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Nonpublic community banks should be aware of additional reporting requirements regarding fair value measurement and other issues for the year-end.

Year-End Accounting Issues Affecting Community Bankers

  • 11/26/2012

Year-End Accounting Issues Affecting Community Bankers

By Todd Sprang

Nonpublic community banks should be aware of additional reporting requirements regarding fair value measurement.

The Financial Accounting Standard Board’s Accounting Standards Update 2011-04 is effective for nonpublic banks for periods ending after December 31, 2011. The standard clarifies existing fair value measurement guidance, but shouldn’t materially impact a community bank’s financial statements. The standard does, however, require some enhanced fair value disclosures. Although public companies adopted this standard during the first quarter of 2012, nonpublic community banks will now be affected in the following ways:

  • Additional information about Level 3 inputs. For community banks, this will mean more information about recurring valuations for items such as certain investments, mortgage servicing rights, and derivatives, as well as nonrecurring valuations for items such as impaired loans and other real estate owned (OREO).
    • Quantitative information about unobservable inputs utilized for Level 3 valuations. Community banks should disclose the type and range of these inputs. The standard also requires disclosure by class, even though we haven’t seen much class reporting by smaller public banks.
    • Qualitative information about the valuation process. If community banks utilize third party valuations without any adjustment, community banks should disclose this in lieu of qualitative information. However, most institutions will adjust third party valuations for impaired loans and OREO.
  • Qualitative information about valuation techniques and inputs for Level 2 valuations. This requirement is new for nonrecurring valuations but not for recurring valuations. As many community banks nonrecurring valuations are Level 3, we don’t expect additional disclosure burden for community banks.
  • Use of the exception for certain instruments and description of use in cases where current use differs from highest and best use. These disclosure requirements are more commonly applicable to larger banks and, as such, additional disclosure by community banks is expected to be rare.

Allowance for loan losses

The largest banks in the United States have significantly reduced their allowance balances via negative provisions over the past several quarters. The regulatory agencies have been clear about the skepticism they will apply to negative provisions and bankers are feeling pressure to maintain adequate reserves. In our interactions with community banks, we expect many will consider the following actions as the result of regulatory examinations:

  1. Increased use of unallocated reserves by institutions to support larger reserves or prevent negative provisions.
  2. A return to the application of loss ranges instead of more specific qualitative factors during this period of economic uncertainty.
  3. Expansion of historical loss periods. Historical loss periods have been reduced over the past few years to decrease reliance on qualitative factors and place more emphasis on recent loss history. In some markets, large amounts of historical losses may soon fall outside those loss periods and banks may expand loss periods to prevent such drop offs, or compensate with increased qualitative factors for the uncertainty of the current environment.

We also recognize a recent scrutiny of loans that become impaired but don’t require a specific reserve. While we appreciate bankers’ willingness to maintain adequate reserves, community banks still need to follow U.S. Generally Accepted Accounting Principles.

OREO accounting

Large gains or losses on sales of OREO can be an indicator of weak monitoring of property valuations. We recommend that institutions employ look-back testing of completed sales as one method of detecting weak monitoring controls in a timely manner. Also, banks need to be familiar with the accounting rules for instances where the bank finances the sale of its OREO property. Financing a significant percentage of the purchase price can trigger the deferral of gains on such sales but losses on such sales continue to be recognized at the time of sale, regardless of the percentage financed.

How we can help

CliftonLarsonAllen can assist bankers with the enhanced fair value measurement guidance and many other issues using practical solutions based on our experience serving community banks throughout the United States.

Todd Sprang, Financial Institutions Partner or 630-954-8175