New Accounting and Reporting Requirements for Banks

Need to Know:  A Financial Institution’s 2011 Checklist

Important Considerations for Financial Institutions Heading into 2011

Proposed Accounting and Disclosure Requirements Significant to Financial Institutions

Clarifications to Accounting for Troubled Debt Restructurings (TDRs) by Creditors Proposal.  In October 2010, FASB published proposed guidance that would apply to all creditors (both public and nonpublic) and is intended to assist them in determining whether modifications of the terms of a receivable meet the criteria to be considered a TDR, both for purposes of recording an impairment and for disclosure of TDRs.  The main provisions of the proposal include:

• The creditor is precluded from using the borrower’s effective rate test (whereby a debtor compares the effective rate on the debt immediately before and immediately after a restructuring to identify whether that restructuring constitutes a concession by the creditor) in its evaluation of whether a restructuring constitutes a TDR.
• If the debtor does not otherwise have access to funds at a market rate for debt with similar risk characteristics as the restructured debt, the restructuring would be considered to be at below a market rate and therefore should be considered a TDR.
• A restructuring that results in a temporary or permanent increase in the contractual interest rate cannot be presumed to be at a rate that is at or above market.
• A borrower that is not currently in default may still be considered to be experiencing financial difficulty when payment default is considered “probable in the foreseeable future”.
• A restructuring that results in an insignificant delay in contractual cash flows may still be considered a TDR.  This factor should be considered along with other terms of a restructuring to determine whether a TDR restructuring exists.

For purposes of measuring impairment, the proposed clarifications would be effective on a prospective basis for interim and annual periods ending after June 15, 2011, with retrospective application permitted.  For purposes of identifying and disclosing TDRs, the proposed clarifications would be effective for interim and annual periods ending after June 15, 2011 and would be applied retrospectively to restructurings occurring on or after the beginning of the earliest period presented.
The most likely impact of this proposed guidance is that more loan modifications will be considered TDRs.

Effective date for required disclosures about troubled debt restructurings will be reconsidered by FASB.  The FASB has proposed to change the effective date of the disclosures as described in ASU No. 2010-20 Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses to make it concurrent with the effective date of the proposed clarifications discussed above related to the identification of TDRs.

Lease Accounting Proposal (jointly developed by the FASB and IASB).  This will significantly impact lessees with “operating leases” requiring the Company’s to record on their balance sheet a “right-of-use” asset as well as a corresponding “obligation to pay rentals”.  Rent would disappear from the income statement and be replaced with interest expense (therefore impacting your net interest margin) and amortization.  The timing of the expense recognition would also be accelerated under this proposed guidance.  Leverage and capital ratios will deteriorate due to the newly inflated balance sheet.  Existing leases will not be grandfathered; all leases will need to be reflected on the balance sheet upon adoption (the date of initial application is the beginning of the first comparative period presented in the first financial statements in which the Company applies this guidance).  The exposure draft was issued in August 2010.  A final standard is expected in 2011; the Boards are still deliberating the effective dates of the standard but it is expected to be 2013 or later.

Proposed Changes in Accounting for Repos.  An exposure draft issued by the FASB in November 2010 intends to simplify the accounting for repurchase agreements (“repos”) by eliminating the collateral maintenance provision when a Company is assessing effective control in determining whether or not to recognize a transfer of a financial asset as a sale or a secured borrowing.  This change seeks to base the effective control assessment on contractual rights and obligations rather than practical ability to exercise those rights or honor those obligations.  The elimination of this provision may cause more repos to be accounted for as secured borrowings rather than as sales.  This will be effective for new transfers and existing transactions that are modified as of the beginning of the first interim or annual period after the final issuance of the standard (expected to occur during the first quarter of 2011).  The comment period closes on January 15, 2011.

Proposed Enhanced Disclosures about Short-Term Borrowings for SEC filers.  This proposal would require a separately captioned subsection of Management’s Discussion and Analysis of Financial Condition and Results of Operations providing a comprehensive explanation of short-term borrowings including both quantitative and qualitative information.  This proposed amendment would be applicable to annual and quarterly reports as well as proxy or information statements that include financial statements and registration statements under both the Securities Exchange Acts of 1934 and 1933.  There are also proposed conforming amendments for the Form 8-K that would require the use of the terminology contained in this proposed short-term borrowings requirement.  The comment period closed on November 29, 2010.

I will continue throughout the next year to keep you abreast of current developments impacting financial institutions.  With increased monitoring and reporting requirements as well as increased complexities in accounting for financial institutions, we can be your trusted advisor to help you navigate through the myriad of changes.  Please contact me directly 315.214.7562 or jkeiser@bonadio.com with any questions or concerns or if I can be of any assistance to you or your institution.