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FDIC grants some banks temporary regulatory relief of Part 363 Audit and Reporting requirements

10.21.20

Read this if you are a bank.

On October 20, 2020, the FDIC Board of Directors voted to issue an interim final rule (the Rule) to provide temporary relief from the Part 363 Audit and Reporting requirements. Banks have experienced increases to their consolidated total assets as a result of large cash inflows resulting from participation in the Paycheck Protection Program (PPP) and the effects of other government stimulus efforts. 

Since these inflows may be temporary, but are significant and unpredictable, the Rule allows banks to determine the applicability of Part 363 of the FDIC’s regulations, Annual Independent Audits and Reporting Requirements, for fiscal years ending in 2021 based on the lesser of the bank’s:

  1. consolidated total assets as of December 31, 2019, or
  2. consolidated total assets as of the beginning of its fiscal year ending in 2021.

This Rule provides relief to banks that were going to meet the $1 billion FDICIA internal control audit requirement, or the $500 million management report and independence requirements, for 2021 due to asset growth from PPP loan activity and deposit liquidity. 

Note, a bank may be required to comply with one or more requirements of Part 363 if the FDIC determines that asset growth was related to a merger or acquisition. 

Planning tip

Despite the temporary relief, based on pre-COVID total assets and organic growth, banks could meet the requirements in 2022. Therefore, we recommend banks continue preparing internal control over financial reporting documentation and conduct preliminary testing to ensure a comfortable project timeline and smooth implementation. 

If any questions arise, please contact the BerryDunn FDICIA compliance team. We're here to help.
 

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Read this if you are a community bank.

The Federal Deposit Insurance Corporation (FDIC) recently issued its fourth quarter 2020 Quarterly Banking Profile. The report provides financial information based on call reports filed by 5,001 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community bank performance. In fourth quarter 2020, this includes the financial information of 4,559 FDIC-insured community banks. Here are our key takeaways from the community bank section of the report:

  • There was a $1.3 billion increase in quarterly net income from a year prior despite a 38.1% increase in provision expense and continued net interest margin (NIM) compression. This increase was mainly due to loan sales, which were up 159.2% from 2019. Year-over-year, net income is up 3.6%. However, the percentage of unprofitable community banks rose from 3.7% in 2019 to 4.4% in 2020.
  • Provision expense for the year increased $4.1 billion (a 141.6% increase) from 2019.
  • Year-over-year NIM declined 27 basis points to 3.39%. The average yield on earning assets fell 61 basis points to 4.00%.
  • Net operating revenue increased by $3.4 billion from fourth quarter 2019, a 14.5% increase. This increase is attributable to higher revenue from loan sales (increased $1.8 billion, or 159.2%) and an increase in net interest income.
  • Non-interest expenses increased 10.4% from fourth quarter 2019. This increase was mainly attributable to salary and benefit expenses, which saw an increase of $1.1 billion (12.6%). That being said, average assets per employee increased 16% from fourth quarter 2019.
  • Trends in loans and leases showed a moderate contraction from third quarter 2020, decreasing by 1.6%. This contraction was mainly seen in the C&I loan category, which was driven by a reduction in Paycheck Protection Program (PPP) loan balances. However, total loans and leases increased by 10.3% from fourth quarter 2019. Although all major loan categories expanded in 2020, the majority of growth was seen in C&I loans, which accounted for approximately two-thirds of the year-over-year increase in loans and leases. However, keep in mind, C&I loans include PPP loans that were originated in the first half of 2020.
  • Nearly all community banks reported an increase in deposit volume during the year. Growth in deposits above the insurance limit drove the annual increase while alternative funding sources, such as brokered deposits, declined.
  • Average funding costs fell 33 basis points to 61 basis points for 2020.
  • Noncurrent loans (loans 90 days or more past due or in nonaccrual status) increased $1.5 billion (12.8%) from fourth quarter 2019 as noncurrent balances in all major loan categories grew. However, the noncurrent rate remained relatively stable compared to fourth quarter 2019 at 77 basis points, partly due to strong year-over-year loan growth.
  • Net charge-offs decreased 4 basis points from fourth quarter 2019 to 15 basis points. The net charge-off rate for C&I loans declined most among major loan categories having decreased 24 basis points.
  • The average community bank leverage ratio (CBLR) for the 1,844 banks that elected to use the CBLR framework was 11.2%.
  • The number of community banks declined by 31 to 4,559 from third quarter 2020. This change includes two new community banks, four banks transitioning from non-community to community banks, three banks transitioning from community to non-community banks, 30 community bank mergers or consolidations, two community bank self-liquidations, and two community bank failures.

2020 was a strong year for community banks, as evidenced by the increase in year-over-year net income of 3.6%. However, tightening NIMs will force community banks to either find creative ways to increase their NIM, grow their earning asset bases, or find ways to continue to increase non-interest income to maintain current net income levels. Some community banks have already started dedicating more time to non-traditional income streams, as evidenced by the 40.1% year-over-year increase in non-interest income.

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. 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.

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

Article
FDIC issues its fourth quarter 2020 Quarterly Banking Profile

Read this if you are a bank.

Consolidated Appropriations Act
On December 27, 2020, the Consolidated Appropriations Act, 2021 (CAA) was signed into law. For financial institutions, aside from approving an additional $284 billion in Paycheck Protection Program funding, the CAA most notably extended troubled debt restructuring (TDR) relief. Originally provided in Section 4013 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, this relief allows financial institutions to temporarily disregard TDR accounting under US generally accepted accounting principles for certain COVlD-19-related loan modifications. Under the CARES Act, this relief was set to expire on December 31, 2020. The CAA extends such relief to January 1, 2022.

Relief from CECL implementation was also extended from December 31, 2020 to January 1, 2022.

We are here to help
If any questions arise, please contact the financial services team with any questions.

Article
TDR and CECL relief is extended for financial institutions

Read this if you are a community bank.

On December 1, 2020, the Federal Deposit Insurance Corporation (FDIC) issued its third quarter 2020 Quarterly Banking Profile. The report provides financial information based on call reports filed by 5,033 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community-bank performance based on the financial information of 4,590 FDIC-insured community banks. Here are some highlights from the community bank section of the report:

  • The community bank sector experienced a $659.7 million increase in quarterly net income from a year prior, despite a 116.6% increase in provision expense and continued net interest margin (NIM) compression. This increase was mainly due to loan sales, which were up 154.2% from 2019. Year-over-year, net income increased 10%.
  • Provision expense decreased 32.3% from second quarter 2020 to $1.6 billion. That said, year-to-date provision expense increased 194.3% compared to 2019 year-to-date.
  • NIM declined 41 basis points from a year prior to a record low of 3.27% (on an annualized basis). 
  • Net operating revenue increased by $2.8 billion from third quarter 2019, a 12.1% increase. This increase was attributable to higher revenue from loan sales and an increase in net interest income mainly due to higher interest income from commercial and industrial (C&I) loans (up 14.8%) and a decrease in interest expense (down 36.8%).
  • Average funding costs declined for the fourth consecutive quarter to 0.53%.
  • Growth in total loans and leases was stagnant from second quarter 2020, growing by only 1%. However, total loans and leases increased by 13.4% from third quarter 2019. This increase was mainly due to C&I lending, which was up 71%. This growth in C&I lending was mainly comprised of Paycheck Protection Program loans originated in the second quarter.
  • The noncurrent rate (loans 90 days or more past due or in nonaccrual status) remained unchanged at 0.80% from second quarter 2020. That being said, noncurrent balances were up $1.6 billion in total from third quarter 2019. This year-over-year increase was mainly attributable to increases in noncurrent nonfarm nonresidential, C&I, and farm loan balances.
  • Net charge-offs decreased 22.1% year-over-year and currently stand at 0.10%.
  • Total deposit growth since second quarter 2020 was modest at 1.8%. However, total deposits compared to third quarter 2019 were up 16.7%.
  • The number of community banks declined by 34 to 4,590 from second quarter 2020. This change included one new community bank, three banks transitioning from non-community to community banks, eight banks transitioning from community to non-community banks, 29 community bank mergers or consolidations, and one community bank self-liquidation.

Community banks have been resilient and weathered the 2020 storm, as evidenced by an increase in year-over-year net income of 10%. However, tightening NIMs will force community banks to find creative ways to increase their NIM, grow their earning asset base, and identify ways to increase non-interest income to maintain current net income levels. 

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. 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. 

Despite the turbulence caused by the pandemic, there are many positive takeaways, and community banks have proven their resilience. Previous investments in technology, including customer facing solutions and internal communication tools, have saved time and money. As the pandemic forced many banks to move away from paper-centric processes, the resulting efficiencies of digitizing these processes will last long after the pandemic. 

If you have questions about your specific situation, please don’t hesitate to contact BerryDunn’s Financial Services team. We’re here to help.
 

Article
FDIC issues its third quarter 2020 banking profile

Read this if you are a Financial Operations Principal or in the compliance department.

On July 30, 2013 the Securities and Exchange Commission (SEC) amended certain reporting, audit, and notification requirements for broker-dealers registered with the SEC. Among other things, these amendments required broker-dealers to file one of two new reports with the SEC—a compliance report, if the broker-dealer did not claim it was exempt from Rule 15c3-3 under the Securities Exchange Act of 1934, or an exemption report if the broker-dealer did claim it was exempt from Rule 15c3-3 throughout the fiscal year. The Division of Trading and Markets of the SEC came out with frequently asked questions regarding the amendments made on July 30, 2013 and periodically updates this list of frequently asked questions. This list was updated July 1, 2020. Here are some of the most notable changes to the FAQs. For the full list, click here.

Exemption provisions

As noted above, a broker-dealer may claim exemption from Rule 15c3-3. Paragraph (k) of Rule 15c3-3 outlines four exemption provisions: (k)(1), (k)(2)(i), (k)(2)(ii), and (k)(2)(iii). Exemption provision (k)(1) may be claimed by broker-dealers that only perform direct-way mutual fund or variable annuity business. If the broker-dealer performs any other type of business, this exemption may not be claimed. Exemption provision (k)(2)(i) is commonly seen as a catch-all for broker-dealers whose businesses don’t qualify for a different exemption. However, to qualify, the broker-dealer cannot carry margin accounts, must promptly transmit all customer funds and deliver all securities received, and cannot otherwise hold funds or securities for, or owe money or securities to, customers. All transactions must be completed through one or more bank accounts specially designated for such transactions. Exemption provision (k)(2)(ii) is for broker-dealers that introduce transactions to a carrying broker-dealer on a fully disclosed basis. Lastly, exemption provision (k)(2)(iii) may be granted by the SEC upon written application by a broker-dealer. However, the SEC has never granted such an exemption.

Exemption report prohibitions

In some instances, a broker-dealer may not meet any of the exemption provisions of paragraph (k) of Rule 15c3-3. However, the broker-dealer may have also not held customer securities or funds during the fiscal year and therefore not be required to file a compliance report. In these instances, the broker-dealer should file an exemption report, along with a corresponding accountant’s report based on a review of the exemption report. 

Since the broker-dealer has not claimed an exemption under paragraph (k) of Rule 15c3-3, its exemption report should include a description of all the broker-dealer’s business activities and a statement that during the reporting period the broker-dealer (1) did not directly or indirectly receive, hold, or otherwise owe funds or securities for or to customers, other than money or other consideration received and promptly transmitted in compliance with paragraph (a) or (b)(2) of Rule 15c2-4; (2) did not carry accounts of or for customers; and (3) did not carry a propriety securities account of a broker or dealer (PAB accounts, as defined in Rule 15c3-3). Furthermore, on the broker-dealer’s FOCUS report, items 4550, 4560, 4570, and 4580 should be left blank.

Broker-dealers with multiple lines of business

Non-carrying broker-dealers may have multiple lines of business with customers. For instance, a broker-dealer may introduce some customer transactions to a carrying broker-dealer on a fully disclosed basis and also provide M&A transaction services. For the former, a (k)(2)(ii) exemption would be most appropriate. However, in the latter, a (k)(2)(i) exemption would be most appropriate. In these cases, it is common for the broker-dealer to disclose the exemption that best fits their primary line of business. However, the SEC has indicated the broker-dealer should disclose both exemption provisions in these instances, including any exceptions under either exemption. Each exemption provision being claimed should also be indicated on the broker-dealer’s FOCUS report. 

Similarly, some broker-dealers may provide activities that qualify under one or more of the exemption provisions of Rule 15c3-3 as well as activities that involve the activities described in items 1, 2, and 3 above. In these instances, the broker-dealer would not qualify for exemption from Rule 15c3-3 and would be required to file a compliance report with a corresponding accountant’s report based on an examination of the compliance report.

The exemption provisions for broker-dealers can be difficult to navigate. Further exacerbating the difficulty of navigating the exemption provisions, each broker-dealer has a different set of circumstances. The SEC’s Division of Trading and Markets also acknowledges these difficulties, hence the creation of its FAQ list. Broker-dealers should refer to this list, in conjunction with Rule 15c3-3, to ensure compliance. If further clarification is needed, the broker-dealer should consult their Financial Industry Regulatory Authority (FINRA) representative. 

Article
The SEC updates its broker-dealer financial reporting rule FAQs 

Read this if you administer a 401(k) plan.

On December 20, 2019, the Setting Every Community up for Retirement Enhancement (SECURE) Act was signed into law. The SECURE Act makes several changes to 401(k) plan requirements. Among those changes is a change to the permissible minimum service requirements.  
 
Many 401(k) retirement plan sponsors have elected to set up minimum service requirements for their plan. Such requirements help eliminate administrative burden of offering participation to part-time employees who may then participate in the plan for a short period of time and then keep their balance within the plan. Although plan sponsors do have the ability to process force-out distributions for smaller account balances, a minimum service requirement, such as one year of service, can help eliminate this situation altogether.  

Long-term part-time employees now eligible

The SECURE Act will now require that long-term part-time employees be offered participation in 401(k) plans if they are over the age of 21. The idea behind the requirement is that 401(k) plans are responsible for an increasingly larger amount of employees’ retirement income. Therefore, it is essential that part-time employees, some of which may not have a full-time job, have the ability to save for retirement.  
 
Long-term is defined as any employee who works three consecutive years with 500 or more hours worked each year. This new secondary service requirement becomes effective January 1, 2021. Previous employment will not count towards the three-year requirement. Therefore, the earliest a long-term part-time employee may become eligible to participate in a plan under the secondary service requirement is January 1, 2024.  

403(b) plans not affected 

Please note this provision is only applicable for 401(k) plans and does not impact 403(b) plans, which are subject to universal availability. Furthermore, although long-term part-time employees will be allowed to make elective deferrals into 401(k) plans, management may choose whether to provide non-elective or matching contributions to such participants. These participants also may be excluded from nondiscrimination and top-heavy requirements.  
 
This requirement will create unique tracking challenges as plans will need to track hours worked for recurring part-time employees over multiple years. For instance, seasonal employees who elect to work multiple seasons may inadvertently become eligible. We recommend plans work with their record keepers and/or third-party administrators to implement a tracking system to ensure participation is offered to those who meet this new secondary service requirement. If a feasible tracking solution does not exist, or plans do not want to deal with the burden of tracking such information, plans may also consider amending their minimum service requirements by reducing the hours of service requirement from 1,000 hours to 500 hours or less. However, this may allow more employees to participate than under the three-year, 500-hour requirement and may increase the employer contributions each year. 

If you have questions regarding your particular situation, please contact our Employee Benefit Audits team. We’re here to help.

Article
New permissible minimum service requirements for 401(k) plans

Read this if you are a bank with over $1 billion in assets.

It’s no secret COVID-19 has had a substantial impact on the economy. As unemployment soared and the economy teetered on the edge of collapse, unprecedented government stimulus attempted to stymie the COVID-19 tidal wave. One tool used by the government was the creation of the Paycheck Protection Program (PPP). Part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the PPP initially authorized the lending of $349 billion to encourage businesses to keep workers employed and cover certain operating expenses during the coronavirus pandemic. The PPP was then extended through August 8, 2020 with an additional $310 billion authorized.

Many financial institutions scrambled to free up resources and implement processes to handle the processing of PPP loan applications. However, such underwriting poses unique challenges for financial institutions. PPP loans are 100% guaranteed by the US Small Business Administration (SBA) if the borrowers meet certain criteria. Establishing appropriate controls over the loan approval and underwriting process is more a matter of ensuring compliance with the PPP, rather than ensuring the borrower can repay their loan.

Federal Deposit Insurance Corporation Improvement Act of 1991 compliance 

Banks with total assets over $1 billion as of the beginning of their fiscal year must comply with the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). Amongst other things, FDICIA requires management perform an assessment and provide a resulting attestation on the operating effectiveness of the bank’s internal controls over financial reporting (ICFR) as of the bank’s fiscal year-end. Although this attestation is as of year-end, management must perform testing of the bank’s ICFR throughout the bank’s fiscal year to obtain sufficient evidence regarding the operating effectiveness of ICFR as of year-end. Key controls over various transaction cycles are typically housed in a matrix, making it easy for management and other users, such as independent auditors, to review a bank’s key ICFR. 

Internal control documentation

If the process for originating PPP loans is different from the bank’s process for traditional loan products, it’s likely the internal controls surrounding this process is also different. Given that $659 billion in PPP loans have been granted to date, it is possible PPP loans may be material to individual banks’ balance sheets. If PPP loans are material to your bank’s balance sheet, you should consider the controls that were put in place. If the controls are deemed to be different from those already documented for other types of loans, you should document such controls as new controls in your FDICIA matrix and test accordingly.

As noted earlier, the risks a financial institution faces with PPP loans are likely different from traditional underwriting. If these unique risks could impact amounts reported in the financial statements, it’s smart to address them through the development of internal controls. Banks should assess their individual situations to identify any risks that may have not previously existed. For instance, given the volume of PPP loans originated in such a short period of time, quality control processes may have been stretched to their limits. The result could be PPP loans inaccurately set up in the loan accounting system or loan files missing key information. Depending on the segregation of duties, the risk could even be the creation of fictitious PPP loans. A detective internal control that could address inaccurate loan setup would be to scan a list of PPP loans for payment terms, maturity dates, or interest rates that appear to be outliers. Given the relatively uniform terms for PPP loans, any anomalies should be easily identifiable. 

Paycheck Protection Program loan fees

Aside from internal controls surrounding the origination of PPP loans, banks may also need to consider documenting internal controls surrounding PPP loan fees received by the SBA. Although the accounting for such fees is not unique, given the potential materiality to the income statement, documenting such a control, even if it is merely addressing the fees in an already existing control, exhibits that management has considered the impact PPP loan fees may have on their ICFR. 

The level of risk associated with PPP loan fees may differ from institution to institution. For instance, a bank that is calculating its PPP loan fees manually rather than relying on the loan accounting system to record and subsequently recognize income on these fees, inherently has more risk. This additional level of risk will need to be addressed in the development and documentation of internal controls. In this example, a periodic recalculation of PPP loan fees on a sample basis, including income recognition, may prove to be a sufficient internal control.

With the calendar year-end fast approaching, it is time to take a hard look at those FDICIA matrices, if you haven’t already done so:

  • Consider what has changed at your bank during the fiscal year and how those changes have impacted the design and operation of your internal controls. 
  • Ensure that what is happening in practice agrees to what is documented within your FDICIA matrix. 
  • Ensure that new activities, such as the origination of PPP loans, are adequately documented in your FDICIA matrix. 

With Congress considering another round of PPP loans, there is no time like the present to make sure your bank is ready from an ICFR perspective. If you have questions about your specific situation, or would like more information, please contact the FDICIA compliance team

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Do your FDICIA controls "CARES" about the Paycheck Protection Program?