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Eligible
broker-dealers
: Take advantage of SEC's 30-day filing extension

09.20.21

Read this if you are responsible for meeting your broker-dealer’s annual report filing requirement under Securities Exchange Act (SEA) Section 15.

In February, the US Securities and Exchange Commission (SEC) approved a 30-day extension for eligible broker-dealers to file their annual reports, effective immediately. Firms that meet the criteria should consider taking advantage of the filing extension. Here are a few details and tips to help broker-dealers understand more about the 30‑day extension.

SEA Section 15 filing extension background

Normally, each broker-dealer registered under Securities Exchange Act (SEA) Section 15 must file annual reports—including financial and compliance or exemption reports, along with those prepared by an independent accountant—no more than 60 days after the broker-dealer’s fiscal year ends. But in light of disruption caused by the COVID-19 pandemic, the Financial Industry Regulatory Authority (FINRA) requested that the SEC allow broker-dealers an extra 30 days to file their annual reports. The extension, FINRA argued, would allow broker-dealers more time to obtain audit services.

Criteria for broker-dealers eligible for the extension

To qualify for a filing extension of 30 calendar days, a broker-dealer must meet the following criteria:

  1. Was in compliance with 15c3-1 (Net Capital) as of its most recent fiscal year end and had total capital and allowable subordinated liabilities of less than $50 million,
  2. Is permitted to file an exemption report as part of its most recent fiscal year-end annual reports,
  3. Submits written notification to FINRA and the Securities Investor Protection Corporation (SIPC) of its intent to rely on this order on an ongoing basis for as long as it meets the conditions of the order, and
  4. Files the annual report electronically with the SEC using an appropriate process.

The extension does not apply to just this year alone. It is understood to be in effect on an ongoing basis.

How to notify FINRA of your intent to take advantage of the extension

Broker-dealers that meet the aforementioned conditions are required to notify FINRA of their intent to take advantage of the extension. FINRA advises eligible broker-dealers to send an email to their Risk Monitoring Analyst with a message structured according to the following template:

“My firm wishes to have an additional 30 calendar days for filing its annual report on an ongoing basis for as long as my firm meets the conditions set forth in the SEC Order of February 12, 2021, regarding additional time for filing annual reports under SEA Rule 17a-5.”

How to file electronically

In addition to notifying FINRA, those looking to benefit from the extension are required to file electronically. There are multiple ways to do so, but the most user-friendly and efficient avenue to electronic filing is through the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system.

Using the EDGAR system, broker-dealers must upload only two attachments maximum. The EDGAR system offers two options for electronic filing:

  1. The broker-dealer could attach one document containing all the annual reports as a public document; or
  2. The broker-dealer could attach two documents to its submission: (1) a public document containing the statement of financial condition, the notes to the statement of financial condition and the accountant’s report which covers the statement of financial condition, and (2) a non-public document containing all the components of the annual reports.

Implications for annual filings

An upcoming filing deadline is a stressful event, especially for broker-dealers contending with the upheaval of the past 18 months. Fortunately, FINRA has advocated on their behalf, and the SEC has complied by offering a 30-day filing extension.

The extension provides broker-dealers excess time to review documents and schedule a session with their auditor. Auditors will likely appreciate the extension as well, as it allows them to serve their various clients over a longer period of time, alleviating some of the pressure traditionally associated with filing season.

For these reasons and more, broker-dealers who qualify are encouraged to take the steps required to benefit from this grace period. If you have questions or would like more information, please contact our broker-dealer consulting team. We're here to help.

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Read this if you are a financial institution.

As you know by now, ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326), better known as the CECL standard, has already been implemented for some and will soon be implemented for all others (fiscal years beginning after December 15, 2022 to be exact). During your implementation process, the focus has likely been on your loan portfolio, and rightfully so, as CECL overhauls 40+ years of loan loss reserve practices. But, recall that the CECL standard applies to all financial instruments carried at amortized cost. So, it therefore includes held-to-maturity (HTM) debt securities. And, although not carried at amortized cost, the CECL standard also makes targeted enhancements to available-for-sale (AFS) debt securities. As if re-hauling your entire allowance methodology wasn’t enough! Before tearing out your hair because of another CECL-related change, let’s quickly review what is currently required for securities, and then focus on how this will change when you implement CECL.

Current US GAAP

Under current US generally accepted accounting principles (GAAP), direct write-downs on HTM and AFS debt securities are recorded when (1) a security’s fair value has declined below its amortized cost basis and (2) the impairment is deemed other-than-temporary. This assessment must be completed on an individual debt security basis. Providing a general allowance for unidentified impairment in a portfolio of securities is not appropriate. The previous amortized cost basis less the other-than-temporary impairment (OTTI) recognized in earnings becomes the new amortized cost basis and subsequent recoveries of OTTI may not be directly reversed into interest income. Rather, subsequent recoveries of credit losses must be accreted into interest income.

CECL: Held-to-maturity securities

Then comes along CECL  and changes everything. Once the CECL standard is implemented, expected losses on HTM debt securities will be recorded immediately through an allowance for credit loss (ACL) account, rather than as a direct write-down of the security’s cost basis. These securities should be evaluated for risk of loss over the life of the securities. Another key difference from current GAAP is that securities with similar risk characteristics will need to be assessed for credit losses collectively, or on a pool basis, not on an individual basis as currently prescribed. Also, contrary to current GAAP, since expected losses will be recorded through an ACL account, subsequent improvements in cash flow expectations will be immediately recognized through earnings via a reduction in the ACL account. CECL effectively eliminates the direct write-down method, with write-offs only occurring when the security, or a portion thereof, is deemed to be uncollectible. 

In practice, there may be some types of HTM debt securities that your institution believes have no risk of nonpayment and thus risk of loss is zero. An example may be a US Treasury debt security or possibly a debt security guaranteed by a government-sponsored enterprise, such as Ginnie Mae or Freddie Mac. In these instances, it is acceptable to conclude that no allowance on such securities is necessary. However, such determination should be documented and changes to the credit situation of these securities should be closely monitored.

Financial institutions that have already implemented CECL have appreciated its flexibility; however, just like anything else, there are challenges. One of the biggest questions that has risen is related to complexity, specifically from financial statement users in regards to the macroeconomic assumptions used in models. Another common challenge is comparability to competitors’ models and estimates. Each financial institution will likely have a different methodology when recording expected losses on HTM debt securities due to the judgment involved. These concerns are not unique to the ACL on HTM debt securities but are nonetheless concerns that will need to be addressed. A description of the methodology used to estimate the ACL, as well as a discussion of the factors that influenced management’s current estimate of expected losses must be disclosed in the financial statements. Therefore, management should ensure adequate information is provided to address financial statement users’ concerns.  

CECL: Available-for-sale securities

Upon CECL adoption, you are also expected to implement enhancements to existing practices related to AFS debt securities. Recall that AFS debt securities are recorded at fair value through accumulated other comprehensive income (AOCI). This will not change after adoption of the CECL standard. However, the concept of OTTI will no longer exist. Rather, if an AFS debt security’s fair value is lower than its amortized cost basis, any credit related loss will be recorded through an ACL account, rather than as a direct write-down to the security. This ACL account will be limited to the amount by which fair value is below the amortized cost basis of the security. Credit losses will be determined by comparing the present value of cash flows expected to be collected from the security with its amortized cost basis. Non-credit related changes in fair value will continue to be recorded through an investment contra account and other comprehensive income. So, on the balance sheet, AFS debt securities could have an ACL account and an unrealized gain/loss contra account. The financial institution will be responsible for determining if the decline in the value below amortized cost is the result of credit factors or other macroeconomic factors. In practice, the following flowchart may be helpful:

Although changes to debt securities may not be top of mind when working through CECL implementation, ensuring you reserve time to understand and assess the impact of these changes is important. Depending on the significance and composition of your institution’s debt security portfolio, these changes may have a significant impact on your financial institution’s financial statements from CECL adoption forward. 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.

Article
Don't forget about me! Changes in debt security accounting resulting from CECL 

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

The Financial Accounting Standards Board (FASB) issued its second Accounting Standards Update (ASU) of 2022 on March 31, 2022. Seen as a fairly quiet year thus far on the accounting standards issuance front, both ASUs issued so far should catch the attention of financial institutions’ accounting and finance teams. For readers who may have missed it, on March 31, 2022, we wrote about the FASB’s first ASU of 2022: ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method. Seen as enhancing the flexibility of hedge accounting, this ASU, among other things, expands on the “last-of-layer” hedging method by allowing multiple hedged layers to be designated for a single closed portfolio of financial assets or one or more beneficial interests secured by a portfolio of financial instruments.

The most recently issued ASU, ASU No. 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, responds to feedback received during the FASB’s Post-Implementation Review process of ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Commonly known as the “CECL (current expected credit loss) standard,” financial institutions that have not yet adopted ASU No. 2016-13 should be well into their CECL implementation plan. ASU No 2016-13 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. 

The CECL standard is seen as a major disruptor event for financial institutions. I encourage you to check out my colleague Susan Weber’s CECL implementation series (the latest article can be found here) for best practices on a successful CECL implementation.

As soon as you see the acronym “CECL” in an article, especially one in regards to a new accounting standard, you may be already looking to “X” out of your web browser and save whatever horrors this ASU brings for another day. But, the changes that are forthcoming as a result of ASU No. 2022-02 are generally seen as being well received by accounting and finance teams (and likely credit teams as well). 

As its name implies, ASU No. 2022-02 addresses two separate issues: Troubled debt restructurings and vintage disclosures.

Troubled debt restructurings

The ASU eliminates the current troubled debt restructuring accounting guidance within Accounting Standards Codification (ASC) Subtopic 310-40 in its entirety. To help illustrate the impact of the proposed changes, let’s quickly review ASC Subtopic 310-40. ASC Subtopic 310-40, among other things, indicates a troubled debt restructuring should not be accounted for as a new loan because a troubled debt restructuring is part of a creditor’s ongoing effort to recover its investment in the original loan. A loan modification is considered a troubled debt restructuring if made to a borrower experiencing financial difficulty and if the modification grants a concession. Furthermore, all troubled debt restructurings are considered impaired loans. After adoption of the ASU, financial institutions will evaluate whether the modification represents a new loan or a continuation of an existing loan, in accordance with current ASC guidance (ASC 310-20-35-9 through 35-11). 

Current ASC guidance indicates a loan modification shall be treated as a new loan if the terms of the modification are at least as favorable to the lender as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the lender. This condition would be met if the new loan’s effective yield is at least equal to the effective yield for such loans and modifications of the original debt instrument are more than minor. A modification is considered “more than minor” if the present value of the cash flows under the terms of the new debt instrument is at least 10 percent different from the present value of the remaining cash flows under the terms of the original instrument. However, even if the difference is less than 10 percent, the financial institution should evaluate whether the modification is more than minor based on the specific facts and circumstances surrounding the modification.

The ASU also modifies disclosure requirements. Rather than disclosing information on troubled debt restructurings, 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. Among other things, ASC 310-10-10-50-42 through 50-44 requires financial institutions to disclose, by class of financing receivable, the types of modifications utilized and certain financial effects of the modification, depending on the type of modification. ASC 310-10-55-12A provides an example of the disclosures required by ASC 310-10-10-50-42 through 50-44. The new disclosures must be made regardless of whether a modification to a debtor experiencing financial difficulty results in a new loan. In part, this section of the ASU is seen as providing structure around some of the types of modification disclosures financial institutions were providing during the coronavirus pandemic. 

Financial institutions have long had internal controls surrounding the determination of troubled debt restructurings given the impact such restructurings can have on the allowance for loan losses and financial statement disclosures. Although internal controls surrounding loan modifications will still need to exist, they will likely need to evolve as a result of ASU No. 2022-02. Furthermore, the data gathered for preparation of financial statement disclosures will also change. However, the data needed to satisfy the new disclosure requirements should be readily available, with possibly minor manipulation required to obtain the information needed under the new disclosure requirements.

Vintage disclosures

The ASU amends ASC 326-20-50-6 to require public business entities to disclose current-period gross writeoffs by year of origination for financing receivables and net investment in leases within the scope of ASC Subtopic 326-20. ASC 326-20-55-79 provides an example of this disclosure.

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. As always, if you have any questions as to how this 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.
 

Article
FASB is on a roll: Another ASU aimed at financial institutions

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

Back in November 2021, we wrote about Accounting Standards Update (ASU) No. 2017-12 and the flexibility it adds to hedge accounting. In the article we mentioned a proposed ASU the Financial Accounting Standards Board (FASB) had issued in May 2021. On March 28, 2022 the FASB finalized this proposed ASU with the issuance of its first ASU of 2022: ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method. Among other things, the ASU expands on the “last-of-layer” hedging method by allowing multiple hedged layers to be designated for a single closed portfolio of financial assets or one or more beneficial interests secured by a portfolio of financial instruments. As a result, an entity may be able to achieve hedge accounting for hedges of a greater proportion of its interest rate risk inherent in the assets included in the closed portfolio, further aligning hedge accounting with risk management strategies. The “last-of-layer” method has thus been renamed the “portfolio layer” method. 

The ASU also allows an entity to reclassify debt securities classified in the held-to-maturity category at the date of adoption of the ASU to the available-for-sale category. However, this reclassification may only occur if the entity applies portfolio layer method hedging to one or more closed portfolios that include those debt securities. The decision of which securities to reclassify must be made within 30 days after the date of adoption, and the securities must be included in one or more closed portfolios that are designated in a portfolio layer method hedge within that 30-day period.

ASU No. 2022-01 is effective for public business entities for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. Early adoption is permitted for those entities that have adopted ASU No. 2017-12 for the corresponding period.

This ASU further enhances the flexibility of hedge accounting and ultimately builds upon the framework set by ASU No. 2017-12. Financial institutions using, or looking to use, derivatives and hedge accounting to manage interest rate risk should review this ASU to determine if it provides opportunity for revised hedging techniques and strategies that may benefit the institution. As always, if you have any questions as to how this 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.
 

Article
FASB issues its first ASU of 2022: Much anticipated changes to hedge accounting are here

Read this if you are a community bank.

The Federal Deposit Insurance Corporation (FDIC) recently issued its fourth quarter 2021 Quarterly Banking Profile. The report provides financial information based on Call Reports filed by 4,839 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community bank performance. In fourth quarter 2021, this section included the financial information of 4,391 FDIC-insured community banks. BerryDunn’s key takeaways from the community bank section of the report are as follows:

  • The banking industry as a whole saw a $132 billion increase in net income from a year prior despite continued net interest margin (NIM) compression. This increase was mainly attributable to the $163.3 billion decrease in provision expense, supported by continued economic growth and supplementary credit quality improvement. NIM declined to 2.54%, a 28 basis-point decrease from 2020 as the growth rate in average earning assets outpaced the growth rate in net interest income.
  • For community banks, full-year net income increased $7.4 billion to $32.7 billion. Despite the increase in annual net income, community banks saw a $719.9 million decrease in net income from third quarter 2021. Higher noninterest expenses continue to place pressure on community banks as inflation rates spike going into 2022. Annual NIM fell 12 basis points from 2020 to 3.27%. The average yield on earning assets fell 42 basis points to 3.58%, while the average funding cost fell 30 basis points to 0.31%. The percentage of unprofitable community banks declined to 3.2%, the lowest level on record. 

    *See Exhibit B at the end of this article for more information on the fourth-quarter year-over-year change in income.
     
  • Net gains on loan sales revenue declined $1.5 billion (50.6%) from fourth quarter 2020. However, growth in net interest income of $1.3 billion (6.7%) from fourth quarter 2020 overcame the $707 million decline in noninterest income. Net operating revenue increased $588.4 million (2.3%) from fourth quarter 2020.
  • Noninterest expense increased 3.4% from fourth quarter 2020. This increase was mainly attributable to higher data processing and marketing expenses. That being said, average assets per employee increased 10% from fourth quarter 2020. Noninterest expense as a percentage of average assets declined 16 basis points from fourth quarter 2020 to 2.51%, despite 69.4% of community banks reporting higher noninterest expense.
  • Noncurrent loan balances (loans 90 days or more past due or in nonaccrual status) declined by $1.1 billion to $11.1 billion from third quarter 2021. The noncurrent rate dropped 7 basis points to 0.58% from third quarter 2021, the lowest noncurrent rate on record for community banks.
  • 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 53.7 percentage points from a year ago to 223.8%. This ratio is well above the 147.9% reported before the pandemic in fourth quarter 2019 and continues to be a record high. The coverage ratio for community banks is 49.9 percentage points above the coverage ratio for noncommunity banks. As a result, provision expense declined $914.9 million from fourth quarter 2020, but remained at $320.8 million for fourth quarter 2021, representing a $39.2 million increase from third quarter 2021.
  • The net charge-off rate declined 6 basis points from fourth quarter 2020 to 0.09%.
  • Trends in loans and leases started looking up, as community banks saw an increase of $24.3 billion within fourth quarter 2021. This growth was mainly seen in the nonfarm nonresidential commercial real estate (CRE), which held a balance of $16.3 billion. Total loans and leases increased by $34.2 billion (2%) for the year 2021. Growth of $50.6 billion in CRE loans attributed to the increase. A decline in commercial and industrial loan balances of $62.3 billion (20.1%) from fourth quarter 2020 offset a portion of this increase. This decline was mainly due to Paycheck Protection Program (PPP) loan repayment and forgiveness.

    *See Exhibit C at the end of this article for more information on the change in loan balances.
     
  • More than 75% of community banks reported an increase in deposit balances for the fourth quarter. In total, deposit growth was 2.8% during fourth quarter 2021.
  • The average community bank leverage ratio (CBLR) for the 1,699 banks that elected to use the CBLR framework was 11.2%, nearly unchanged from third quarter 2021. The average leverage capital ratio was 10.16%.
  • The number of community banks declined by 59 to 4,391 from third quarter 2021, a decrease of 168 from December 2020. This change includes six banks transitioning from community to noncommunity banks, four banks transitioning from noncommunity to community banks, 54 community bank mergers or consolidations, and three community banks having ceased operations.

Fourth quarter 2021 was another strong quarter for community banks, as evidenced by the increase in year-over-year quarterly net income of 7.1% ($511.6 million). This quarter concluded another strong year financially for community banks. However, NIMs continue to show record lows, as shown in Exhibit A, which shows the trends in quarterly NIM.

The consensus remains that community banks will likely need to find creative ways to increase their NIM, grow their earning asset bases, or continue to increase noninterest income to maintain current net income levels. In regards to the latter, many pressures to noninterest income streams exist. Financial technology (fintech) companies are changing the way we bank by automating processes that have traditionally been manual (for instance, loan approval). Decentralized financing (DeFi) also poses a threat to the banking industry. Building off of fintech’s automation, DeFi looks to cut out the middle-man (banks) altogether by building financial services on a blockchain. Ongoing investment in technology should continue to be a focus, as banks look to compete with non-traditional players in the financial services industry. 

The larger, noncommunity banks are also putting pressure on community banks and their ability to generate noninterest income, as recently seen by Citi, Bank of America, and many other large banks following behind Capital One Bank in eliminating all overdraft fees. According to the Consumer Financial Protection Bureau, the financial services industry brought in $15.5 billion in overdraft fees in 2019. Seen as a move to enhance Capital One Bank’s financial inclusion of customers, community banks will also need to find innovative ways to enhance relationships with current and potential customers. As fintech companies and DeFi become more mainstream and accepted in the marketplace, the value propositions of community banks will likely need to change. Furthermore, as PPP loan forgiveness comes to an end, PPP loan fees will no longer supplement revenues. Although seen as a one-time extraordinary event, this fee income was significant for many community banks’ 2021 and 2020 revenues.

The importance of the efficiency ratio (see Exhibit D below) is also magnified as community banks attempt to manage their noninterest expenses in light of low NIMs and inflationary pressures. Although noninterest expense as a percentage of average assets declined 16 basis points from fourth quarter 2020, such expenses increased 3.4% from fourth quarter 2020. And, inflationary pressures will likely be exacerbated as a result of Russia’s invasion of Ukraine. Inflationary pressure was already seen in fourth quarter 2021, as net income decreased $719.9 million from third quarter 2021, despite only a $39.2 million increase in provision expense from third quarter 2021. Banks with manual processes can improve efficiency and support a remote workforce with increased automation.

Furthermore, many of the uncertainties that we have been discussing quarter-over-quarter, and that have thus become “themes” for the banking industry in 2021, still exist. For instance, although significant charge-offs have not yet materialized, the financial picture for many borrowers remains uncertain. Also, 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 and many community banks had nominal amounts of borrowers that remained on deferral as of December 31, 2021. 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.

The outlook for office space remains uncertain. 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. As noted in a recent FDIC article, “the full effects of changing dynamics in the sector are still developing. Office property demand may take time to stabilize as tenants navigate remote work decisions and adjust how much space they need.” The FDIC article further mentions reduced office space could also have implications for the multifamily and retail markets that cater to those office employees. Similarly, the hotel industry remains in flux and the post-pandemic success of the industry is likely dependent on the recovery of business travel and gas prices for hotels dependent on summer tourism. If virtual conferences and meetings become the new norm, the hotel industry could see itself having to pivot. Even a transition to a hybrid model, which is more likely to occur, could have significant implications for the industry. Banks should closely monitor these borrowers, as identifying early signs of credit deterioration could be essential to preserving the relationship.

The financial services industry is full of excitement right now. While the industry faces many challenges, these challenges also bring opportunity for banks to experiment and differentiate themselves. Bank customers arguably need the assistance of their bank more than ever as they navigate continued financial uncertainty. This need allows community banks to do what they do best: develop long-lasting relationships with customers and become a trusted advisor. If there is anything this pandemic has shown to the financial industry, it is that community banks are truly one of the leaders of their communities. As always, please don’t hesitate to reach out to BerryDunn’s Financial Services team if you have any questions.

Article
FDIC Issues its Fourth Quarter 2021 Quarterly Banking Profile

Read this if you are a plan sponsor of a 401(k) plan.

The trend of US workers leaving their jobs and employers struggling with high levels of employee turnover continues to gain momentum. Another 4.5 million US workers quit their jobs in November alone, according to data from the US Bureau of Labor Statistics. Meanwhile, the number of job openings in the US remains elevated at 10.6 million, as companies across sectors and industries continue to have a hard time recruiting and retaining employees.

How are the issues related to what is now called the “Great Resignation” affecting plan sponsors in particular? The current environment not only makes it hard to build and manage an effective workforce, but plan sponsors also may face problems down the road when departing workers leave their 401(k) balances with their previous employers. These abandoned accounts can lead to penalties, additional administrative fees, and administrative challenges for employers.

How can plan sponsors resolve these issues?

Fortunately, there are some easy ways for plan sponsors to limit the potential burden of abandoned 401(k) accounts. Plan sponsors should start by ensuring that they have up-to-date contact information before an employee’s final day with the organization. Cell phone numbers, email addresses, and mailing addresses are critical data points to gather. Email addresses and other digital contact information are especially important in today’s increasingly digital world.

Existing rules can help employers resolve smaller abandoned accounts. By law, employers are allowed to cash out small, vested accounts of $1,000 or less. For vested account balances between $1,000 and $5,000, employers are permitted to move these assets to an Individual Retirement Account.

Currently, there is no specific guidance for account balances larger than $5,000. Because of this, employers have relied on Field Assistance Bulletin (FAB) 2014-01, which is meant for participants in terminated defined contribution plans. Under this bulletin, plan sponsors are instructed to send a certified letter to the participant’s last known address; keep records on attempts to reach the missing participant; ask co-workers how to find the missing participant; and call the missing participant’s cell phone, among other instructions.

To help mitigate these issues in the future, some employers are adopting auto-portability benefits. These tools automatically transfer small balances to new employers. Plan sponsors that offer auto-portability benefits should explain how this tool works to departing employees.

Plan document language on forfeitures and cash-outs

For participants who leave before they are fully vested in a 401(k) plan, employer contributions are typically placed in forfeiture accounts. Employers can write this section of the plan document in a variety of ways, so it is crucial to understand how your specific plan establishes the timing and use of the forfeiture account.

For example, forfeitures can be paid at the time of termination or when the participant hits a five-year break in service. Employers wanting to access non-vested amounts more quickly should consider amending the plan document to allow access to non-vested amounts at the time of termination (as opposed to the time of distribution).

While plan documents can set cash-out thresholds (within the minimum and maximum allowable amounts), plans may elect the small balance cash-out option for accounts under $5,000. Rollover balances also can be disregarded when determining the $5,000 threshold, but the plan document must include this caveat.

Opportunity in the next plan restatement cycle

Every six years, the Internal Revenue Service requires employers with qualified, pre-approved plans to re-write or restate their basic plan documents. The current restatement cycle for defined contribution plans will close on July 31, 2022. 

The current restatement cycle provides an opportunity to amend your plan to make it beneficial to employers and employees when team members leave your organization. Your advisor can help review your plan documents and make the most of your plan restatement process in the context of current trends in the labor market and your organization’s objectives. As always, if questions arise, please don’t hesitate to contact our Employee Benefits Audit team.

Article
Easing the potential burden of abandoned 401(k) accounts 

Read this if you are a community bank.

The Federal Deposit Insurance Corporation (FDIC) recently issued its third quarter 2021 Quarterly Banking Profile. The report provides financial information based on Call Reports filed by 4,914 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community bank performance. In third quarter 2021, this section included the financial information of 4,450 FDIC-insured community banks. Community banks are identified based on criteria defined in the FDIC’s 2020 Community Banking Study. Here are BerryDunn’s key takeaways from the community bank section of the report:

  • There was a $1.4 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 $2.2 billion due to lower interest expense and higher commercial and industrial (C&I) loan interest income, mainly due to fees earned through the payoff and forgiveness of Paycheck Protection Program (PPP) loans. Provision expense decreased $1.4 billion from third quarter 2020. However, it remained positive at $270.4 million, which was an increase of $219.2 million from second quarter 2021. For noncommunity banks, provision expense was negative $5.2 billion for third quarter 2021

    *See Exhibit B at the end of this article for more information on the third-quarter year-over-year change in income.
     
  • Quarterly NIM increased 3 basis points from third quarter 2020 to 3.31%. The average yield on earning assets fell 20 basis points to 3.60% while the average funding cost fell 23 basis points to 0.29%. This was the first annual expansion of NIM since first quarter 2019. The annual decline in both yield and cost of funds were the smallest reported since first quarter 2020.
  • Net gains on loan sales revenue declined $1.2 billion (41.5%) from third quarter 2020. However, other noninterest income increased $343.3 million or 15.2% while revenue from service charges on deposit accounts increased $100.3 million or 14.5%. In total, noninterest income decreased $616.3 million from third quarter 2020.
  • Noninterest expense increased 5.7% from third quarter 2020. This increase was mainly attributable to salary and benefit expenses, which saw an increase of $402.2 million (4.3%). That being said, average assets per employee increased 10.4% from third quarter 2020. Noninterest expense as a percentage of average assets declined 12 basis points from third quarter 2020 to 2.45%, despite 74.1% of community banks reporting higher noninterest expense.
  • Noncurrent loan balances (loans 90 days or more past due or in nonaccrual status) declined by $847 million, or 7.1%, from second quarter 2021. The noncurrent rate dropped 4 basis points to 0.65% from second 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 44.1 percentage points year-over-year to 203.5%. This ratio is well above the financial crisis average of 147.9% and is a record high. The coverage ratio for community banks is 26.2 percentage points above the coverage ratio for noncommunity banks.
  • Net charge-offs declined 4 basis points from third quarter 2020 to 0.06%.
  • Loans and leases declined from second quarter 2021 by 0.2%. This decrease was mainly seen in the C&I loan category, which was driven by a $45.6 billion decrease in PPP loan balances due to their payoff and forgiveness. Total loans and leases declined by $19.2 billion (1.1%) from third quarter 2020. The largest decline was shown in C&I loans ($87.3 billion or 24.9%). Growth in other loan categories, such as nonfarm nonresidential commercial real estate, construction & development, and multifamily loans of $69.9 million offset a portion of this decline. 

    *See Exhibit C at the end of this article for more information on the change in loan balances.
     
  • Nearly seven out of ten community banks reported an increase in deposit balances during the third quarter. Growth in deposits above the insurance limit increased by $57.8 billion, or 5.5%, while growth in deposits below the insurance limit showed an increase of $1.7 billion, or 0.1%, from second quarter 2021. In total, deposit growth was 2.6% during third quarter 2021.
  • The average community bank leverage ratio (CBLR) for the 1,737 banks that elected to use the CBLR framework was 11.3%. The average leverage capital ratio was 10.25%.
  • The number of community banks declined by 40 to 4,450 from second quarter 2021. This change includes one new community bank, 10 banks transitioning from community to noncommunity bank, five banks transitioning from noncommunity to community bank, 35 community bank mergers or consolidations, and one community bank having ceased operations.

Third quarter 2021 was another strong quarter for community banks, as evidenced by the increase in year-over-year quarterly net income of 19.6% ($1.4 billion). However, NIMs remain low despite seeing growth in the most recent quarter (for the first time since first quarter 2019), as shown in Exhibit A. The consensus remains that community banks will likely need to find creative ways to increase their NIM, grow their earning asset bases, or continue to increase noninterest income to maintain current net income levels. In regards to the latter, many pressures to noninterest income streams exist. Financial technology (fintech) companies are changing the way we bank by automating processes that have traditionally been manual (for instance, loan approval). Decentralized financing (DeFi) also poses a threat to the banking industry. Building off of fintech’s automation, DeFi looks to cut out the middle-man (banks) altogether by building financial services on a blockchain. Ongoing investment in technology should continue to be a focus, as banks look to compete with nontraditional players in the financial services industry. The larger, noncommunity banks are also putting pressure on community banks and their ability to generate noninterest income, as recently seen by Capital One Bank eliminating all overdraft fees.

According to the Consumer Financial Protection Bureau, the financial services industry brought in $15.5 billion in overdraft fees in 2019. Seen as a move to enhance Capital One Bank’s relationships with its customers, community banks will also need to find innovative ways to enhance relationships with current and potential customers. As fintech companies and DeFi become more mainstream and accepted in the marketplace, the value propositions of community banks will likely need to change.

The importance of the efficiency ratio (noninterest expense as a percentage of total revenue) is also magnified as community banks attempt to manage their noninterest expenses in light of low NIMs. Banks appear to be strongly focusing on noninterest expense management, as seen by the 12 basis point decline from third quarter 2020 in noninterest 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 modest in August and September 2021. Supply chain pressures, labor shortages, and concerns over COVID-19 variants (delta and now omicron) have slowed economic growth and continue to provide uncertainty as to (1) the trajectory of the economy, (2) whether inflation is transitory, and (3) the need for the Federal Reserve to increase the federal funds target rate. If an increase in the federal funds target rate is used to combat inflation, community banks could see their NIMs in another transitory stage.

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. Banks should closely monitor these borrowers, as identifying early signs of credit deterioration could be essential to preserving the relationship.

The financial services industry is full of excitement right now. While the industry faces many challenges, these challenges also bring opportunity for banks to experiment and differentiate themselves. The forces at play right now indicate the industry will likely look much different ten years from now. However, as the pandemic has exhibited, you may be full steam ahead in one direction and then an unforeseen force may totally up-end your plans. 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 Third Quarter 2021 Quarterly Banking Profile

Read this if you are a Chief Financial Officer, Chief Compliance Officer, FINOP, or charged with governance of a broker-dealer.

The results of the Public Company Accounting Oversight Board’s (PCAOB) 2020 inspections are included in its 2020 Annual Report on the Interim Inspection Program Related to Audits of Brokers and Dealers. There were 65 audit firms inspected in 2020 by the PCAOB and, although deficiencies declined 11% from 2019, 51 firms still had deficiencies. This high level of deficiencies, as well as the nature of the deficiencies, provides insight into audit quality for broker-dealer stakeholders. Those charged with governance should be having conversations with their auditor to see how they are addressing these commonly found deficiencies and asking if the PCAOB identified any deficiencies in the auditor’s most recent examination. 

If there were deficiencies identified, what actions have been taken to eliminate these deficiencies going forward? Although the annual report on the Interim Inspection Program acts as an auditor report card, the results may have implications for the broker-dealer, as gaps in audit quality may mean internal control weaknesses or misstatements go undetected.

Attestation Standard (AT) No. 1 examination engagements test compliance with the financial responsibility rules and the internal controls surrounding compliance with the financial responsibility rules. The PCAOB examined 21 of these engagements and found 14 of them to have deficiencies. The PCAOB continued to find high deficiency rates in testing internal control over compliance (ICOC). They specifically found that many audit firms did not obtain sufficient, appropriate evidence about the operating effectiveness of controls important to the auditor’s conclusions regarding the effectiveness of ICOC. This insufficiency was widespread in all four areas of the financial responsibility rules: the Reserve Requirement rule, possession or control requirements of the Customer Protection Rule, Account Statement Rule, and the Quarterly Security Counts Rule.

The PCAOB also identified a firm that included a statement in its examination report that referred to an assertion by the broker-dealer that its ICOC was effective as of its fiscal year-end; however, the broker-dealer did not include that required assertion in its compliance report.

AT No. 2 review engagements test compliance with the broker-dealer’s exemption provisions. The PCAOB examined 83 AT No. 2 engagements and found 19 of them to have deficiencies. The most significant deficiencies were that audit firms:

  • Did not make required inquiries, including inquiries about controls in place to maintain compliance with the exemption provisions, and those involving the nature, frequency, and results of related monitoring activities.
  • Similar to AT No. 1 engagements, included a statement in their review reports that referred to an assertion by the broker-dealer that it met the identified exemption provisions throughout the most recent fiscal year without exception; however, the broker-dealers did not include that required assertion in their exemption reports.

The majority of the deficiencies found were in the audits of the financial statements. The PCAOB did not examine every aspect of the financial statement audit, but focused on key areas. These areas were: revenue, evaluating audit results, identifying and assessing risks of material misstatement, related party relationships and transactions, receivables and payables, consideration of an entity’s ability to continue as a going concern, consideration of materiality in planning and performing an audit, leases, and fair value measurements. Of these areas, revenue and evaluating audit results had the most deficiencies, with 45 and 27 deficiencies, or 47% and 26% of engagements examined, respectively.

Auditing standards indicate there is a rebuttable presumption that improper revenue recognition is a fraud risk. In the PCAOB’s examinations, most audit firms either identified a fraud risk related to revenue or did not rebut the presumption of revenue recognition as a fraud risk. These firms should have addressed the risk of material misstatement through appropriate substantive procedures that included tests of details. The PCAOB noted there were instances of firms that did not perform any procedures for one or more significant revenue accounts, or did not perform procedures to address the assessed risks of material misstatement for one or more relevant assertions for revenue. The PCAOB also identified deficiencies related to revenue in audit firms’ sampling methodologies and substantive analytical procedures. Other deficiencies of note, that were not revenue related, included:

  • Incomplete qualitative and quantitative disclosure information, specifically in regards to revenue from contracts with customers and leases.
  • Missing required elements from the auditor’s report.
  • Missing auditor communications:
    • Not inquiring of the audit committee (or equivalent body) about whether it was aware of matters relevant to the audit.
    • Not communicating the audit strategy and results of the audit to the audit committee (or equivalent body).
  • Engagement quality reviews were not performed for some audit and attestation engagements.
  • Audit firms assisted in the preparation of broker-dealer financial statements and supplemental information.

Although there have been improvements in the amounts of deficiencies found in the PCAOB’s examinations, the 2020 annual report shows that there is still work to be done by audit firms. Just like auditors should be inquiring of broker-dealer clients about the results of their most recent FINRA examination, broker-dealers should be inquiring of auditors about the results of their most recent PCAOB examination. Doing so will help broker-dealers identify where their auditor may reside on the audit quality spectrum. If you have any questions, please don’t hesitate to reach out to our broker-dealer services team.

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2020 Annual Report on the Interim Inspection Program Related to Audits of Brokers and Dealers

Read this if you are working on ESG initiatives at your organization.

Whether you are a director or an executive well into the journey of developing and communicating your company’s strategic sustainability plans or in early stages, the rising public demand for environmental, social, and governance (ESG) reporting is becoming a force that cannot be ignored by boards and management teams.

ESG overview: reminders and FAQs

What does ESG information comprise? The term “ESG” reporting, used broadly, covers qualitative discussions of topics and quantitative metrics used to measure a company’s performance against ESG risks, opportunities, and related strategies. ESG, sustainability, and corporate social responsibility are terms often used interchangeably to describe nonfinancial reporting being shared publicly by companies. Such information is not currently subject to a singular authoritative set of standards.

What are examples of ESG and sustainability information? The following do not represent all-inclusive lists and, while some ESG information may be measured quantitatively, there are often many means to calculate metrics or information that may be difficult to quantify and therefore may be expressed qualitatively and described as such: 

As corporate ESG activities increase in relevance and importance to stakeholders, companies are seeking to both understand the complex landscape of ESG disclosure and reporting and determine the best path forward. This includes identifying, collecting, sharing, and improving upon qualitative and quantitative metrics reflecting long-term, strategic ESG value creation.

Organizations are in various stages of readiness to report on such decision-useful information. Currently, a myriad of reporting frameworks and wide variations in how companies choose to publicly share ESG information exist, making the ESG landscape complex to navigate. However, two things are certain:

  1. The pressure for companies to publicly disclose their approach to sustainability and ESG reporting continues to mount from a broad variety of stakeholders, and 
  2. ESG is rapidly rising to the forefront of boardroom agendas.

We have prepared the following to provide useful reminders, FAQs, and insights for those charged with governance as they consider the rapidly changing current ESG reporting landscape and evolving regulatory developments.

Is there a single authoritative set of ESG reporting standards? 

There are currently several frameworks and standards in use globally by companies to report on ESG, many of which may be complementary and used in combination for external reporting. Some of the more commonly used frameworks are: Sustainability Accounting Standards Board (SASB); Global Reporting Initiative (GRI); Task Force on Climate-Related Financial Disclosures (TCFD); International Integrated Reporting Council (IIRC); and Climate Disclosures Standards Board (CDSB). While many of these may already be complementary to each other, there is also growing support for a singular, global set of reporting standards for ESG, though the timing to achieve the necessary convergence remains uncertain.

Are U.S. companies required to disclose ESG information? 

Outside of certain industry regulators, such as required reporting by the Environmental Protection Agency on greenhouse gas emissions, implementation by U.S. companies remains voluntary. However, pressure from institutional investors—BlackRock, State Street and Vanguard—is mounting in support of companies providing ESG disclosures that align with both the SASB and TCFD frameworks. Additionally, sustainability risk issues are increasingly integrated into organizational risk frameworks such as COSO’s Enterprise Risk Management (ERM) framework.

Companies must also assess whether other ESG information, such as climate risk disclosures, are required under current MD&A disclosure rules. For example, if the risk represents a known trend or uncertainty the company reasonably expects will have a material impact on the company’s results of operations or capital resources, additional disclosure would be required.

What companies are reporting, and what information are they reporting? 

ESG disclosures vary significantly depending on the nature of the business, geography, industry, and stakeholder base, as well as available resources to devote to ESG. The largest global public companies have led the way in external ESG reporting and engagement, but this reporting is rapidly expanding to encompass smaller public entities and private entities. Companies of all sizes are both feeling the pressure to produce ESG reporting and identifying it as a means to differentiate themselves in the market by proactively conveying their corporate stories and strategies.

As noted in a recent White & Case study of proxy statements and filed 10-Ks for the top 50 companies by revenue in the Fortune 100, the following ESG categories showed the most significant increase in disclosures from the prior year:

  • Human capital management (HCM)
  • Environmental
  • Corporate culture
  • Ethical business practices
  • Board oversight of environment & social (E&S) issues
  • Social impact/community
  • E&S issues in shareholder engagement

The study noted that a majority of E&S disclosures in the SEC filings were qualitative and did not provide quantitative metrics. However, disclosures pertaining to environmental, HCM, and E&S goals, along with social impact and community relations were more likely to contain quantitative metrics.

Where do companies report ESG information? The most common places companies are providing public ESG disclosures include:

  • Standalone reports including corporate social responsibility (CSR)/sustainability reports
  • Company websites and marketing materials
  • MD&A sections of annual and quarterly reports
  • Earnings calls
  • Proxy statements and 8-Ks

Evolving auditor ESG attestation

Many of the metrics and qualitative disclosures around ESG information are not “governed” by an established framework such as generally accepted accounting principles (GAAP), and thus, may not be subject to the same rigor of processes and controls over such processes to ensure the integrity and accuracy of the underlying data and the appropriateness of the decisions and judgments being made by management in reporting on such information. For example, the fear of corporate “green or impact washing”—the incentive to make stakeholders believe that a company is doing more to promote ESG activities, particularly environmental protections, than it actually is—has left many stakeholders questioning the reliability, consistency, and accuracy of company ESG reporting. As ESG reporting continues to evolve and become a significant consideration for boards, investors, employees, suppliers, lenders, regulators, and others in making business decisions, there is a growing focus on the value of assurance on such information provided by independent third parties.

Type of attestation services to be provided

Determining the scope and level of assurance to be provided will vary based on company objectives in presenting ESG information, management’s readiness, and intended users and uses of ESG information. Attest services may include:

  • Examination: Consists of an examination performed by an auditor resulting in an independent opinion indicating whether the ESG information is in accordance with the agreed upon criteria, in all material respects. An examination engagement is the closest equivalent to the reasonable assurance obtained in an audit of financial statements.
  • Review: Consists of limited procedures, performed by an auditor, that result in limited assurance. The objective of a review engagement is for the auditor to express a conclusion about whether any material modifications should be made to the ESG information in order for it to be in accordance with the agreed upon criteria. Review engagements are substantially less in scope than examination engagements.


The ESG journey: first steps for boards just beginning the ESG reporting journey

The AICPA and Center for Audit Quality (CAQ) have issued a roadmap for audit practitioners laying out initial steps for those organizations and their boards who are in the beginning phases of the ESG reporting journey:

  • Conduct a materiality or risk assessment to determine which ESG topics are prioritized as important or “material” to the organization, its investors and other stakeholders
  • Implement appropriate board oversight of material ESG matters
  • Integrate/align material ESG topics into the ERM process
  • Integrate ESG matters into the overall company strategy
  • Implement effective internal control over ESG data collection, processing, and reporting


For boards considering an attestation engagement

The CAQ has further prepared the following questions boards may consider for companies that have already started reporting on ESG and may be considering an attestation engagement:

  • What is the purpose and objective of the attestation engagement on ESG information?
  • Who are the intended users of the ESG information and related attestation report?
  • Why do the intended users want or need an attestation report on the ESG information?
  • What are the potential risks associated with a misstatement or omission in the ESG information?
  • Does the company have a clear understanding what ESG information the intended users want or need to be in the scope of the attestation engagement?
  • What level of attestation service (examination or review engagement) will help the company achieve its objective?

Additional questions for board members to consider regarding their company’s preparedness for reporting include:

  • Does management have well established controls, policies, and procedures for the collection of and disclosure of ESG information? Are there gaps to be addressed?
  • Has the board, along with management, set specific objectives and goals for external reporting of ESG information?
  • Is the information disclosed by the company consistent across its various communication channels?
  • Are the ESG responsibilities at the board level clearly defined among appropriate committees and are those responsibilities directly linked to corporate strategic ESG goals and external reporting needs?
  • Have the right advisors been identified to assist in preparing for reporting and/or to attest to the quality of reporting?

Next steps

We encourage management, audit committees, and other board members to continue to educate themselves on the evolving landscape of ESG and carefully consider the needs of various stakeholders broadly when mapping out their ESG reporting needs. Particular attention should be paid to regulatory developments in this area.

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ESG reporting: Considerations for boards and those charged with governance