Current Financial Reporting Issues for Community Banks

Garry Rank | Shareholder | Elliott Davis

The Financial Accounting Foundation Board of Trustees established the private Company Council (PCC) to improve the process of setting accounting standards for private companies. Elliott Davis’s Garry Rank suggests banks should invite a reputable CPA or public accounting firm, whether they are currently a vendor or not, on a periodic basis to update them relative to accounting trends. Sessions could include a review of accounting products and services that could help the bank improve performance in such areas as credit underwriting or providing lower-cost alternatives to borrowers.

One of the overriding themes in regulator communications since the financial crisis emanates from the realization that weaknesses in underwriting lending standards were observable of up to three years before a bank failed. As such, regulators believe they didn’t do enough to end such practices and don’t want to find themselves in that position again.

In 2014, eight new accounting standards updates (ASU) have been issued, two of which are relevant to banks:

  • ASU 2014-01, “Accounting for Investments in Qualified Affordable Housing Projects,” provides guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in projects that qualify for the low-income housing tax credit. It permits use of the proportional amortization method if certain conditions are met.
  • ASU 2014-04, “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure,” clarifies when an in-substance repossession or foreclosure occurs. The update was issued in light of an increase in foreclosures, contains nothing altering current standards, and clarifies criteria to move loans to OREO.

While the Committee of Sponsoring Organizations (COSO) developed a framework for compliance with Sarbanes-Oxley (SOX) for public companies, private companies can be held to these internal control standards. The framework gained wide acceptance following financial control failures of the early 2000s. The five COSO components are: control environment, risk assessment, control activities, information and communication, and monitoring. The framework requires expanded financial reporting to include internal reporting and external non-financial reporting, additional focus on controls relative to competition, accountability, ethics, etc. Companies are required to have policies and procedures to identify and address problems relating to internal controls.

2014. Five steps recommended to make the transition are:

    • Develop awareness, expertise and alignment.
    • Conduct a preliminary impact assessment.
    • Perform a detailed review of the new areas of focus.
    • Develop and execute a COSO transition plan for SOX compliance that includes a remediation plan and updated documentation and test plans.
    • Communicate updates to external auditors.

Other observations:

  • Federal regulators have not objected to removing, under certain circumstances, a loan from the GAAP TDR classification.
  • Unallocated reserves are acceptable but should be held to 10–15 percent of reserves to be in the “safe zone.” A recent survey of 109 banks found 51 had an unallocated allowance; the unallocated portion of their allowances averaged 9.3% of their overall reserves.
  • A zero or negative ALLL calculation can occur when there is significant recovery in the current period, significant improvement in charge-off history and a reduction of Q factor impact due to improved credit quality. Marked improvement over three to four quarters is generally required before reporting a zero or negative provision.
  • Deferred tax asset recognition requirements, outlined under ASC 740, requires analysis of all factors to determine a need for a reversal of valuation allowance. Evidence of positive trends should extend back at least six to nine months and should include evidence of continued improvements in loan quality metrics.
  • Under the proposed ASU 2013-270, a lease would be defined as “a contract in which the right to use a specified asset is conveyed, for a period of time, in exchange for consideration.” It would lead to classifications of leases that would require new accounting approaches.