Perspectives

Banking & Capital Markets

Accounting and Financial Reporting Update (2018)

The 2018 edition of our annual update highlights selected accounting and reporting developments that may be of interest to entities in the banking and securities sector. Some of the notable standard-setting developments in 2018 were (1) the discussions by the FASB’s credit losses transition resource group (TRG) of certain implementation issues related to the guidance on measurement of credit losses on financial instruments, (2) the issuance of guidance related to the inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) rate as a benchmark interest rate for hedge accounting purposes, and (3) continued work by the various standard setters on issues related to implementation of the new leasing standard.

Introduction

The year 2018 has been a strong growth year to date, as shown by solid market performance and the Federal Reserve’s continued focus on raising the federal funds rate. Banking and securities institutions have remained focused on complying with industry regulations while managing expenses.

Economic Environment

The banking and capital markets industry continues to be affected by costs and complexities of litigation as well as increasing domestic and global regulatory requirements, although the current political environment may bring about changes in the level of regulations imposed. Residential, commercial, and consumer lending has continued to increase. With the increases in interest rates, customers are increasingly seeking higher returns on their deposits, leading to compression in interest rate spreads as competition has led to rises in deposit interest rates. In turn, the Office of the Comptroller of the Currency (OCC) has reported incremental easing in commercial credit underwriting practices as competition has increased.

Financial Reporting Developments

New Guidance on Measurement of Credit Losses on Financial Instruments

In June 2016, after several years of deliberations and exposure drafts, the FASB issued ASU 2016-13 on measurement of credit losses on financial instruments. The ASU introduces the current expected credit loss (CECL) model to U.S. GAAP. This CECL model will require entities to record all losses that are expected for the life of the financial instrument. The ASU does not provide specific methods for measuring the expected credit losses; rather, the principles-based guidance allows individual institutions to develop their own calculations to reflect their expected credit losses, and it permits certain practical expedients. In addition, the ASU makes certain improvements to the existing other-than-temporary impairment model in ASC 320 for certain available-for-sale (AFS) debt securities to eliminate the concept of “other than temporary” from that model.

In 2018, the FASB and the credit losses TRG addressed a number of implementation issues, including (1) consideration of capitalized interest by using a method other than a discounted cash flow (DCF) method under the CECL model, (2) the definition of “amortized cost basis” and the reversal of accrued interest on nonperforming financial assets, (3) the transfer of loans between held for sale (HFS) and held for investment (HFI) and the transfer of credit-impaired debt securities between available for sale (AFS) to held to maturity (HTM), and (4) accounting for recoveries under the CECL model. The TRG will continue to meet on an as-needed basis throughout the implementation period.

For public business entities (PBEs) that meet the U.S. GAAP definition of an SEC filer, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For PBEs that do not meet the U.S. GAAP definition of an SEC filer, the ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.

Banking institutions and their regulators continue to consider the capital implications of CECL. In May 2018, the Federal Reserve Board issued a proposal to revise its regulatory capital rules to provide an option to phase in the regulatory capital effects of the CECL approach. The proposal, if finalized, would allow banking organizations to phase in the day 1 regulatory capital effects of CECL adoption over a three-year period. In addition, in November 2018, 21 large U.S. banks authored a joint letter to the FASB requesting relief with the following proposals:

  • For nonimpaired financial assets, loss expectations within the first year would be recorded to provision for losses in the income statement.
  • Loss expectations beyond the first year would be recorded in accumulated other comprehensive income (AOCI).
  • For impaired financial assets, lifetime expected credit losses would be recognized entirely in earnings.

The letter was submitted to the FASB, which is in the process of reviewing the proposals. Although there is no guarantee that the FASB will reconsider the CECL model in light of this letter, interested parties should continue to monitor developments.

Inclusion of the SOFR OIS Rate as a Benchmark Interest Rate for Hedge Accounting Purposes

During the hedge accounting project that led to the issuance of ASU 2017-12 in August 2017, the Federal Reserve Board and the Federal Reserve Bank of New York (the “Fed”) requested that the OIS rate based on the SOFR be considered eligible as a U.S. benchmark interest rate for hedge accounting purposes under ASC 815. The SOFR is a volume-weighted median interest rate that is calculated daily on the basis of overnight transactions from the prior day’s trading activity in specified segments of the U.S. Treasury repurchase agreement (“repo”) market. Similar to the OIS rate based on the Fed Funds Effective Rate, which is a swap rate based on the underlying overnight Fed Funds Effective Rate, the OIS rate based on the SOFR will be a swap rate based on the underlying overnight SOFR.

In 2014, the Fed convened the Alternative Reference Rates Committee (ARRC), made up of a consortium of major financial institutions and other market participants, to identify a suitable alternative to the U.S. dollar London Interbank Offered Rate (LIBOR) that is more firmly based on actual transactions in a robust market.

The ARRC in 2017 identified a broad Treasury repo financing rate (i.e., the SOFR) as its preferred alternative reference rate, and the Fed began publishing that daily rate on April 3, 2018. The ARRC expressed the importance of including the OIS rate based on the SOFR as a benchmark rate for hedge accounting purposes to facilitate broader use of the underlying SOFR in the marketplace.

In October 2018, the FASB issued ASU 2018-16, which introduces the SOFR OIS rate as an eligible benchmark interest rate for hedge accounting purposes. The ASU was issued because of concerns expressed by the Fed regarding the sustainability of the LIBOR.

Targeted Improvements to Accounting for Leases

In February 2016, the FASB issued ASU 2016-02 on accounting for leases. The ASU’s intent is to establish principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. The ASU significantly amends the accounting for leases, causing lessees in particular to recognize most leases on the balance sheet. ASU 2016-02 will have a significant impact on the balance sheets of all entities, including banking and securities institutions.

In July 2018, the FASB issued ASU 2018-10, which makes 16 separate amendments to ASC 842 related to implementation issues, primarily to clarify the guidance’s intent and provide technical corrections. Also in July 2018, the FASB issued ASU 2018-11, which provides entities with relief from the costs of implementing certain aspects of ASU 2016-02. Under the amendments made by ASU 2018-11, entities may elect not to recast the comparative periods presented when transitioning to ASC 842. In addition, lessors may elect not to separate lease and nonlease components when certain conditions are met.

For PBEs, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods therein. For all other entities, the ASU is effective for annual periods beginning after December 15, 2019 (i.e., calendar periods beginning on January 1, 2020), and interim periods thereafter. Early adoption is permitted for all entities.

For additional information about industry issues and trends, see Deloitte’s 2019 Financial Services Industry Outlooks.

View the rest of the banking and capital markets newsletter.

Banking & Capital Markets — Accounting and Financial Reporting Update (2018)
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