How CECL Impacts Acquisitive Banks


CECL-7-30-19.pngBank buyers preparing to review a potential transaction or close a purchase may encounter unexpected challenges.

For public and private financial institutions, the impending accounting standard called the current expected credit loss or CECL will change how they will account for acquired receivables. It is imperative that buyers use careful planning and consideration to avoid CECL headaches.

Moving to CECL will change the name and definitions for acquired loans. The existing accounting guidance classifies loans into two categories: purchased-credit impaired (PCI) loans and purchased performing loans. Under CECL, the categories will change to purchased credit deteriorated (PCD) loans and non-PCD loans.

PCI loans are loans that have experienced deterioration in credit quality after origination. It is probable that the acquiring institution will be unable to collect all the contractually obligated payments from the borrower for these loans. In comparison, PCD loans are purchased financial assets that have experienced a more-than-insignificant amount of credit deterioration since origination. CECL will give financial institutions broader latitude for considering which of their acquired loans have impairments.

Under existing guidance for PCI loans, management teams must establish what contractual cash flows they expect to receive, as well as the cash flows they do not expect to receive. The yield on these loans can change with expected cash flows assessments following the close of a deal. In contrast, changes in the expected credit losses on PCD loans will impact provisions for loan losses following a deal, similar to changes in expectations on originated loans.

CECL will significantly change how banks treat existing purchased performing loans. Right now, accounting for purchased performing loans is straightforward: banks record loans at fair value, with no allowance recorded on Day One.

Under CECL, acquired assets that have only insignificant credit deterioration (non-PCD loans) will be treated similarly to originated assets. This requires a bank to record an allowance at acquisition, with an offset to the income statement.

The key difference with the CECL standard for these loans is that it is not appropriate for a financial institution to offset the need for an allowance with a purchase discount that is accreted into income. To take it a step further: a bank will need to record an appropriate allowance for all purchased performing loans from past mergers and acquisitions that it has on the balance sheet, even if the remaining purchase discounts resulted in no allowance under today’s standards.

Management teams should understand how CECL impacts accounting for acquired loans as they model potential transactions. The most substantial change relates to how banks account for acquired non-PCD loans. These loans first need to be adjusted to fair value under the requirements of accounting standards codification 805, Business Combinations, and then require a Day One reserve as discussed above. This new accounting could further dilute capital during an acquisition and increase the amount of time it takes a bank to earn back its tangible book value.

Banks should work with their advisors to model the impact of these changes and consider whether they should adjust pricing or deal structure in response. Executives who are considering transactions that will close near their bank’s CECL adoption date not only will need to model the impact on the acquired loans but also the impact on their own loan portfolio. This preparation is imperative, so they can accurately estimate the impact on regulatory capital.

Here’s How to Address CECL’s Biggest Question


CECL-4-26-19.pngA debate is raging right now as to whether the new loan loss accounting standard, soon to go into effect, will aggravate or alleviate the notoriously abrupt cycles of the banking industry.

Regulators and modelers say the Current Expected Credit Loss model, or CECL, will alleviate cyclicality, while at least two regional banks and an industry group argue otherwise. Who’s right? The answer, it seems, will come down to the choices bankers make when implementing CECL and their view of the future.

CECL requires banks to record losses on assets at origination, rather than waiting until losses become probable. The hope is that, by doing so, banks will be able to prepare more proactively for a downturn.

This debate comes as banks are busy implementing CECL, which goes into effect for some institutions as early as 2020.

Last year, internal analyses conducted by BB&T Corp. and Zions Bancorp. indicated that CECL will make cycles worse compared to the existing framework, which requires banks to record losses only once they become probable.

Both banks found that CECL will force a bank with an adequate allowance to unnecessarily increase it during a downturn. Their concern is that this could make lending at the bottom of a cycle less attractive.

The increase in provisions would “directly and adversely impact retained earnings,” wrote Zions Chief Financial Officer Paul Burdiss in an August 2018 letter, without changing the institution’s ability to absorb losses. BB&T said that adjusting its existing reserves early in a recession, as called for under CECL, would deplete capital “more severely” than the current practice.

BB&T declined to comment, while Zions did not return requests for comment.

The Bank Policy Institute, an industry group representing the nation’s leading banks, said in a July 2018 study that the standard “will make the next recession worse.” CECL’s lifetime approach forces a bank to add reserves every time it makes a loan, which will increase existing reserves during a recession, the group argued.

“The impact on loan allowances due to a change in the macroeconomic forecasts is much higher under CECL,” the study says.

And in Congressional testimony on April 10, JPMorgan Chase & Co. Chairman and CEO Jamie Dimon said CECL could impact community banks’ ability to lend in a recession.

“I do think it’s going to put smaller banks in a position where, when a crisis hits, they’ll virtually have to stop lending because putting up those reserves would be too much at precisely the wrong time,” he said.

Those results are at odds with research conducted by the Federal Reserve and firms like Moody’s Analytics and Prescient Models. Some of the differences can be chalked up to modeling approach and choices; other disagreements center on the very definition of ‘procyclicality.’

Moody’s Analytics believes that CECL will result in “easier underwriting and more lending in recessions, and tighter underwriting and less lending in boom times,” according to a December 2018 paper. The Federal Reserve similarly found that CECL should generally reduce procyclical lending and reserving compared to the current method, according to a March 2018 study.

Yet, both the Fed and Moody’s Analytics concluded that CECL’s ability to temper the credit cycle will vary based on the forecasts and assumptions employed by banks under the framework.

“The most important conclusion is that CECL’s cyclicality is going to depend heavily on how it’s implemented,” says Moody’s Analytics’ deputy chief economist Cristian deRitis. “You can … make choices in your implementation that either make it more or less procyclical.”

DeRitis says the “most important” variable in a model’s cyclicality is the collection of future economic forecasts, and that running multiple scenarios could provide banks a baseline loss scenario as well as an upside and downside loss range if the environment changes.

The model and methodology that banks select during CECL implementation could also play a major role in how proactively a bank will be able to build reserves, says Prescient Models’ CEO Joseph Breeden, who looked at how different loan loss methods impact an economic cycle in an August 2018 paper.

A well-designed model, he says, should allow bankers to reserve for losses years in advance of a downturn.

“With a good model, you should pay attention to the trends. If you do CECL right, you will be able to see increasing demands for loss reserves,” he says. “Don’t worry about predicting the peak, just pay attention to the trends—up or down—because that’s how you’re going to manage your business.”

In the final analysis, then, the answer to the question of whether CECL will alleviate or aggravate the cyclical nature of banking will seemingly come down to the sum total of bankers’ choices during implementation and execution.

Five Tips on Choosing the Right CECL Solutions for Community Banks


CECL-10-8-18.pngAny big accounting change—especially one as large as CECL (current expected credit loss)—is bound to cause some pain. But, there are ways to make sure your bank is not making the challenge bigger than it has to be. Here are five tips on selecting a calculation methodology that’s compatible with your institution.

1. Consider the complexity.
Banks can choose from several methodologies that range in complexity. The more complex the methodology, the more data needed—and the more inherent risk of error. Both the Financial Accounting Standards Board (FASB) and regulators have consistently indicated that complex CECL models aren’t required. Nevertheless, some community institutions seem to be choosing more complex methodologies over simpler solutions that can decrease cost and reduce risk.

Overall, the choice of a more complex methodology can impose additional costs and risks to a bank. If a community bank is going to use a complex methodology, it should go into it with clear understanding of the cost and risk involved.

2. Select your methodology first.
Regulatory agencies — including the Securities and Exchange Commission and the FASB — have continually discussed how Excel is an acceptable tool for fulfilling CECL requirements. As a general rule, the more complex the methodology, the more likely you’ll need new software. Industry participants are becoming aware that they can use, with some adapting, methodologies similar to those they use today. That means they can continue to use Excel.

CECL software does have its advantages. For example, there’s functionality for quickly disaggregating the portfolio to a finer degree and the ability to explore various methodologies, which could be beneficial. But, new software won’t eliminate all of the hard work of making estimates requiring a managerial decision.

3. Don’t panic about the reasonable and supportable forecast requirements.
The accounting standard provides a framework for incorporating a reasonable and supportable forecast. The standard doesn’t require fancy and sophisticated forecasting techniques with regression equations. Using charts with historical economic information compared to long-term trend lines can be a way to reasonably support a forecast. This framework is illustrated within the accounting standard and consists of comparing the general direction of two economic indicators (unemployment and real estate values) and using historical loss periods with similar directional trends as a basis for qualitative adjustments.

4. Start with what makes sense and add complexity as needed.
The more complex the methodology, the more historical, loan-level data will be required. Many institutions won’t have accurate and complete data from several years ago readily available. They could do a tremendous amount of work right now to obtain that historical data. A better solution might be for those institutions to start changing their processes for the current year, so that going forward, they’ll have the correct data. In the meantime, they can use a less complex methodology that’s acceptable to regulators, such as the weighted average remaining maturity that doesn’t require loan-level information.

5. Ignore the hype and do what’s right for your institution.
Much of the focus in the industry now is on the big banks that are closest to adoption. A big, complex institution will require a complex CECL solution, so much of the dialogue in the industry relates to those complex methodologies. But, what’s good for your bank? Much of the industry buzz around advanced methodologies and CECL software has little to do with the needs of community institutions. The adoption deadline for community banks, which is still a couple of years away and simpler than that for large banks, is not an argument for procrastination. Rather, it’s a reminder that community institutions can craft solutions appropriate to their own needs that are efficient, effective, and economical.

Some community banks are still not working on CECL with necessary diligence and speed. Others are introducing complexity that makes the process more difficult than it has to be. An approach that recognizes there’s work to do—but understanding it can be minimized—is the right CECL strategy for the large majority of banks.

What’s The Same – And What’s Not – In Assessing Credit Quality


assessment-7-30-18.pngSince the 1970s, there has been an inevitable march toward a macro, quantitative assessment of credit quality. Technology and big data ensured its emergence to complement the more traditional, transactional counterpart of credit risk management.

Since the adoption of the 2006 allowance for loan and lease losses (ALLL) guidance, and the ferocity of loan losses during the great recession, we have seen the growing confluence among credit, accounting, regulatory and investor constituencies attempting to answer the same age-old questions: How much loss is embedded in the loan portfolio? How much is this portfolio worth?

While having comparable goals, each level of management has its priorities, biases and specialized methodologies for answering those questions. For directors, there may be a need to connect the dots to determine the objective of these measures.

Today’s ALLL
The current loss methodology was also used in 2006, prior to the massive, mainly real estate, credit losses from the great recession. The 2006 methodology included pool, formula-driven and specific impairment loss estimates. The incurred loss bias of the current methodology–often known as a “run-rate” approach–inflates the most recent credit quality performances. With no significant losses prior to the crisis, the industry was largely pushed into the abyss with low loss reserves–unable to raise reserves for forecasted losses. Given the relatively benign state of credit currently, it could be said that we are back to the future, having to defend ALLL levels, largely with qualitative justifications.

Tomorrow’s CECL
The soon-to-be implemented current expected credit loss (CECL) methodology is the inevitable reaction to the roller coaster nature of today’s ALLL. Some even consider it a fall back to the failed bid, about eight years ago, to impose mark-to-market valuations on the entirety of banks’ loan portfolios. Regardless of the pejorative “crystal ball” moniker often describing CECL–not to mention estimates of significant Day One implementation increases in reserves–its integration of historical losses, current conditions and reasonable forecasts is designed to be the more holistic, life-of-loan estimation of losses.

There is a high presumption in CECL that quantitative measures, such as discounted cash flows or probabilities of default (PDs)/loss given defaults (LGDs), overlaid by recovery lags, will be used to project future losses. In theory, it may be a more reliable estimate than the current guidance; however, its greatest hindrance is the perception that it is yet another de facto variant layer of capital buffer mandated by the Dodd-Frank Act, and Basel III.

Exit Price Notion
This accounting-based fair value measure disclosure (ASU 2016-01), often referred to as fair value/exit pricing, is new for 2018 and specifies the method by which public financial institutions calculate the fair value of their loan portfolios for purposes of disclosure. Fair value is the amount that would be received to sell an asset or paid to transfer a liability at the measure date. The estimate of fair value must be supported through specified protocols of valuation and calculation. Credit-based assessments, coupled with ties to loan review and risk grade migrations, will be key to justifying a reasonable, point-in-time fair value calculation.

Credit Mark in Mergers & Acquisitions (M&A)
Speaking of fair value, in M&A, it is truly in the eye of the beholder. How skeptical is the buyer? How much does the buyer want the deal? Determining a credit mark, or rational estimate (or range) of discounts to be applied to a prospective purchased loan portfolio, is very much a credit-based, symbiotic marriage between a traditional, more qualitative loan review and the more quantitative metrics of PDs, LGDs, risk grade migrations, yield marks, recovery lags and probabilistic modeling. Using one approach, without the informing nature of the other, is problematic and increases inaccuracies. What is sacrosanct in credit mark, is that an institution never wants to undershoot the estimates. Accounting plays a greater role when the deal-negotiated credit mark is refreshed at the deal’s completion, known as Day One accounting.

The credit discipline has often described as a qualitative decision stacked on an array of quantitative metrics. That remains an apt description for transactional credit–where it all begins. However, the new frontier in managing credit risk, even at smaller financial institutions, is in the ever-evolving, mostly mandated, macro, quantitative measures–some of which are described above. Each of these, not unlike a Venn diagram, has similarities and overlapping portions, but each has separate purposes, as well. Directors, like credit officers, need to understand and embrace these quantitative measures, which will, in turn, lead to better decision making for the bank.

A Practical Guide for CECL Implementation


CECL-1-12-18.pngBy now, most community bankers are familiar with the Current Expected Credit Loss standard (CECL), which was issued by the Financial Accounting Standards Board in June of 2016 as a new standard for the recognition and measurement of credit losses for loans and debt securities. However, your bank may be struggling with applying its theoretical concepts. We’ve put together a few simple steps to help you start your implementation process.

Form an implementation team.
CECL implementation cannot be the responsibility of just one or two people. It requires a team that should include:

  • A chief financial officer or equivalent who has knowledge of loan loss accounting and basic modeling capabilities;
  • A chief audit executive or equivalent to identify key controls necessary to the new process;
  • A chief credit officer with deep knowledge of the loan portfolio and related documentation;
  • And a chief technology officer to assist with data gathering and retention.

We advise documenting the members of your team, and briefly summarizing their skill sets and roles in implementing CECL.

Confirm your implementation deadline.
The deadline for implementation of CECL is based on whether or not the bank is considered a Public Business Entity (PBE), unless the institution is a Securities and Exchange Commission registrant. It is important to periodically re-evaluate, document, and receive concurrence from auditors and regulators regarding the bank’s status as a PBE. The American Institute of Certified Public Accountants’ (AICPA) Technical Questions and Answers (TQA) document can help institutions with this determination. Based on this document, most non-SEC registrants will not qualify as a PBE, so most institutions will be expected to implement CECL by December 31, 2021. For SEC registrants, the standard will go into effect one year earlier, in December 2020.

Establish a simple project plan.
A CECL project plan does not need to be voluminous in order to be effective. Start with a single page implementation timeline as a foundation. Next, break the project into manageable segments. For near-term deadlines, record specific tasks and dates. Assign broader timeframes to latter segments to allow sufficient time in the event that there are changes in the bank’s operations, such as an acquisition or PBE classification updates.

Understand CECL’s impact.
It is important to quantify the impact of CECL by understanding industry reserve levels compared to current accounting rules. For the historical loss component of the allowance, which will be the base component for this new standard, current industry data shows the following:

  • Most financial institutions use between a three- and five-year average annual loss rate to compute the historical loss component of the allowance.
  • Based on quarterly call report data, the average three-year net charge-off rate for all bank loans from December 31, 2014 to December 31, 2016 was 0.49 percent. The average five-year net charge-off rate was 0.68 percent.
  • The percentage of allowance to loans for the historical loss component for all banks over $1 billion in assets was 1.24 percent as of September 30, 2017.

Under current accounting rules, this data would suggest that the industry believes incurred losses in the loan portfolio are 0.56 percent to 0.75 percent worse than the average of the last three to five years of actual charge-offs. This could indicate there may be some excess in current reserve levels, which could reduce your previous expectation of the impact of CECL on your institution.

Start retaining available data and use it for modeling.
Consider what models can be built with information that is readily available to most community banks, such as a standard loan trial balance, the history of net charge-offs by loan number and a watch list for set periods of time. Starting with a limited number of data points and simple models can help banks gain familiarity with modeling basics, and identify modeling flaws and potential additional data point requirements.

Effective models such as discounted cash flow, vintage analysis, migration analysis and static pool analysis can be built with these limited reports. The important step in data retention is to ensure core system reports are maintained for a period of time. This will ensure when you begin your modeling efforts, you will have the data necessary to start to build your model.

Even though the implementation date is a couple years away, it is important for institutions to get started with data collection and modeling efforts, as there will be unforeseen challenges along the way. The sooner an institution begins its modeling efforts, the sooner it can identify potential additional data requirements, and the potential impact of this new standard to the balance sheet and income statement.

Fundbox: Friend or Foe


friend-or-foe-3.png

For small businesses and freelancers, successfully performing work for customers and clients is only half the battle. Oftentimes, businesses wait up to 90 days to receive payment for their outstanding invoices. This delayed cash flow can create a variety of problems, especially when it comes to covering overhead expenses like rent and payroll.

That’s why Eyal Shinar developed the Fundbox software service, to help small businesses fix their cash flow problems as it relates to outstanding invoices. Fundbox is the leading cash flow optimization platform for small businesses, and who better to start a fintech company focused on this problem than someone who learned it at his mother’s knee? Shinar’s mother was a small business owner, so growing up he saw the pain and frustration that delayed payment of invoices can cause. According to a recent report, 82 percent of small businesses fail due to poor cash management. Where some see problems, others see solutions, and that’s where Fundbox comes in.

The process is straightforward. Business owners simply connect their existing accounting software to Fundbox and submit their outstanding invoices for immediate reimbursement. The business owner incurs a small fee for this service and they are given up to 24 weeks to pay Fundbox back.

For banks looking to offer new or better services to small business clients and freelancers, though, is Fundbox a good partner? Let’s look a little closer.

THE GOOD
Small business accounts are a much coveted group for banks, so providing new tools to improve service and/or relationships with this group should be of interest area to most any financial institution. The fact that Fundbox already has some traction in the small business space should be a good indicator for banks that the service they provide—instant cash flow—is a needed service for this group.

Once a small business owner submits an invoice to the Fundbox platform, they are typically paid within one to two days. Fundbox connects easily with most existing accounting platforms that small businesses are already using, such as QuickBooks, Freshbooks, Xero, Wave and Sage One, so there is very little to do in terms of importing data. Fundbox connects with a few simple clicks and pulls any outstanding invoices that business owners might want to turn into cash. Also, when the user signs up for their account, Fundbox uses big data and algorithms to quickly determine the consumer’s financial health rather than putting them through a lengthy application and approval processes.

The pricing model is simple and transparent. For an invoice of $1,000, the fee is $48 per week over 24 weeks, or $89 per week over 12 weeks. Fees are reduced if the business pays back what it owes prior to the deadline, which is a good incentive to keep Fundbox’s own cash flow looking good, although they have no shortage of funding—another point that might give banks some comfort in partnering with the company.

THE BAD
While the Fundbox fee structure is quite straightforward and transparent, it’s also relatively expensive and can really add up over time, especially for businesses that regularly choose the 24-month financing option. After you do the math, the annual percentage rate for Fundbox repayments can range anywhere from 13 percent to 68 percent. Fundbox also places a $100,000 limit on invoices that it will fund, so it isn’t an option for companies seeking to turn accounts receivable for amounts larger than that into cash.

While Fundbox is compatible with most of the common accounting software mentioned earlier, small businesses that use less common accounting packages or Excel spreadsheets can’t utilize its service. Other drawbacks are that Fundbox doesn’t provide cash for past-due invoices, and the approval process for credit limit increases can take some time. So while the service is helpful in many use cases, it certainly doesn’t match every situation. Finally, Fundbox is rolling out additional credit products as well, which could increase its presence as a possible competitor in the banking space.

OUR VERDICT: FOE
Fundbox offers an important service to small businesses and entrepreneurs, and does so more conveniently than most banks do today. At a time when so much emphasis is being placed on the customer experience, banks should be taking notice of this heavily-funded bank alternative. If an entrepreneur has outstanding invoices and needs cash to keep the lights on, their only option with traditional banks is to apply for a small business loan, or to go to their credit card company, which charges even higher rates than Fundbox. Furthermore, between the application process, credit checks and agreeing upon collateral, it can be weeks or months before businesses see a penny of the cash they need. For this reason, I applaud what Fundbox is doing, and I think it is certainly a —friend’ to many entrepreneurs in their times of need.

As Fundbox encourages more and more small business owners to come to them for cash, though, this obviously chips away from the bank’s importance and its relationship with their small business clients—a relationship they certainly don’t want to lose. And to date, Fundbox cannot boast of any existing bank partnerships or list banks as an area of interest. Of course, if this was to change, we might reconsider our foe designation.

In the meantime, banks would be wise to understand why entrepreneurs are using services like Fundbox, and how they might better address this particular need, whether it’s partnering with fintech companies, investing in new solutions or building them internally. In short, business owners have enough things to worry about, and getting paid on time doesn’t have to be one of them. Who can blame small business owners for looking outside their banking relationship for help?

The Board’s Role in the Transition to CECL


CECL-9-30-16.pngThis summer, the Financial Accounting Standards Board (FASB) completed its project on credit losses with the issuance of a new standard that brings one of the most significant changes to financial reporting that financial institutions have seen in decades: The incurred loss model for estimating credit losses will be replaced with a new model, the current expected credit loss (CECL) model. In many cases, the new credit loss calculations are expected to result in an increase in the allowance, and, thus, might have a significant impact on capital requirements. Banks will need sufficient time to prepare and adjust capital planning and capital management strategies.

Banks are educating themselves on the changes, and boards of directors should be aware of the challenges faced by the banks they oversee.

As with any major initiative, a successful transition to the new standard will require the active involvement of the audit committee, the board of directors, and senior management. Given the audit committee’s responsibility for overseeing financial reporting, it has a critical role to play in overseeing implementation.

Recently, speakers from the Securities and Exchange Commission’s (SEC’s) Office of the Chief Accountant have emphasized the role that audit committees should have in implementing new significant accounting standards. In his speeches at Baruch College and the AICPA Bank Conference, Wes Bricker, interim chief accountant, addressed CECL implementation. Likewise, the federal financial institution regulatory agencies have addressed the role of the board in implementing the new credit loss standard. The agencies issued a joint statement on June 17, and in March the Federal Reserve System (Fed) released an article, “New Rules on Accounting for Credit Losses Coming Soon.” The speeches, joint statement, and article highlight tasks that boards of directors and audit committees may consider during transition, including:

  • Evaluate management’s implementation plan, including the qualified resources allocated for execution.
  • Monitor the progress of the implementation plan, including any concerns raised by the auditors or management that might affect future financial reporting.
  • Understand the changes to the accounting policies that are required for implementation.
  • Understand management’s transition to any new information systems, modeling methodologies, or processes that might be necessary to capture the data to implement the standard.
  • Oversee any changes to internal control over financial reporting in transitioning to the new standard.
  • Review impact assessments of the new standards, including impact on financial statements; key performance metrics, including credit loss ratios, that might be disclosed to investors outside the financial statements; regulatory capital; and other aspects of the organization such as compensation arrangements and tax-planning strategies.
  • Understand management’s plan to communicate the impact of the new standard on key stakeholders, including the new disclosures required by the standards and disclosures made leading up to the adoption date. Those who file with the SEC will need to disclose information about standards effective in future periods, including the expected impact when adopted.

In evaluating management’s implementation plan, it is important to develop an understanding of management’s timeline for implementing the new standards and to be aware of the effective date. Recognizing that the definition of a public business entity (PBE) under FASB includes many financial service entities, the FASB split the definition to provide additional time for PBEs that are not SEC filers.

  • For PBEs that are SEC filers, the standard is effective in fiscal years beginning after Dec. 15, 2019, and interim periods in those fiscal years. For calendar year-end SEC filers, it first applies to the March 31, 2020, interim financial statements.
  • For PBEs that are not SEC filers, the standard is effective in fiscal years beginning after Dec. 15, 2020.
  • For all other entities, the effective date includes fiscal years beginning after Dec. 15, 2020, and interim periods in fiscal years beginning after Dec. 15, 2021.
  • Early adoption is permitted for all entities in fiscal years beginning after Dec. 15, 2018, and interim periods in those fiscal years. That means, any calendar year-end entity may adopt as early as the March 31, 2019, interim financial statements.

While those dates might seem somewhat distant, there really is no time to lose in preparing for the transition.

Driving Revenue with Better Treasury Management


accounting-7-22-16.pngTreasury services are a large source of fee revenue for banks – selling payment rails, wire services and other bread and butter offerings. However, when it comes to small and mid-size companies, banks can and should be a source for more than just payments and transfers. There is a huge opportunity to be generating more revenue for the bank, and perhaps more importantly, to make themselves an indispensable part of the client’s business operations.

In previous years, treasury services professionals had no need to understand their customers’ finance and accounting situation. They were selling traditional bank services, in which they were well versed. However, today’s increasingly complex fintech environment means that these professionals have a huge opportunity. There are far more technological products and solutions for banks to offer that improve their customers’ lives; and the advantage of offering them is that your customer is less likely to go somewhere else to get them. By better understanding the pain points their customers feel from a business and operations standpoint, they can offer technology that can ease customers’ headaches and drive incremental revenue for the bank.

Accounting Systems–The Heart of the Company
For growing companies, having the right accounting system is vital. Everything from payroll to accounts payable runs through it, meaning mistakes or inefficiencies can lead to everything from cash flow problems to security breaches. For these reasons, every treasury services professional should have basic knowledge of the major accounting systems and should start the sales process by asking what system a company uses. From there, they can begin to understand the company’s workflow and how it might be improved.

Increase Incremental Revenue
By understanding the customer’s pain points, a treasury services manager who is well-versed in the language of accounting will be able to identify and offer solutions to streamline processes, save time and increase security. Perhaps the customer is spending hours each week manually inputting invoices. Offering that customer an automated invoice capture solution will save the accounting team time and resources. Perhaps the customer still is filing receipts in a filing cabinet and could use a document storage system to enable faster search functionality.

Deliver End-to-End Solutions
By fully understanding accounting systems and processes and upselling additional services where appropriate, the bank can deliver an end-to-end solution for the customer and generate more revenue for the bank. For example, if the bank is an issuer of corporate credit cards, there is the opportunity to drive more payables onto those cards and drive more interchange revenue to the bank.

Everything from invoice capture, to accounts payable, to payments and payroll can all flow seamlessly through the central hub. Offering multiple products together will ensure proper integration and mean that systems aren’t cobbled together or require work-arounds. And, these solutions offer additional benefits such as fraud protection, increased visibility and cash flow management and security controls.

However, the treasury services professional’s job doesn’t have to stop after they make a sale. By keeping in touch regularly and nurturing the relationship, he or she will be able to identify when it’s time to upgrade systems. For example, a small business may start with QuickBooks but eventually outgrow the system and graduate to a more robust accounting platform like Intacct or NetSuite. Keeping an eye on data that indicates account health, such the volume of payments or other activity, could be a good indicator of when to check in with them.

Make Your Bank Sticky
It’s all too easy for a business to switch banks–especially if it is using the bank only for payments and transfers. Customers can be fickle and easily lured away by a slightly better rate or lower fee structure. But a treasury services professional can be at the front lines of customer retention by showing value that makes it difficult for customers to leave.

Studies have shown that online bill payers are twice as likely to remain active banking customers and as high as 70 percent less likely to leave the bank. So it stands to reason that the more products and services a bank can offer, the harder it will be for the customer to leave. As a treasury services professional, this is crucial to keep in mind–closing sales is about more than just fee revenue, it’s also important to client retention, and it all begins with understanding the customer’s accounting systems and processes.

Understanding M&A Accounting: What to Watch For


9-29-14-Crowe.pngOne of the worst things for an acquirer to find out after the fact is that the target wasn’t worth what the acquirer thought it was. That egg is on the board’s face and can cause significant headaches. The following are key trends and issues we have found recently in merger and acquisition (M&A) due diligence reviews.

Asset Quality
There is no better indicator of credit quality than a thorough loan review. We have seen a significant rise in collateral values in areas that were the hardest hit and modest recovery in others. Once-troubled institutions are recovering and finally are beginning to move other real estate owned and problem loans that sat unmarketable for several years. While the cleanup might not lead to a recapitalization of a bank for a variety of financial and legacy reasons, it has positioned many institutions as attractive acquisition targets at reasonable franchise values.

However, the not-so-happy news is that weak loan demand and the need to deploy capital efficiently have led to easing credit standards in commercial and industrial (C&I) and commercial real estate loans. It is important to check for deficiencies such as borrower base certificate compliance, waived or reset covenants, and lack of field audits. Also, current underwriting with extended amortizations and lower debt service requirements can present long-run risk to an acquirer. Additionally, we see institutions engaging in new loan products, which can present long-term risk if lender qualifications and track records have not been tested through a variety of economic cycles.

Quality of Earnings and Balance Sheet
Tangible book value (TBV), a common metric within the financial services industry, is used as an anchor for pricing a potential acquisition. Understanding the ways in which improper accounting or one-time income or expense items may skew this figure is important in arriving at a proper value for the bank. In the private company setting, we often find the rigor applied to interim accounting records does not match that applied to the annual audited financials. As management teams are more focused on normalizing yearly results, non-operating expense items might level out over the course of the year to not dramatically affect monthly results. We’ve observed a number of improperly capitalized items buried in other assets and underaccrued liabilities that can significantly distort the net book value of a bank. When establishing a fair purchase price based on a multiple of TBV, a $1 million interim balance sheet misstatement could mean a $1.5 million to $2 million purchase price adjustment.

Similarly, a $100,000 overstatement of core earnings could be a $1.6 million to $2 million purchase price adjustment using current multiples. We continue to see earnings supported by reserve releases, investment security salesA, and various other anomalies that have to be deciphered in order to get a true picture of normalized earnings. Determining a bank’s core earnings potential is more difficult in the current landscape because many acquisition targets have completed bank acquisitions of their own in the past few years. Both open-bank and failed-bank acquisitions come with accounting complexities related to recognition of interest income on the loans acquired. It’s imperative to understand the difference between the accounting yields and the cash income created from these acquired assets in order to avoid overestimating core earnings.

If a target bank has completed a failed-bank acquisition with loss-share agreements in place, significant consideration should be given to the accounting and record keeping of the loss-share arrangement. Acquirers should focus on understanding the remaining terms of any loss sharing, the ability to collect under the loss-share terms, and the potential hole that might be created from overstatement of the indemnification asset. Many of these arrangements may not be completely settled with the Federal Deposit Insurance Corp. (FDIC) for several more years, and many agreements contain a “true-up” provision whereby the FDIC could be owed significant sums of money if the loans perform better than expected. Each loss-share contract is unique, and potential acquirers need to fully understand the complexities associated with these agreements during the due diligence phase.

The issues highlighted here are just a few of the more common issues we’re seeing in current due diligence findings. Execution of a well-conceived due diligence plan can help eliminate surprises from an accounting, operational and credit perspective and lead to a successful transaction.

How the New FASB Standard on Revenue Recognition May Impact Banks


revenue-maze.jpgThe Financial Accounting Standards Board (FASB) recently released its long-awaited standard addressing revenue recognition. Existing U.S. generally accepted accounting principles (GAAP) were largely developed on a piecemeal basis and are industry- or transactional-focused. Consequently, economically similar transactions sometimes resulted in different revenue recognition. Accounting Standards Update (ASU) 2014-09, “Revenue From Contracts With Customers (Topic 606),” adopts a standardized approach for revenue recognition. This was a joint effort with the International Accounting Standards Board (IASB), resulting in converged guidance under both GAAP and International Financial Reporting Standards (IFRS). Of course, companies will report the same total amount of revenue over time, but the timing of the recognition could be accelerated or delayed when compared with current practices. 

A Core Principle and a Five-Step Approach

The new ASU is based on a core principle: “Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” To achieve this principle, the guidance spells out several steps that a company must take when determining when to recognize revenue on its financial statements.

  1. Identify the contract with a customer.
  2. Identify the separate performance obligations in the contract.
  3. Determine the transaction price.
  4. Allocate the transaction price to the separate performance obligations.
  5. Recognize revenue when (or as) performance obligations are satisfied.

Is This a Big Deal for Banks? 

The new ASU could be a challenge from two perspectives. First, there are certain industries for which there will be wholesale changes, including the software, telecommunication and real estate industries. For the banking industry, wholesale changes are not expected—largely because much of a bank’s revenue comes from financial instruments (including debt securities, loans and derivatives), and many of those are scoped out. That is not to say that banks won’t be affected, because most will. But for most banks, the effect is not likely to be significant.

Second, the challenge for banks (as well as other industries) will be taking the core principle and accompanying steps and figuring out how the guidance applies. In other words, the five steps provided are not written with a specific industry in mind, so a shift in thinking will be necessary to evaluate how the accounting will change for those transactions that will apply to banks. A few areas of potential application for banks include:

  • Loyalty point programs
  • Asset management fees
  • Credit card interchange fees
  • Deposit account fees

Effective Dates

The boards provided a lengthy implementation time for the new rules, giving companies time to develop and put in place new controls and processes. The ASU is effective for public companies for annual reporting periods (including interim reporting periods within) beginning after Dec. 15, 2016; early implementation is not allowed. For nonpublic companies, the guidance is effective for annual reporting periods beginning after Dec. 15, 2017, and interim and annual reporting periods thereafter. Early adoption is permitted for nonpublic companies with certain caveats.

Help Is on the Way

In addition to establishing a revenue recognition working group to own the guidance, the American Institute of Certified Public Accountants (AICPA) created 16 different industry task forces charged with providing industry-specific guidance. One of those 16 task forces is the depository institutions revenue recognition task force. With the issuance of the standard, the work now can begin.

In addition, the FASB and the IASB are forming a joint transition resource group, which will consist of 15 to 20 specialists representing preparers, auditors, regulators, users, and other stakeholders. Its objective will be to promote effective implementation and transition.

At just more than 700 pages, the new standard is the longest the FASB has ever issued. This was a major undertaking by the boards, and given the girth of the standard and the fact that it is not industry specific, it’s safe to say it’s just going to take time to digest.