2023 Banking industry key takeaways: Preparing your bank for 2024

• Banks can lower their effective tax rates and save tax money with tax credit programs.
• There is a continued high focus on banks for the ESG tax credits.
• Tax credit programs can additionally provide Community Reinvestment Act (CRA) credits.
• The recent Inflation Reduction Act (IRA) will produce many transferable tax credits available for purchase.
• The now more widely available proportional amortization accounting method is available on tax credit programs – keep the benefit on the income tax line of financials.

The NMTC program was enacted with the Community Renewal Tax Relief Act of 2000 and since then, over $80 billion of NMTCs have been awarded by the US Treasury Department since inception without a known event of recapture. NMTCs stimulate commercial investment in low-income census tracts. It works by investors purchasing the stream of credits at a discount where their total return is in the form of the tax credits.

• Investors can purchase NMTCs at an NPV discount (around $0.78-0.82 as of Nov. 2023), which are earned over a 7-year period and applied to offset federal income tax liability.
• Proceeds from NMTC investors fund businesses and community facilities in low-income communities that create jobs, provide social services and other outcomes that benefit low-income people and communities.
• Recapture of the credits is not tied to the financial outcome of the underlying project and Baker Tilly is not aware of a recapture event in the history of the NMTC program.
• Several states offer a state-level NMTC program that can be combined with federal NMTC, including: Alabama, Kentucky, Nebraska, Arkansas, Louisiana, Nevada, Georgia, Maine, Ohio, Illinois, Mississippi and Utah

• The IRA enabled the portability of Federal Investment and Production Tax Credits (ITCs and PTCs) allowing the developer of a renewable energy project to sell the credits to a third-party purchaser that has no stake in the project.
• Factors such as the use of prevailing wages, domestic content and location of the project determine the ITC rate, which can be up to 50% of eligible costs.
• Purchasers may carry back ITC up to three years from the date that the renewable project was placed in service (year of production for PTC) for a refund and carried forward for 22 years.
• ITC has a 5-year recapture period, which is often mitigated with recapture insurance or an indemnification from a credit rated seller. PTC is not subject to recapture.
• As of November 2023, pricing for ITC is $0.90-0.92 and $0.92-0.94 for PTC.

CECL updates

• Regulatory expectation of periodic CECL model validation by a third party.
• CECL qualitative factors (q factors) quantifications need to follow supportable and quantifiable approaches.
• New loan modification disclosures under CECL require additional analysis.

ASU 2022-02 key takeaways

• Eliminated TDR guidance.
• Enhanced disclosure requirement for certain loan modifications to borrowers experiencing financial difficulty.
• Requires gross write-off information in vintage disclosures for public business entities.
• Effective for years beginning after December 15, 2022. Early adoption was available for CECL adopters only.
• FDICIA part 363 reminders.

Audit committee

• IDI with total assets of $500 million but less than $1 billion – majority of audit committee’s members (outside directors) should be independent of management.
• IDI with total assets of $1 billion or greater – audit committees should be comprised solely of outside directors that are independent of management.
• IDI with total assets of greater than $3 billion – audit committee must include members with banking or related financial management expertise, have access to its own outside counsel and should not include any large customers.

Independence

• Independent public accountants are in compliance with independence standards of AICPA, SEC and PCAOB.
• Ensure no limitation of liability provisions in audit and related engagement letters.

Auditor’s report and management’s assessment

• IDI with total assets of $1 billion or greater, it was clarified that the report on ICFR should reference the regulatory reports filed at the consolidated level. (e.g. call report or FR Y-9C)
• Holding company parent-only references (FR Y -9SP or FR Y-LP) should not be referenced any longer.

The economy shows mixed signals with lower Gross Domestic Product (GDP) growth and persistent inflation above the Federal Reserve System’s target.

• Predictions of a 2024 recession coincide with a favorable outlook for the mortgage market, anticipating lower rates, slower housing price increases, and increased origination volume.
• Lenders are exploring liquidity sources like private label securitization, while focusing on alternative mortgage products.
• Keep an eye out as Basel III regulations may reshape lending practices: Banks with more than $1 billion in assets require more capital. Higher capital concentrations across the board could force banks to reduce their overall mortgage footprint.

An effective risk management system should be a focus for your institution going into 2024. Institutions should proactively assess and mitigate risks to safeguard information and assets and protect value.

Regulatory updates:

• Continued focus areas for your business should be on the Bank Secrecy Act (BSA) and fair lending.
• Interagency Guidance on third-party relationships has been released.
• Consumer Financial Protection Bureau (CFPB) and Dodd Frank Section 1071 is on hold due to pending litigation.
• Public Company Accounting Oversight Board (PCAOB) Amendments to Auditing Standards: The revised standard aims to enhance investor protection by strengthening procedures that enhance an auditor's ability to identify fraud in certain circumstances and thereby elevating the overall quality of audits.

Vendor management

• Interagency guidance replaces existing agency guidance (FRB – 2013, FDIC – 2008, OCC – 2013 and 2020 FAQ) adopts the OCC's guidance focused on: planning, due diligence and selection, contract negotiation, ongoing monitoring and termination.
• Increased focus on fourth parties: know who they are and how you are monitoring yours
• Overall, as many banks utilize third-parties, it doesn’t reduce the responsibility for proper oversight and monitoring.

Credit risk

• Primary concerns facing credit departments in 2023 relate to rising interest rates and inflation
• An increased risk of defaults within CRE portfolios – specifically office space and retail

CECL

• Model should be validated and management having proper controls in place to ensure data feeding into the model is complete and accurate

In 2023, these were the hottest trending cyber topics for financial institutions:

• Social engineering attacks
• Malware and ransomware attacks
• Artificial intelligence and machine learning (AI/ML) attacks
• Cloud security threats
• Fourth-party/supply chain attacks

To have an effective cybersecurity oversight, we suggest reviewing the National Association of Corporate Directors’ (NACD) annual handbook on cyber risk oversight. Key principles include:

• Cybersecurity as a strategic risk
• Legal and disclosure implications
• Board oversight structure and access to expertise
• An enterprise framework for managing cyber risks
• Cybersecurity measurement and reporting
• Encourage systemic resilience and collaboration

Money laundering and sanctions are in the headlines every day. From the geopolitical crises between Russia, Ukraine and in the Middle East, to crypto exchanges and illegal marijuana businesses in the U.S., this is an area of every increasing focus and scrutiny by the regulators. Ahead of 2024, make sure your risk assessment and BSA/AML/sanctions programs are updated to reflect the changing landscape, which is a critical first step to safeguarding your institution and reputation from violations. Key focuses should be:

• Technology: Technology is more important than ever to help you get a better picture of suspicious activity, customer behaviors and risk levels. This also helps your human resources to focus on the things that require the most nuance and critical thinking.
• Compliance: Understanding your third-party risks, including their compliance, with applicable AML regulations is a key area of focus for regulators. Focus on scrutinizing your contracts and relationships and getting comfortable with their compliance program and results of their independent testing.

The banking industry trends for liquidity have shown significant volatility from extreme highs during the onset of COVID-19 to recent declines in deposits over the last 12 months. Market interest rates have played a large factor in these swings. In response to these swings' liquidity stress-testing is becoming a large focus area. Stress testing can:

• Identify surge deposits and amount that is left on the balance sheet
• Test deposit decay and pricing betas
• Review impacts to cost of funds and NIM