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What SEC-Registered Banks Can Expect at Next Review

By Bridget Day

In today’s turbulent economic times, wouldn’t you like to have a crystal ball to see what questions might be posed by the Securities and Exchange Commission (SEC) or your regulators? Well, while there’s no crystal ball available, there are some visible trends in what “they” have been asking.

After searching SEC correspondence for the 12-month period ended September 2010 for commercial banking, consumer lending and savings institution registrants in the New Jersey, New York and Pennsylvania marketplace, certain topics began to appear with regularity.
To no one’s surprise, allowance for loan losses was the biggest winner. Questions posed focused on adding more detail to future filings, specifically relating to trends in specific reserves, charge offs, impaired loans, non-accrual statistics, etc. Accounting Standards Update (ASU) No. 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” issued July 2010, summarizes the required disclosures. A number of comments asked for a more robust discussion of the allowance for loan loss methodology and supporting trends.
With the recent unprecedented economic volatility, discussion of historic trends and their impact on reserving has become less relevant. This causes inconsistencies in the information presented and leaving the regulators with unanswered questions. In other words, the SEC wants to know what you are basing reserves on now, knowing that history is no longer relevant.
Other than temporary impairment (OTTI) was another repeat item. You can expect the regulators to want a detailed discussion on the components of any OTTI impairment analysis (credit versus market), the methodology used to perform the impairment analysis and its frequency. The OTTI discussion should be as granular as possible including but not limited to, disclosure of individual issuers, credit ratings, dollar value at risk and concentrations, where applicable.
Goodwill impairment was another hot topic. Current US GAAP requires a two-step process for identifying and quantifying goodwill impairment. Registrants have been asked to expand disclosures relating to their two-step process.
The first step in this process is to compare the fair value of goodwill to the carrying value for any reporting unit which includes goodwill. If this test suggests impairment, a second step is required which determines if the carrying value of the goodwill exceeds its implied fair value. In this case “implied fair value” represents the excess of the fair value of a reporting unit as a whole over the individual fair values assigned to its assets and liabilities.
All too often registrants have glossed over the detailed thought processes behind the identification of a “reporting unit” and the mandated calculations. The SEC is now challenging these registrants to discuss the calculations at the reporting unit level, specifically requesting details even where the calculations do not yield impairment, but are close. In this regard a “reporting unit” is defined as “an operating segment or a component of an operating segment that is one level below the operating segment as a whole.” A unit must constitute a business as defined by accounting technical guidance and have available discrete financial information regarding its operating results that is regularly reviewed by segment management.
Furthermore, the SEC has expressed its view that this current two-step process may be flawed in that it ignores an “enterprise value” for the reporting unit in favor of an “equity value.” The SEC notes that when the carrying value of equity is negative, a reporting unit would appear to always pass a step-one goodwill impairment test when performed on an equity basis, despite the fact that significant goodwill may exist and the operations of that entity may be deteriorating. As such, it is important to perform a step-one analysis based on enterprise value when the book value of equity is negative.
Recent media attention to bank profitability and increased public scrutiny of certain lending institutions resulting from their role in the recent subprime lending debacle seems to have given rise to the next two areas of frequent comment, related party transactions and executive compensation. With the ultimate goal of transparency for the investor, registrants have been mandated to provide more detail about any transactions involving insiders. Materiality doesn’t matter and is not a valid defense against a lack of disclosure. Registrants need to include in their filings detailed disclosures and discussions regarding compensation, any performance targets used in determining compensation, incentive compensation, bonuses, details for all highly paid executives, employment agreement terms, benchmarking tools employed to determine compensation levels and discussions on any newly implemented benefit plans.
While not appearing as frequently as the five areas of inquiry discussed thus far, other real estate owned (OREO), repurchase transactions, securities lending and non-GAAP measures were also seen to repeat with some level of frequency. In all cases the regulator wanted enhanced disclosure and more details about the items presented so as to enable the investor to better understand it.
So how can all this be summarized? Clearly registrants have been charged with giving the investor more information in an understandable fashion so as to enable the investor to make an informed decision. While plain English might demand a better prose, it, coupled with the current economic environment, seems to also demand more data, therefore making any discussion more meaningful to the reader.
Preparers and reviewers of financial statements and regulatory filings need to be cognizant of trends and consistencies. They need to step back and ask, “What would I want to know about a certain transaction, series of transactions or event?” “What can I include to make someone else understand?” “What information, if I knew it, would alter my decision-making process?” “What trends need to be disclosed and potential impact explained?”
While no one can predict with any level of certainty what the SEC or other regulatory body might ask or challenge, consideration and adequate disclosure of the areas of focus outlined above might make for a more informed investor and ultimately reduce the risk of a potential restatement. 

Bridget Day, CPA, is a partner with the EisnerAmper Banking Group.


Posted on Thursday, April 14, 2011 (Archive on Wednesday, July 13, 2011)
Posted by Scott  Contributed by Scott


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