming.”  

Earlier this year, by a vote of 5-2, the FASB (Financial Accounting Standards Board) closed the door to any further delays to CECL adoption, citing an overarching need to unify the industry under one standard. FASB’s decision also mercifully ended the on-again off-again cycle that has characterized CECL preparation efforts since early 2020. One might think the decision would have resulted in relief. But with so much change in the world over the past few years, is it any wonder institutions are instead feeling change-saturated?  

Organizational change

CECL has been heralded as the most significant change to bank accounting ever, replacing 40+ years of accounting and regulatory oversight practices. But the new standard does much more than that. Implementing CECL has an effect on everything from executive and board strategic discussions to interdepartmental workflows, systems, and controls. The introduction of new methods, data elements, and financial assets has helped usher in new software, processes, and responsibilities that directly affect the work of many people in the organization. CECL isn’t just accounting—it’s organizational change. 

Change management

Change management best practices often focus on leading from optimism—typically leadership and an executive sponsor talk about opportunities and the business reasons for change. Some examples of what this might sound like as it relates to CECL might include, by converting to lifetime loss expectations, the institution will be better prepared to weather economic downturns; or, by evolving data and modeling precision, an institution’s understanding and measure of credit risk is enhanced, resulting in more strategic growth, pricing, and risk management. 

But leading from optimism is sometimes hard to do because it isn’t always motivating—especially when the change is mandated rather than chosen.  

Perhaps a more judiciously used tactic is to focus on the risk, or potential penalty, of not changing. In the case of CECL, examples might include, your external auditor not being able to sign-off on your financials (or significant delays in doing so), regulatory criticism, inefficient/ineffective processes, control issues, tired and frustrated staff. These examples expose the institution to all kinds of key risks: compliance, operational, strategic, and reputational, among them.

CECL success and change management

With so much riding on CECL implementation and adoption going well, some organizations may be at heightened risk simply because the effort is being compartmentalized—isolated within a department, or assigned to only one or two people. How effectively leadership connects CECL implementation with tenets of change management, how quickly they understand, then together embrace, promote, and facilitate the related changes affecting people and their work, may prove to be the key factor in achieving success beyond compliance.  

One important step leaders can take is to perform an impact assessment to understand who in the organization is being affected by the transition to CECL, and how. An example of this is below. Identifying the departments and functions that will need to be changed or updated with CECL adoption might expose critical overlaps and reveal important new or enhanced collaborations. Adding in the number of people represented by each group gives leaders insight into the extent of the impact across the institution. By better understanding how these different groups are affected, leaders can work together to more effectively prioritize, identify and remove roadblocks, and support peoples’ efforts longer term.           

 
No matter where your institution is currently in its CECL implementation journey, it is not too late to course-correct. Leadership—unified in priority, message, and understanding—can achieve the type of success that produces efficient sustainable practices, and increases employee resilience and engagement.

For more information, visit the CECL page on our website. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions. For more tips on documenting your CECL adoption, stay tuned for our next article in the series, revisit past articles, or tune in to our CECL Radio podcast. You can also follow Susan Weber on LinkedIn.

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Implementing CECL: Kicking and screaming

Read this if you are a community bank.

The Federal Deposit Insurance Corporation (FDIC) recently issued its first quarter 2022 Quarterly Banking Profile. The report provides financial information based on Call Reports filed by 4,796 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community bank performance. In first quarter 2022, this section included the financial information of 4,353 FDIC-insured community banks. BerryDunn’s key takeaways from the report are as follows:

Community banks continue to feel the impact of shrinking net interest margins and inflation.

Community bank quarterly net income dropped to $7 billion in first quarter 2022, down $1.1 billion from a year ago. Lower net gains on loan sales and higher noninterest expenses offset growth in net interest income and lower provisions. Net income declined $581.3 million, or 7.7 percent from fourth quarter 2021 primarily because of lower noninterest income and higher noninterest expense.

Loan and lease balances continue to grow in first quarter 2022

Community banks saw a $21.5 billion increase in loan and lease balances from fourth quarter 2021. All major loan categories except commercial & industrial and agricultural production grew year over year, and 55.3 percent of community banks recorded annual loan growth. Total loan and lease balances increased $35.1 billion, or 2.1 percent, from one year ago. Excluding Paycheck Protection Program loans, annual total loan growth would have been 10.2 percent.

Community bank net interest margin (NIM) dropped to 3.11 percent due to strong earning asset growth.

Community bank NIM fell 15 basis points from the year-ago quarter and 10 basis points from fourth quarter 2021. Net interest income growth trailed the pace of earning asset growth. The yield on earning assets fell 28 basis points while the cost of funding earning assets fell 13 basis points from the year-ago quarter. The 0.24 percent average cost of funds was the lowest level on record since Quarterly Banking Profile data collection began in first quarter 1984. 

Community bank allowance for credit losses (ACL) to total loans remained higher than the pre-pandemic level at 1.28 percent, despite declining 4 basis points from the year-ago quarter.


NOTE: The above graph is for all FDIC-Insured Institutions, not just community banks.

The ACL as a percentage of loans 90 days or more past due or in nonaccrual status (coverage ratio) increased to a record high of 236.7 percent. The decline in noncurrent loan balances outpaced the decline in ACL, with the coverage ratio for community banks emerging 57.9 percentage points above the coverage ratio for noncommunity banks. 

The banking landscape continues to be one that is ever-evolving. With interest rates on the rise, banks will find their margins in flux once again. During this transition, banks should look for opportunities to increase loan growth and protect and enhance customer relationships. Inflation has also caused concern not only for banks but also for their customers. This is an opportune time for banks to work with their customers to navigate the current economic environment. Community banks, with their in-depth knowledge of their customers’ financial situations and the local economies served, are in a perfect position to build upon the trust that has already been developed with customers.

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 First Quarter 2022 Quarterly Banking Profile