Category: Financial Institutions and Banking

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Financial Institutions and Banking

Bank Stress Tests – Two Approaches, Four Methods

Should you be stress testing your borrowers?
Most banks are familiar with the concept of stress testing: By evaluating the impact of adverse external events on a bank’s earnings, capital adequacy and other financial measures, stress testing can be a highly effective risk management tool. And while community banks generally aren’t required to conduct stress testing, banking regulators view it as a best practice.
For example, Office of the Comptroller of the Currency (OCC) guidance considers “some form of stress testing or sensitivity analysis of loan portfolios on at least an annual basis to be a key part of sound risk management for community banks.” Stress testing is often performed at the enterprise, or portfolio, level. However, testing at the individual loan level — beginning during the underwriting process — can be a powerful technique for revealing hidden risks.
Two approaches, four methods
Stress testing generally involves scenario analysis. This consists of applying historical or hypothetical scenarios to predict the financial impact of various events, such as a severe recession, loss of a major client or a localized economic downturn. Tools for performing such tests can range from simple spreadsheet programs to sophisticated computer models.
The OCC’s guidance doesn’t prescribe any particular methods of stress testing. It describes two basic approaches to stress testing: “bottom up” and “top down.” A bottom-up approach generally involves conducting stress tests at the individual loan level and aggregating the results. In contrast, a top-down approach applies estimated stress loss rates under various scenarios to pools of loans with similar risk characteristics.
The guidance outlines four methods to consider:
  1. Transaction level stress testing. This estimates potential losses at the loan level by assessing the impact of changing economic conditions on a borrower’s ability to service debt.
  2. Portfolio level stress testing. This method helps identify current and emerging loan portfolio risks and vulnerabilities (and their potential impact on earnings and capital) by assessing the impact of changing economic conditions on borrower performance, identifying credit concentrations and gauging the resulting change in overall portfolio credit quality.
  3. Enterprisewide stress testing. This considers various types of risk — such as credit risk within loan and security portfolios, counterparty credit risk, interest rate risk and liquidity risk — and their interrelated effects on the overall financial impact under a given economic scenario.
  4. Reverse stress testing. This approach assumes a specific adverse outcome, such as credit losses severe enough to result in failure to meet regulatory capital ratios. It then works backward to deduce the types of events that could produce such an outcome.
The right approach and method for a particular bank depends on its portfolio risk and complexity, as well as its resources. Even a simple stress-testing approach can produce positive results. (See “Canada’s mortgage stress-testing law.”)
Stress testing and the underwriting process
A bottom-up approach at the transaction level may offer a significant advantage: In addition to assessing the potential impact of various scenarios on a bank’s earnings and capital, it can, according to the OCC, help the bank “gauge a borrower’s vulnerability to default and loss, foster early problem loan identification and strategic decision making, and strengthen strategic decisions about key loans.”
For example, when evaluating a loan application, consider gathering information on the various risks the borrower faces — including operational, financial, compliance, strategic and reputational risks. This information can be used to run stress tests that measure the potential impact of various risk-related scenarios on the borrower’s ability to pay. An added benefit of this process is that, by discussing identified risks and stress test results with borrowers, you can help them understand their risks and develop strategies for managing and mitigating them, such as tightening internal controls, developing business continuity / disaster recovery plans or purchasing insurance.
A powerful tool
Stress testing is an important part of a community bank’s risk management process. It can also be a powerful tool for evaluating loan applications and revealing hidden vulnerabilities that may jeopardize potential borrowers’ ability to pay down the road. 
Sidebar: Canada’s mortgage stress-testing law
Canada takes an interesting approach to evaluating mortgage loans. Under a law that took effect in 2018, federally regulated banks are required to “stress test” all mortgage applicants. To pass the stress test, an applicant must qualify for a loan at the contractual interest rate plus 2% or at the Bank of Canada’s five-year benchmark rate (5.19% at press time), whichever is higher. So, for example, a borrower applying for a 3.75% mortgage would have to qualify for a mortgage at 5.75%. The rule doesn’t apply to borrowers who are renewing a mortgage with the same lender.
The idea behind the law is that requiring borrowers to qualify at a higher rate than they’re actually paying prevents them from overextending themselves. And since the law took effect, delinquency rates are down. But the law is also controversial because, among other things, it reduces purchasing power for many homebuyers and the benchmark rate is susceptible to manipulation by the largest banks. © 2020
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Financial Institutions and Banking General

Take steps to curb power of attorney abuse

A financial power of attorney can be a valuable planning tool. The most common type is the durable power of attorney, which allows someone (the agent) to act on the behalf of another person (the principal) even if the person becomes mentally incompetent or otherwise incapacitated. It authorizes the agent to manage the principal’s investments, pay bills, file tax returns and handle other financial matters if the principal is unable to do so as a result of illness, injury, advancing age or other circumstances. However, a disadvantage of a power of attorney is that it may be susceptible to abuse by scam artists, dishonest caretakers or greedy relatives.
  • Watch out for your loved ones. A broadly written power of attorney gives an agent unfettered access to the principal’s bank and brokerage accounts, real estate, and other assets. In the right hands, this can be a huge help in managing a person’s financial affairs when the person isn’t able to do so him or herself. But in the wrong hands, it provides an ample opportunity for financial harm. Many people believe that, once an agent has been given a power of attorney, there’s little that can be done to stop the agent from misappropriating money or property. Fortunately, that’s not the case. If you suspect that an elderly family member is a victim of financial abuse by the holder of a power of attorney, contact an attorney as soon as possible. An agent has a fiduciary duty to the principal, requiring him or her to act with the utmost good faith and loyalty when acting on the principal’s behalf. So your relative may be able to sue the agent for breach of fiduciary duty and obtain injunctive relief, damages (including punitive damages) and attorneys’ fees. 
  • Take steps to prevent abuse. If you or a family member plans to execute a power of attorney, there are steps you can take to minimize the risk of abuse: Make sure the agent is someone you know and trust. Consider using a “springing” power of attorney, which doesn’t take effect until certain conditions are met, such as a physician’s certification that the principal has become incapacitated. Use a “special” or “limited” power of attorney that details the agent’s specific powers. (The drawback of this approach is that it limits the agent’s ability to deal with unanticipated circumstances.) Appoint a “monitor” or other third party to review transactions executed by the agent and require the monitor’s approval of transactions over a certain dollar amount. Provide that the appointment of a guardian automatically revokes the power of attorney. Some state laws contain special requirements, such as a separate rider, to authorize an agent to make large gifts or conduct other major transactions. 
  • Act now. If you’re pursuing legal remedies against an agent, the sooner you proceed, the greater your chances of recovery. And if you wish to execute or revoke a power of attorney for yourself, you need to do so while you’re mentally competent. 
Considering appointing a power of attorney? Contact your long-term business partner to discuss planning. Contact us with questions.
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The Tax Aspects of Selling Mutual Fund Shares

Perhaps you’re an investor in mutual funds or you’re interested in putting some money into them. You’re not alone. The Investment Company Institute estimates that 56.2 million households owned mutual funds in mid-2017. But despite their popularity, the tax rules involved in selling mutual fund shares can be complex.
Tax basics
If you sell appreciated mutual fund shares that you’ve owned for more than one year, the resulting profit will be a long-term capital gain. As such, the maximum federal income tax rate will be 20%, and you may also owe the 3.8% net investment income tax. When a mutual fund investor sells shares, gain or loss is measured by the difference between the amount realized from the sale and the investor’s basis in the shares. One difficulty is that certain mutual fund transactions are treated as sales even though they might not be thought of as such. Another problem may arise in determining your basis for shares sold.
What’s considered a sale
It’s obvious that a sale occurs when an investor redeems all shares in a mutual fund and receives the proceeds. Similarly, a sale occurs if an investor directs the fund to redeem the number of shares necessary for a specific dollar payout. It’s less obvious that a sale occurs if you’re swapping funds within a fund family. For example, you surrender shares of an Income Fund for an equal value of shares of the same company’s Growth Fund. No money changes hands but this is considered a sale of the Income Fund shares. Another example: Many mutual funds provide check-writing privileges to their investors. However, each time you write a check on your fund account, you’re making a sale of shares.
Determining the basis of shares
If an investor sells all shares in a mutual fund in a single transaction, determining basis is relatively easy. Simply add the basis of all the shares (the amount of actual cash investments) including commissions or sales charges. Then add distributions by the fund that were reinvested to acquire additional shares and subtract any distributions that represent a return of capital. The calculation is more complex if you dispose of only part of your interest in the fund and the shares were acquired at different times for different prices.
You can use one of several methods to identify the shares sold and determine your basis:
First-in first-out.
The basis of the earliest acquired shares is used as the basis for the shares sold. If the share price has been increasing over your ownership period, the older shares are likely to have a lower basis and result in more gain.
Specific identification.
At the time of sale, you specify the shares to sell. For example, “sell 100 of the 200 shares I purchased on June 1, 2015.” You must receive written confirmation of your request from the fund. This method may be used to lower the resulting tax bill by directing the sale of the shares with the highest basis.
Average basis.
The IRS permits you to use the average basis for shares that were acquired at various times and that were left on deposit with the fund or a custodian agent.
As you can see, mutual fund investing can result in complex tax situations. Contact us if you have any questions. We can explain in greater detail how the rules apply to you. © 2020
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Financial Institutions and Banking

Fed issues guidance on accounting for leased bank premises

With the effective date of the Financial Accounting Standards Board’s new lease accounting standard rapidly approaching for nonpublic companies, most community banks are preparing for the standard’s impact on loan covenants and regulatory capital. But it’s also important to consider its potential impact on your institution’s investment in bank premises, such as office space and retail branch leases.

For banks supervised by the Federal Reserve, adoption of the new standard may trigger certain obligations under Regulation H, which places limits on such investments. Recently, the Fed issued guidance on this subject.

When do the new rules take effect?

The new standard — Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842) — is effective for fiscal years starting after December 15, 2019, and for interim periods in fiscal years starting after December 15, 2020. (The standard is already in effect for many public companies.) Banks may adopt the new standard early. But, if they do, they must apply it in its entirety to all lease-related transactions.

What’s the impact on operating leases?

The most significant impact of the new standard will be on operating leases. Under current accounting standards, lessees don’t recognize lease assets or liabilities on the balance sheet for operating leases (as opposed to capital leases). But the new standard will require most lessees to record both a right-of-use asset and a lease liability on their balance sheets, based on the present value of minimum payments under the lease (with certain adjustments). After a bank adopts the standard, it will be required to record all of its operating leases (with limited exceptions) on its balance sheet. That includes those entered into before the standard’s effective date.

What are the Regulation H implications?

Regulation H implements Section 24A of the Federal Reserve Act. One of its provisions prohibits Fed-supervised banks from making aggregate investments in bank premises that exceed the amount of the bank’s capital stock, unless they first obtain the Fed’s approval. For some banks, adoption of the new lease accounting standard will cause the carrying value of bank premises (which includes leases recorded on the balance sheet) to surpass their capital stock.

The Fed’s guidance — found in Supervision and Regulation Letter No. SR 19-7 — clarifies that Fed approval isn’t needed when adopting the new standard requires a bank to capitalize premises leased before the standard’s effective date. In other words, if a bank’s investment in bank premises is less than its capital stock before adopting the standard, but adoption causes that investment to increase to an amount that exceeds the bank’s capital stock, it’s not necessary to seek the Fed’s approval. But prior approval will be required for any postadoption leases that cause investments in bank premises to exceed capital stock.

What’s your plan?

As you plan your bank’s transition to the new accounting standard for leases, it’s important to evaluate the impact of adopting the standard on your investment in bank premises. Moving existing leases to the balance sheet won’t cause you to run afoul of Regulation H. But if you’re planning any significant new leases of retail branches or other facilities, be sure to consider the timing of those investments in relation to your planned adoption of the standard. Your financial professional can help you assess the impact.

© 2019

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Financial Institutions and Banking

Bank Wire

How S corporation banks can qualify for the pass-through deduction

The Tax Cuts and Jobs Act created a new “pass-through” deduction (found in Internal Revenue Code Section 199A), which allows owners of S corporations and other pass-through entities to deduct up to 20% of their “qualified business income.” But Sec. 199A is subject to several restrictions and limitations. These include disallowance of the deduction with respect to specified service trades or businesses (SSTBs) for owners whose income exceeds certain thresholds.

SSTBs include financial services, brokerage services, investing and investment management, securities dealing, and several other services. So some S corporation banks have been uncertain about whether they’re eligible for the deduction. But recently finalized regulations provide welcome guidance, clarifying that “financial services” don’t include taking deposits or making loans. Further, originating loans for sale on the secondary market doesn’t fall under the “dealing in securities” umbrella.

Banks whose trust departments or wealth management advisors provide investment-related services or are involved in other SSTB activities may still qualify for the deduction, if either:

  • These activities produce less than 5% of gross receipts (10% for banks with gross receipts under $25 million), or
  • The bank is able to segregate its SSTB from its non-SSTB activities.

Homeowners Protection Act is on CFPB radar

In the Winter 2019 issue of its Supervisory Highlights report, the Consumer Financial Protection Bureau (CFPB) signaled a renewed focus on compliance with the Homeowners Protection Act (HPA). The HPA requires residential mortgage servicers to cancel private mortgage insurance (PMI) if certain conditions are met. The CFPB identified several deceptive practices among servicers, such as failing to properly disclose the reasons for denying PMI cancellations, providing inaccurate or incomplete reasons for such denials, and misleading consumers about the conditions for PMI removal.

You can find the full report at https://www.consumerfinance.gov/policy-compliance/guidance.

Guidance out on mortgage servicing rule

The CFPB has released several important implementation tools to help servicers comply with amendments to the mortgage servicing rules in Regulations X and Z. They include 1) a set of frequently asked questions regarding periodic billing statement requirements for borrowers in bankruptcy, 2) an updated small entity compliance guide that reflects the final amendments, and 3) an updated mortgage servicing coverage chart that incorporates the final amendments. You can find these tools at https://www.consumerfinance.gov/policy-compliance/guidance/mortserv.

© 2019

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Financial Institutions and Banking

Opportunity Zones: Can your bank benefit?

The Opportunity Zone program, created by the Tax Cuts and Jobs Act of 2017, provides investors with a powerful tax incentive to make long-term investments in state-designated economically distressed communities. The U.S. Treasury Department has certified approximately 9,000 Qualified Opportunity Zones (QOZs) in urban and rural areas across the country. Investors with capital gains can defer and, in some cases, exclude those gains from income by reinvesting them into an opportunity zone.

The benefits

What are the potential benefits for community banks? It’s unlikely that many banks will invest directly in opportunity zone projects, but some are creating funds to make equity investments in these projects.

But perhaps the most significant benefit for community banks is the opportunity to make loans in connection with development projects that might otherwise not be economically feasible — absent the tax breaks available in opportunity zones. And these loans may also help a bank meet Community Reinvestment Act requirements. (See “CRA compliance matters.”)

The way it works

It’s important to recognize that, to enjoy the tax benefits offered by the program, investors can’t simply write a check to the developer of a project in a QOZ. First, the investor must show recognized capital gains from other investments. Second, the investor must reinvest those gains, within 180 days, in a Qualified Opportunity Fund (QOF), which is a corporation or partnership formed for the purpose of investing in QOZs. Note that special rules apply to capital gains allocated from partnerships and other pass-through entities to their owners. Under those circumstances, investors should consult their tax advisors to determine when the 180-day period starts.

Virtually any individual or organization can create and manage a QOF, with a single investor or many investors. To qualify, at least 90% of the fund’s assets must be “QOZ property.” This includes tangible property that’s used by a trade or business within a QOZ and meets specific other requirements (QOZ business property). It also includes equity interests in qualifying corporations or partnerships (QOZ businesses), if substantially all of their tangible property is QOZ business property.

The tax benefits for investors in QOFs are attractive. First, the tax on reinvested capital gains is deferred until the end of 2026 or the date the QOF investment is disposed of, whichever comes first. Next, investors enjoy a 10% reduction in the amount of taxable capital gain if they hold the QOF investment for at least five years — and 15% if they hold the investment for at least seven years. Finally, investors who hold their QOF investments for at least 10 years avoid capital gains tax on the appreciation of the QOF investment itself.

An example

Consider this example: On September 1, 2019, Bill sells his interest in stock, generating $2 million in capital gain. Bill establishes a single-investor QOF for the purpose of acquiring and developing commercial real estate in a QOZ valued at $10 million. On December 1, Bill reinvests his entire $2 million gain into the QOF, which borrows the remaining $8 million needed to acquire the property from a community bank.

Bill holds the QOF investment until December 15, 2029. At the end of 2026, Bill has satisfied the seven-year holding period, so he’s taxed on only 85%, or $1.7 million, of the original $2 million gain. Now, suppose that the value of Bill’s interest in the QOF has grown to $7 million by the time he disposes of it on December 15, 2029. Because he’s met the 10-year holding period, the entire $5 million in appreciation is tax-free.

Timing is everything

If your bank is exploring ways to take advantage of the Opportunity Zone program, you should start as soon as possible. That’s because investors who wish to maximize the available tax benefits must invest in a QOF by the end of this year. Otherwise, they can’t meet the seven-year holding period that’s required for a 15% gain reduction by year-end 2026. Of course, investors can still enjoy a 10% gain reduction, which requires a five-year holding period. A requirement: They must invest by the end of 2021.

At press time, the IRS was continuing to fine-tune a complex set of proposed regulations on the QOZ program. So be sure to consult your tax advisors before getting involved in QOZ projects.

Sidebar: CRA compliance matters

One potential benefit of opportunity zones for community banks is that loans in those economically distressed areas may help banks meet their obligations under the Community Reinvestment Act (CRA). The CRA’s purpose is to encourage banks to help meet the credit needs of the communities in which they operate, including low- and moderate-income (LMI) neighborhoods. Of course, their activities must be consistent with safe and sound banking operations. In many cases, these LMI neighborhoods are located in, or coincide with, Qualified Opportunity Zones (QOZs) and are eligible for the tax benefits described in the main article.

The federal banking agencies periodically evaluate banks’ records in meeting their communities’ credit needs. And the agencies’ performance evaluations and CRA ratings are made available to the public. A positive rating can enhance a bank’s reputation in its community. And the agencies take a bank’s CRA record into account when considering requests to approve bank mergers or acquisitions, charters, branch openings or deposit facilities. Banks should consider these potential benefits as they evaluate opportunities in QOZs.

© 2019

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Financial Institutions and Banking

Bank Wire

CECL: Banking agencies offer regulatory capital relief

The federal bank regulatory agencies recently finalized a rule that offers banks relief from the regulatory capital impact of the new Current Expected Credit Loss (CECL) standard. CECL discards the traditional incurred-loss model for recognizing credit losses in favor of a forward-looking approach. That is, banks will recognize an immediate allowance for all expected losses over the life of loans and other financial assets covered by the standard.

For some banks, adoption of CECL will negatively affect regulatory capital. Although the actual impact depends on a bank’s particular circumstances, many banks will experience an increase in allowance levels and a reduction in the retained earnings component of equity. This combination will lower their common equity tier 1 capital.

The final rule gives banks the option to phase in the day-one adverse regulatory capital effects of implementing CECL over a three-year period.

A BYOD policy protects banks

These days, the vast majority of your employees have smartphones. Use of these devices to send and receive work-related emails and other communications, and to access the bank’s files and other network resources, can boost productivity. But the ensuing security concerns have led some banks to prohibit employees from using their own devices for bank business. Although an outright ban can be hard to enforce, setting a bring-your-own-device (BYOD) policy enabling the bank to control these devices and manage the risk may be a better approach.

A BYOD policy should, among other things:

  • Provide for management approval and registration of all mobile devices that will access the bank’s servers,
  • Require employees to maintain up-to-date virus protection, authentication and encryption software on mobile devices,
  • Require employees to use strong passwords and other security controls to access mobile devices and the bank’s servers,
  • Specify what type of information can be stored on or transmitted by mobile devices,
  • Allow the bank to remotely wipe a device clean if it’s lost or stolen, and
  • Require employees to provide written consent to comply with the written security procedures before using the device for bank business.

Consider using mobile device management (MDM) software to manage employees’ devices and implement controls to protect the bank’s information.

Regulators approve lengthened examination cycle

On January 17, the federal bank regulatory agencies finalized a rule expanding the availability of an 18-month, on-site examination cycle for qualifying banks with less than $3 billion in total assets (up from $1 billion). The agencies reserved the right to impose more frequent examinations if deemed “necessary or appropriate.”

© 2019

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Financial Institutions and Banking News

Federal Reserve focuses on emerging risks

Late last year, the Federal Reserve released its inaugural Supervision and Regulation Report. The report is designed to summarize banking conditions and the Fed’s supervisory and regulatory activities.

Worth Noting

Here are some highlights from the report:

Banking system conditions. The Fed reports that the U.S. banking system is generally strong, that loan growth remains robust, that the volume of nonperforming loans has declined over the last five years, and that overall profitability is stable. Banks continue to maintain high levels of quality capital and have significantly improved their liquidity since the financial crisis.

Large financial institution (LFI) soundness. According to the report, the safety and soundness of LFIs continues to improve. Capital levels are strong and significantly higher than before the financial crisis. Recent stress test results demonstrate that LFIs’ capital levels would remain above regulatory minimums even after a hypothetical severe global recession.

Regional and community banking organization liquidity risk. The Fed reports that most regional banking organizations (RBOs) and community banking organizations (CBOs) are in satisfactory condition, and that 99% are “well capitalized.” Although liquidity risk is generally low or moderate for RBOs, examiners have observed some deterioration of liquidity positions.

The Fed also has identified opportunities for improving RBO risk management. In 2019, the Fed’s RBO supervisory priorities include:

  • Credit risk (concentrations of credit, commercial real estate [CRE] and construction and land development, and underwriting practices),
  • Operational risk (merger and acquisition risks, IT, and cybersecurity), and
  • Other risks (sales practices and incentive compensation and BSA/AML).

CBOs, the Fed observes, are in “robust financial condition,” with high capital levels and low-to-moderate liquidity risks. But like RBOs, CBOs have experienced “a slight uptick” in liquidity risks. Supervisors continue to focus on three areas of emerging risk: 1) management of concentrations of credit — specifically, CRE, agriculture, and oil and gas, 2) the impact of rising interest rates, and 3) increased liquidity risk.

CBO supervisory priorities for 2019 include:

  • Credit risk (concentrations of credit, CRE and construction and land development, and agriculture),
  • Operational risk (IT and cybersecurity), and
  • Other risks (BSA/AML and liquidity risk).

According to the report, the Fed also has made it a priority to modernize and increase the efficiency of the examination process to reduce the burden on community banks. A key part of this effort is the Bank Exams Tailored to Risk program. Under that program, each bank is classified into a low-, moderate- or high-risk tier. The classification provides examiners with a starting point for determining the scope of work, including the extent of transaction testing and other examination procedures. Examiners have the discretion to consider qualitative factors and apply their own judgment in confirming or adjusting the risk tiers.

A valuable tool

The Fed’s inaugural Supervision and Regulation Report examines trends going back to the financial crisis. Future reports will focus on developments since the previous report. Taken together, these reports provide banks with a valuable tool for keeping their fingers on the pulse of the banking industry and identifying emerging risks.

© 2019

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Financial Institutions and Banking

Staying Ahead of the Game

Abstract: The value of real estate collateral typically is fundamental to the value of many loan portfolios. So it’s important to stay on top of real estate value fluctuations and obtain periodic appraisals according to the rules. This article points out that lenders should understand interagency guidelines, maintain program independence, use selection criteria for valuators and become familiar with appraisal standards. The article suggests that, to ensure real estate collateral is sound, it’s important to set up an effective, efficient and comprehensive review program.

Staying ahead of the game

Review your real estate valuation program

The value of real estate collateral is likely fundamental to the value of your loan portfolios. So it’s important to stay on top of real estate value fluctuations and obtain periodic appraisals according to the rules. You also need to understand interagency guidelines, maintain program independence, use selection criteria for valuators and become familiar with appraisal standards. Doing all this can keep you ahead of the game.

What are the interagency guidelines?

Start your evaluation by revisiting the kingpin of any valuation program, the Interagency Appraisal and Evaluation Guidelines. They apply to appraisals and evaluations for all real estate–related financial transactions originated or purchased by regulated institutions, whether for the institutions’ own portfolios or as assets held for sale. The guidelines cover residential and commercial mortgages, capital markets groups, and asset securitization and sales units.

Most transactions valued at more than $250,000 require appraisals, though certain transactions — listed in Appendix A to the guidelines — are exempt. In addition to the exclusion for transactions at or below the $250,000 threshold, exceptions include:

• Business loans secured by real estate for less than $500,000 (the $500,000 limit for commercial loans took effect on April 9, 2018) whose source of repayment is from other than the rental income or sale of the real estate,
• Extensions of existing credits,
• Loans not secured by real estate, and
• Transactions guaranteed or insured by the U.S. government.

The exemptions are limited, so be sure to scrutinize transactions to determine whether risk factors or other circumstances make an appraisal necessary. Some exempt transactions require a less formal evaluation.

Is your program independent?

Your institution is responsible for developing an effective collateral valuation program. First, consider the independence of your program, which should be isolated from influence by your loan production staff. Individuals who order, review and accept appraisals or evaluations should have reporting lines independent of the production staff as well. Appraisers and individuals performing evaluations (“evaluators”) need to be independent of loan production and loan collection and obviously should have no interest in the transaction or property.
Special rules apply to smaller institutions that lack the staff needed to separate their collateral valuation programs from the production process. For mortgages and other loans secured by a principal dwelling, review amendments to Regulation Z that impose strict independence and conflict-of-interest requirements on appraisers.

What are the selection criteria for valuators?

Next consider how you select valuators. Set criteria for selecting, evaluating and monitoring appraisers and evaluators, and for documenting their credentials. Among other things, ensure that those selected are qualified, competent and independent and that appraisers hold appropriate state certifications or licenses.
Select and engage appraisers directly (though appraisals prepared for other institutions may be used if specific rigorous requirements are met). Approved appraiser lists are permitted, provided you establish safeguards to ensure that list members continue to be qualified, competent and independent.

What are the minimum appraisal standards?

Then make sure that your appraisals conform to the Uniform Standards of Professional Appraisal Practice, although safe and sound banking practices may call for stricter standards. Written reports should provide sufficient detail — according to the transaction’s risk, size and complexity — to support the credit decision.

Appraisers should analyze appropriate deductions and discounts (detailed in Appendix C of the guidelines) for proposed construction or renovation, partially leased buildings, non-market lease terms and tract developments with unsold units.

What are some other factors?

In addition to these touchstones, your program should facilitate credit decisions by ensuring the timely receipt and review of appraisal or evaluation reports. It also should provide criteria for determining whether existing appraisals or evaluations may be used to support subsequent transactions.

Moreover, your valuation program should have in place internal controls that promote compliance. And it should contain standards for monitoring collateral values and for handling transactions not otherwise covered by appraisal regulations.

If you outsource valuation functions, your institution remains responsible for all appraisals and evaluations. The interagency guidelines discuss the resources, expertise, controls and due diligence procedures your institution needs to identify, monitor and manage risks associated with these outsourcing arrangements.

Is it working?

The only way to ensure that your real estate collateral is sound is to set up an effective, efficient and comprehensive program. You’ll also need to review it regularly and adjust as needed to keep it on the right track.

© 2019

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Financial Institutions and Banking

Bank Wire

FinCEN creates exception to Beneficial Ownership Rule

As part of its efforts to combat money laundering and other fraudulent activity, the Financial Crimes Enforcement Network (FinCEN) issued its Beneficial Ownership Rule, effective for new accounts opened on or after May 11, 2018. The rule requires banks, as part of their customer identification programs, to verify the identity of the beneficial owners of certain legal entities. Beneficial owners include individuals who, directly or indirectly, own 25% or more of an entity, as well as any individual who has “significant responsibility to control, manage or direct the legal entity.”

In a September 7, 2018, ruling, FinCEN created an exception to the beneficial ownership rule for legal entities that open new accounts on or after the effective date as a result of:

  • Rolling over a certificate of deposit,
  • Renewing, modifying or extending a loan, commercial line of credit or credit card account that doesn’t require underwriting review and approval, or
  • Renewing a safe deposit box rental.

The exception applies only to rollovers, renewals, modifications or extensions of the above product types that take place on or after May 11, 2018. It doesn’t apply to the initial opening of such accounts.

Banks considering use of alternative credit data

Some lenders are considering the use of alternative data to expand access to credit for people with thin credit histories or negative items on their credit reports. By developing innovative techniques for analyzing a borrower’s ability to repay, lenders can expand their pools of potential borrowers beyond those identified by traditional techniques.

Alternative data refers to information that may be used to evaluate creditworthiness but is not traditionally part of a credit report. Examples include rent payments, mobile phone payments, cable TV payments, and bank account information. This may also include education, occupation and even social media activities.

It may take some time before alternative data techniques catch on among community banks. In 2017, the Consumer Financial Protection Bureau (CFPB) released a “Request for Information” seeking information about alternative data and the modeling techniques used to analyze them. You can find the document, which discusses the benefits and risks associated with alternative data, at https://www.consumerfinance.gov/policy-compliance/notice-opportunities-comment/archive-closed/request-information-regarding-use-alternative-data-and-modeling-techniques-credit-process.

Supervisory guidance isn’t the law

In a recent joint statement, the federal banking agencies clarified that supervisory guidance “does not have the force and effect of law.” Among other things, the agencies intend to limit the use of numerical thresholds or other “bright lines” in describing expectations, and examiners won’t criticize banks for “violations” of supervisory guidance.

© 2018