Anything But CECL Accounting Standards Update Paul Oseland

Anything But CECL: Accounting Standards Update Paul Oseland, CPA Accounting Specialist Federal Reserve Bank of Kansas City

Disclaimer The opinions expressed in this presentation are intended for informational purposes and are not formal opinions of, nor binding on, the Board of Governors of the Federal Reserve System or the Federal Reserve Bank of Kansas City.

Discussion Topics: • Public Business Entity (PBE) Status • Revenue Recognition • Financial Instruments – Recognition and Measurement • Leases • Derivatives and Hedging • Other Recently Issued Accounting Standards • Pending Standards – FASB Agenda • Regulatory Burden Relief

Public Business Entity (PBE) Status • ASU 2013 -12, “Definition of a Public Business Entity” Understanding PBE status is essential for determining new standard effective dates • Non-PBEs fall within the scope of Private Company Council accounting alternatives

Definition of PBE As defined in the ASC Master Glossary, a business entity is a public business entity if it meets any one of the following five criteria: A. It is required by the U. S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing). B. It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC (such as one of the federal banking agencies).

Definition of a PBE (cont. ) C. It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer. D. It has issued debt or equity securities that are traded, listed, or quoted on an exchange or an over-the-counter market, which includes an interdealer quotation or trading system for securities not listed on an exchange (for example, OTC Markets Group, Inc. , including the OTC Pink Markets, or the OTC Bulletin Board). E. It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U. S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.

PBE Determination Resources • “Public Business Entity” entry in the Glossary to the Call Report Instructions • SR 17 -8. “FAQs on CECL”, questions 28 through 33 • AICPA Technical Question & Answer document issues October 24, 2017

PBE Status Considerations • Call Reports do not constitute U. S. GAAP Financial Statements • Banks that satisfy their FDICIA 112 filing requirement at the holding company still satisfies the secondition of paragraph E. • Entities that issue brokered certificates of deposit (CDs) that are traded over the counter with publicly quoted prices meet criterion (d) of the PBE definition

PBE Status Considerations (cont. ) • A market that only certain investors qualified institutional investors or accredited investors) have access to is not an OTC market for purposes of applying the PBE definition – TRACE (Trade Reporting and Compliance Engine), EMMA (Electronic Municipal Market Access) and PORTAL (Private Offering, Resale and Trading through Automated Linkages)

PBE Status Considerations (cont. ) • “Contractual Restrictions” means securities are subject to management approval on resale – A “right of first refusal” is not a contractual restriction on transfer – S Corporation do not inherently result in a contractual restriction on transfer of securities – A bank that is a wholly owned subsidiary of a holding company has an implicit contractual restriction on the resale of its securities

New Standard Effective Dates • Public Business Entities – – – 2018: FI – Recognition and Measurement 2018: Revenue Recognition 2019: Leases 2019: Derivatives and Hedging 2020: CECL • Non-PBEs generally implement 1 year after PBEs • Early adoption may be allowed

Financial Instruments – Recognition and Measurement ASU 2016 -01, “Recognition and Measurement of Financial Assets and Financial Liabilities” • Requires equity securities not accounted for under the equity method or subject to consolidation to be measured at FV with changes recognized in income • Can choose to measure equities that do not have readily determinable FV at cost minus impairment plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer

FI – Recognition & Measurement • Simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment • Eliminates disclosures of FV for financial instruments measured at amortized cost for non. PBEs • PBEs must present Fair Value of loans at “Exit Price” in disclosures

FI – Recognition & Measurement Supervisory Issues • The Call Report is under revision to reflect the elimination of AFS equity securities – Will still be reported separately from trading equities • Recognition of FV changes in current earning could increase volatility • Federal Reserve and FHLB stock are explicitly scoped out, but Bankers Banks are not • “Exit Price” might require new modelling or the use of valuation experts

Revenue Recognition ASU 2014 -09, “Revenue from Contracts with Customers” • Establishes a comprehensive revenue recognition model that replaces numerous industry-specific models • Has been amended repeatedly since 2014 to address implementation issues and Transition Resource Group recommendations

Revenue Recognition (cont. ) Step 1 – Identify the contract with a customer Step 2 – Identify the performance obligations (promises) in the contract Step 3 – Determine the transaction price Step 4 – Allocate the transaction price to the performance obligations in the contract Step 5 – Recognize revenue when (or as) the performance obligation is satisfied

Revenue Recognition Supervisory Issues • Financial instruments and other contractual rights or obligations within the scope of Topic 310 (Receivables), Topic, 320 (Investments – Debt and Equity Securities), and Topic 815 (Derivatives and Hedging) are scoped out – Interest income, fair value adjustments, gains and losses on sales of financial instruments, loan origination fees are out of scope – May change the timing for certain fees associated with credit card arrangements, underwriting fees and costs, wealth management fees, and deposit-related fees.

Revenue Recognition Supervisory Issues (cont. ) Seller financed sales of OREO: • New standard eliminates the prescriptive criteria and methods for sale accounting and gain recognition in ASC 360 -20 • Determining whether a contract exists under the provisions of Topic 606 (step 1) requires judgment – Parties must be committed to perform their respective obligations – The transaction price must be collectible (probable that substantially all of the consideration will be collected)

Leases ASU 2016 -02, “Leases” • Retains the distinction between operating leases and capital (“finance”) leases • Requires lessees to record a right-of-use (ROU) asset and a lease liability on the balance sheet for operating leases • Permits a lessee to make an accounting policy election to exempt leases with a term of one year or less at their commencement date • Various transition “packages” and elections • Doesn’t look like it’s going to be fun to implement

Leases Supervisory Issues • Leases include equipment, etc. premises, autos, telecom – Must review service agreements to determine if there is an imbedded lease • Bringing Leases on balance sheet will impact capital ratio calculations – Impact is not expected to be substantial but does affect some organizations significantly – The ROU asset should be treated as a tangible asset not subject to deduction from regulatory capital and will be weighted at 100 percent

Derivatives and Hedging ASU 2017 -12, “Targeted Improvements Accounting for Hedging Activities” to • Generally makes it easier for companies to qualify for Hedge accounting • Eliminates separate measurement and recording of hedge ineffectiveness • Simplifies assessment of hedge effectiveness • Expands fair value hedges of interest rate risk on closed pools of pre-payable assets (last-of-layer method) • FASB speakers never fail to point out that “everyone likes this one”

Derivative and Hedging Supervisory Issues • Hedging can be a valuable risk management tool, but management must still has understand the nature and risks associated with hedge transactions – Watch out for vendors using the new standard to push sales of derivatives • The accounting is easier, but still complicated • “Don’t early adopt yourself into a material weakness”

Other Recently Issued Standards ASU 2017 -04, “Simplifying the Test for Goodwill Impairment” • Eliminates Step 2 from the goodwill impairment test • Entities will compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount the carrying amount exceeds the reporting unit’s fair value

Other Recently Issued Standards (cont. ) ASU 2017 -08, “Premium Amortization Purchased Callable Debt Securities” on • Shortens the amortization period for certain callable debt securities held at a premium by requiring it to be amortized to the earliest call date • Does not change accounting for securities held at a discount; the discount continues to be amortized to maturity

FASB’s Agenda • FASB appears to be taking a pause from its recent string of major projects – “Broad” versus “Narrow” distinction – “Technical Corrections and Improvements” – “Targeted Improvements” • No major exposure documents outstanding • Current technical agenda projects: – Distinguishing Liabilities from Equity – Elimination of U. S. Steamship Entities (Topic 995)

Cleanse the Palate

Regulatory Burden Relief • Joint Report to Congress - Economic Growth and Regulatory Paperwork Reduction Act (EGRPRA) – Published March 2017 • Recent Notices of Proposed Rulemaking • Call Report Streamlining – FFIEC 051 Call Report for Institutions with assets less than $1 billion • Exam Modernization

Notice of Proposed Rulemaking Regulatory Capital Rules: Retention of Certain Existing Transition Provisions for Banking Organizations That Are Not Subject to the Advanced Approaches Capital Rules • Published August 25 th (30 day comment period expired) • Would extend the current treatment under the regulatory capital rules for certain regulatory capital deductions and risk weights and certain minority interest requirements

Notice of Proposed Rulemaking Simplifications to the Capital Rule Pursuant to the EGRPRA • Published September 27 th (60 day comment period) • Provides for simpler regulatory capital treatment for: – (i) mortgage servicing assets – (ii) certain deferred tax assets arising from temporary differences – (iii) investments in the capital of unconsolidated financial institutions – (iv) capital issued by a consolidated subsidiary of a banking organization and held by third parties (minority interest). • Revises the treatment of high volatility commercial real estate

Call Report Streamlining New FFIEC 051 Call Report for Eligible Small Institutions • Streamlined report implemented as of 3/31/2017 report date for institutions with total assets less than $1 billion – Replaces all or part of 6 schedules with a Supplemental Information schedule on certain complex or specialized activities – Removing, or reducing reporting frequency for, other data items

Call Report Streamlining (cont. ) • Agencies stated their commitment to explore alternatives to the $1 billion asset-size threshold • Some burden-reducing changes to the FFIEC 041 and FFIEC 031 Call Reports also took effect 3/31/2017 • Additional phases of proposed burden-reducing Call Report revisions on track for 3/31/18 report – Would remove, raise reporting threshold for, or reduce reporting frequency for data items in all three versions of the Call Report

Examination Modernization FFIEC members will explore ways to improve safety and soundness examination and supervisory processes and tools • Viewed as a long-term project geared toward community banks • Reviewing examination practices and processes with focus on better use of technology • Reviewing format of examination report and Uniform Bank Performance Report

Questions?