Our Financial Institution Practice - Saltmarsh CPA

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PaulS.Allen,CPA,CGMA,ShareholderSaltmarsh,Cleaveland&Gund

BankExecutiveForum:AccountingUpdateSeptember25,2015

MajorAccountingProposalsUpdateOverviewofCOSORevisionand

FraudConsiderations

Since1944,Saltmarshhasbeenprovidingauditing,tax,andconsultingservicestoawiderangeoffinancialinstitutions.Ourstaffhaveworkedwithhundredsoffinancialinstitutionsoverourhistory,andcurrentlyserveover120financialinstitutions,ranginginsizefrom$20milliontoover$3billionintotalassets.

Servicestofinancialinstitutionsinclude: ExternalAuditandTax InternalAudit,includingLoanandDepositOps,FinancialReporting,CallReportReview,HR,Trust,InvestmentSecurities,IRR/ALM,LiquidityandALLLMethodology

Compliance ISReviews,includingPenetrationandVulnerabilityTesting LoanReview

OurFinancialInstitutionPractice

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DiscussionTopics

• BankingQuickUpdate• AccountingandReportingIssues:

• RevenueRecognitionStandard• Leasesproject• CECL(ExpectedversusIncurredLoss)

• COSOFrameworkRevision• FraudConsiderationsUpdate• CirclingbacktoEnterpriseRiskManagement(ERM)

• ProfitsReturn,ProblemLoansDecrease,NIMstabilize,consumerdelinquenciesandlossesverylow….what’snottolike?– Loandemandslow– Banksturningtoriskierloantypes,ordrivingCREConcentrationshigher

– Questionablewhethercostoffundscangolowerorstayaslowastheyare,pressuringNIM

– Nonbankmarketentrants(Apple?)

BankIndustryUpdate

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RevenueRecognition• RevenueRecognitionTopic606

– Arguablylessimpactoncommunitybanksthanmanyotherindustriesorlargebanks,butmayimpactrecordingsalesofrealestate,suchasREOsaleswheretheBankfinancesthesale(FAQ,oldFAS66downpaymentguidelinesstilluseful?)

– Manytypicalnoninterestincomeitemsscopedout– Questionsremainonapplicationonbundledservicesthatmixaservicefeeplusascopedoutfee

– EffectivedateWASin2016forpublic,and2017fornonpublic;nowproposedtodeferoneyear(periodsbeginningafter12/15/2017public,after12/15/18fornonpublic);earlyapplicationnotbefore12/15/16

MajorImpacts

TotheBank:

• Mayhavetocarefullyconsiderthetimingofrevenuerecognitiononbundledproducts

• Mayhavetodeferincomerecognitiononproductsthathavetraditionallyhitthebottomlineimmediately

• Morecomplicatedaccounting

ToYourCustomers:

• Expectmuchmoreofanimpacttomanufacturingorcontractors

• Maycausea(temporary)dropinincome,asrevenuerecognitiongetsdelayed

• Maycauseanincreaseinoperationalexpenses,foraddedcomplexityinaccounting

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LeasesProject• Status‐ Finalstagesofreviewandapproval,estimatedcompletionQ4of2015;ASUTopic842–revisionof2010ASUTopic840

• UndertheproposalsinthisED,alesseewouldreportassetsandliabilitiesforallleasesofmorethan12monthsonitsbalancesheet

• Doesnotapplytoleasesofintangibleassets,explorationoruseofnaturalresources,biological/timberassets,orserviceconcessionarrangements

• Canexcludeshortterm(12monthsorless)leases

•Keybalancesheetmetrics‐principally,increaseinassets‐maychange•Changestoleaserevenueandexpensesmayaffectotherkeymetrics,suchasearningsbeforeinterest,taxes,depreciationandamortization(EBITDA);lessorsmayhavetodefergainonsale•Debtcovenantsandborrowingcapacitymaybeaffected•Decisionsofwhethertoleaseorbuysignificantassetsmaybeaffected•PossibleimpactonCallReport/CapitalRatios(lowerleverageratio)•ImpactontheCreditdepartmentandhowitwillimpactlendingdecisions

Leases‐LikelyImpacts

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• Overview:newFASBpronouncementexpected,whichwillrevisittheissueofhowtocalculatetheAllowanceforLoanLoss,shiftingfromthehistorical“incurredlosses”basistothe“expectedlossesoverthelifeoftheloan”basis

• HasnotyetbeenissuedbyFASB,earliestlikelyissuancewouldbemid‐to‐late4th quarterof2015,probablyahealthytransitionperiod,likelyearliestforpubliccompaniesin2018,nonpublicin2019

• ExpectedimpactwouldbetorequirehigherlevelsofALLL,perhapsfrom1.5%currentaverageto2.00%average

• Willrequirealotmoredatagatheringandanalysis;significantimpacttothe“FAS5”reserve,notsomuchtothe“FAS114”reserve

CECLProposal

• Recognizeanallowanceforexpectedcreditlossesonfinancialassets– ExpectedCreditLossisdefinedas:

• “Anestimateofallcontractualcashflowsnotexpectedtobecollectedfromarecognizedfinancialasset(orgroupoffinancialassets)orcommitmenttoextendcredit.”

– Considersmoreforward‐lookinginformationthanispermittedundercurrentU.S.GAAP

• Basedonrelevantinformationaboutpastevents,currentconditions,andreasonableandsupportableforecasts thataffecttheexpectedcollectibilityofthefinancialassets’remainingcontractualcashflows

• Includesquantitativeandqualitativefactorsspecifictoborrowersandtheeconomicenvironmentinwhichtheentityoperates.Inadditiontoevaluatingtheborrowers’currentcreditworthiness,theassessmentincludesanevaluationoftheforecasteddirectionoftheeconomiccycle

– Theprobablethresholdandtheincurredlossnotionareremoved

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• Noearlyincorporationof“expectedloss”conceptsor“softadoption”

• NoartificialinflationofALLLtosmoothimpact• Don’twaittoprepare• Don’toverloadatadoption

– No“cookiejar”reserves

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• Updateofthe1992COSOFramework,the“2013Revision”

• COSO:CommitteeofSponsoringOrganizations(AmericanAccountingAssociation‐AAA,AICPA,FinancialExecutivesInternational‐FEI,InstituteofManagementAccountants‐IMA,InstituteofInternalAuditors‐IIA

• Moreofanupdateoftermsandatweak,thanamajorrevision

COSOFrameworkUpdate

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• Threeobjectives– Effectivenessandefficienciesofoperations– Reliabilityofreporting– Compliancewithlawsandregulations

• Fivecomponents– ControlEnvironment– RiskAssessment– ControlActivities– InformationandCommunication– MonitoringActivities

Whatwasretainedfrom1992

• Createsamoreformalstructure,establishes17Principals,organizedunderthe5components,andprovidespointsoffocusforeachprinciple

• Addsandrefreshesguidancewithineachofthe5components

• Includesguidancerequiringenhancedriskassessment,inclusionoffraudrisk,andconsiderationofERM

Whatwasaddedin2013

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• Muchmorerobustriskassessmentprocess,“enhancedriskassessment”,moredynamic,deeperdiveintooperationalrisk;introduces“velocity”and“persistence”ofriskinadditiontoimpactandlikelihood

• Formalrequirementtoconsiderfraudriskasintegralelementofcomprehensiveriskassessment

• Considerationofoutsourcedserviceproviders(12of17principlesrelatetoOSP)

ImpacttoCommunityBanks

Excerpted Slides from the 2014 Global Fraud Study, to focus on the United States, and, where possible, the Banking Industry.

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Industry of Victim Organization

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We’re number one…

Initial Detection of Occupational Frauds

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Note importance of Tips as method of detection…value of audit discussion and inquiry of employees at various levels

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Source of Tips

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Note: Tips most common source of detection, majority from employees…so – do we encourage communication from our employees?

Effectiveness of Controls

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Can we afford NOT to have these controls in place and working?

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Control Weaknesses That Contributed to Fraud

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Behavioral Red Flags Displayed by Perpetrators

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Trust your judgment…top four red flags are what you’d think

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WhatisEnterpriseRiskManagement(ERM)?

Aprocessthatenablesmanagementtoeffectivelydealwithuncertaintyandassociatedriskandopportunity,enhancingthecapacitytobuildshareholdervalue,byconsideringtheinteractionofallriskstheentityfaces.

ERMQuestionHowmuchriskarewewillingtoacceptacross

theentireBank?RiskAppetiteDefinition:Theamountofriskabankiswillingtoacceptinpursuitofvalue.Itreflectsthebank’sriskmanagementphilosophyandinfluencesthecultureandoperatingstyle.Riskappetiteassists(thebank)inaligningthebank,people,andprocessesincreatingtheinfrastructurenecessarytoeffectivelyrespondtoandmonitorrisk.

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Typesofbankingrisk(weknowthese)

• CreditRisk• InterestRateandLiquidityRisk• RegulatoryRisk(compliance)• OperationalandTransactional• LegalRisk• TechnologyRisk• ReputationalRisk• MarketRisk

RecentFinancialCrisisWhatwentwrong?

InternalForces‐growth&profitabilityvs.riskOverlookingcontrolstomitigaterisk

ConcentrationsExternalForces‐competitionovertook

underwritingstandardsPropertyValueExpectations

ComplexityinFinancialInstruments

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• Top5EnterpriseRiskstoWatchfor:– Cybersecurity– Businessinterruptionandsupplychain– Talentmanagement– Crisisresponse– Compliancewithnewregulations

• 2014wasyearof“emergingrisks”– Cyberattacks;Ebola;InstabilityinEasternEurope;ISISandheightenedterrorismrisk

Re:RA‐ 2015RisksperIIA(RichardChambers,President‐ IAA2015Update)

Questions?

Paul S. Allen, CPASaltmarsh, Cleaveland & Gund

Phone 1-800-477-7458, ext 1401Email:

paul.allen@saltmarshcpa.com

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Bill MasseyAlex Hager

Lee Bell Kristen Stogniew

Paul Allen

Denice Miller

Stephen Reyes

Nathan Botts