Disclosure Guidance #5 - from SEC Corporation Finance addresses "Disclosures of Smaller Financial Institutions."  Specifically, this guidance, based on observations by the CorpFin staff, tackles "Management’s Discussion and Analysis" and accounting policy disclosures of smaller financial institutions.

Keep In Mind: As always, CorpFin Disclosure Guidance releases contain statements that represent the views of the Division and its staff.  The contents should not be relied up as rule, regulation or statement of the SEC, and the Commission has neither approved nor disapproved its content.

[Note to Readers: CorpFin uses "we" in its text, which C-I has not changed.  C-I, however, has edited the contents in other respects to provide additional clarity.]

........................................................................................................................

Introduction. In our review of the filings of smaller financial institutions, we frequently issue comments on several topics that impact Management’s Discussion and Analysis (MD&A; see Item 303 of Regulation S-K;  and Form 20-F, Item 5) and accounting policy disclosures. The purpose of this guidance is to summarize our observations on such matters in order to assist smaller financial institutions in enhancing the disclosure they provide investors in the reports they file with the Commission. Not all topics are material, or even apply, to all registrants.  Likewise, these observations may not encompass an individual registrant’s particular facts and circumstances and may not address all of the material disclosure issues applicable to each registrant’s circumstances.  Each registrant should consider its own facts and circumstances when preparing its filings. These observations summarize and discuss certain U.S. generally accepted accounting principles ("GAAP") and certain rules and regulations that the Commission has adopted. However, these observations are not a substitute for the Accounting Standards Codification ("ASC") or the rules and regulations of the Commission.  Only the ASC and the rules and regulations themselves can provide registrants with the complete and definitive requirements applicable to their circumstances. Asset Quality / Loan Accounting Issues Allowance for Loan Losses. The allowance for loan losses is a material item for financial institutions.  GAAP requires that a registrant establish an allowance through the recognition of a provision for loan losses when, based on all available information, it is probable that a loss has been incurred based on past events or conditions existing at the date of the financial statements.  GAAP does not permit a registrant to establish allowances it cannot support with appropriate analyses, and the approach for determining the allowance should be well documented and applied consistently from period to period. A registrant’s allowance for loan losses generally consists of 2 components: (i) that which applies to individually-evaluated loans found to be impaired and is calculated in accordance with ASC 310; (ii) that which applies to all other loans that are not individually identified as impaired pursuant to ASC 310-10 ("non-impaired loans").  This component is calculated for all non-impaired loans on a collective basis in accordance with ASC 450.  Industry Guide 3 ("Guide 3") includes a requirement to disclose the detail of the allowance for loan losses allocated by type of loan. We frequently ask registrants to provide more disclosure about how they calculate the allowance and its components.  Depending on its circumstances, we may ask a registrant to explain:

• Why its allowance ratios, such as its allowance to total loans or allowance to total nonperforming loans, have fluctuated;
• Basis for any large unallocated allowance;
• Rationale for changes in methodologies for determining the allowance;
• Why components of the allowance - i.e., calculated in accordance with ASC 310 or 450 - have fluctuated relative to the total allowance; and
• Details of any geographic or higher-risk loan type concentrations in the loan portfolio.

A widely-used method of calculating the allowance for non-impaired loans is based on historical loss rates.  A registrant may also make adjustments to the allowance for non-impaired loans due to the effects of qualitative or environmental factors for groups of loans with similar risk characteristics. The allowance for non-impaired loans is frequently a significant component of the allowance for loan losses, and we have asked registrants to:

• Describe how they calculate and apply historical loss rates, and how they group loans for purposes of deriving historical loss rates;
• Disclose periods they use to determine historical loss rates, including both the number of periods and the length of time;
• Explain causes for any changes to historical loss rates calculated and applied during the current period;
• Discuss how qualitative and environmental factors are considered in their methodologies - e.g., as an adjustment to historical loss rates or as a separate adjustment to the allowance, etc. - and how such factors are reflected in the allowance; and
• Quantify any portion of the allowance for non-impaired loans that they do not calculate by applying historical or adjusted historical loss rates, describe how they calculate the associated allowance, including why they do not use historical or adjusted historical loss rates, and explain the reasons for any changes in the calculation during the period.

Charge-off and Nonaccrual Policies. Registrants have policies for placing loans on nonaccrual status or charging them off when certain events occur - e.g., loans become a certain number of days past due.  When a registrant appears to have a material amount of loans on nonaccrual status or charged off in a period, we may ask the registrant to describe its nonaccrual and charge-off policies, particularly when its disclosure simply states that the policies comply with bank regulatory requirements.  For example, we may request that registrants:

• Disclose relevant thresholds they use to place loans on nonaccrual status or charge off past due loans;
• Explain why a loan was not charged off at a specific past-due threshold, including the specific factors they considered in reaching that conclusion; and
• Discuss reasons for changes in charge-off policies.

Registrants also have policies for characterizing loans as nonperforming.  We may request that registrants disclose their policies for identifying nonperforming loans. We have issued comments seeking disclosure that describes how charge-offs for credit losses impact the coverage ratio - i.e., the allowance to total nonperforming loans.  For example, we may ask registrants to provide an analysis of:

• Ratio of the recorded investment in nonperforming loans for which they have charged off the credit loss to the recorded investment in total loans;
• Ratio of the recorded investment in nonperforming loans for which they have charged off the credit loss to the recorded investment in total nonperforming loans;
• Charge-off rate for nonperforming loans for which they have charged off the credit loss; and
• Coverage ratio, exclusive of nonperforming loans for which they have charged off the credit loss - i.e., the ratio of the allowance to nonperforming loans on which no charge-offs have been taken.

We also may ask registrants to explain the reasons for any trends related to these ratios. Commercial Real Estate (CRE). CRE loans may have unique characteristics. [C-I SKIPPED SECTION - REFER TO SOURCE DOCUMENT FOR DETAILS] Loans Measured for Impairment Based on Collateral Value. GAAP requires creditors to measure a loan for impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable.  In addition, GAAP allows a creditor to measure an impaired loan on which the repayment of the loan is expected to be provided solely by the underlying collateral (i.e., a collateral-dependent loan) based on the fair value of the collateral.  For registrants with significant loan portfolios that they measure for impairment based on the collateral value, we may ask them to describe:

• How and when they obtain 3rd-party appraisals, and how appraisals impact the amount and timing of any provision or charge-off;
• Types of appraisals they obtain, such as "retail" value or "as-is" value;
• What procedures they perform between receiving updated appraisals to ensure that they appropriately measure loan impairments;
• If applicable, reasons they do not obtain appraisals in a timely manner;
• Typical timing of classifying loans as nonaccrual, recording any provision for loan loss, or recognizing a charge-off;
• How they determine the amount to charge off;
• How they classify and account for partially charged off loans after receiving an updated appraisal - e.g., we may ask for an explanation whether loans are returned to performing status or whether loans remain in nonperforming status;
• Reasons they make any adjustments to appraised values when calculating impairment; and
• What procedures they perform to estimate fair value of the collateral when they do not use external appraisals or have not obtained updated appraisals.

Credit Risk Concentrations. GAAP requires disclosure of all significant concentrations of credit risk arising from financial instruments, whether from an individual counterparty or groups of counterparties.  Some registrants have a small number of loans making up a significant portion of their recorded investment in nonaccrual loans.  We may ask those registrants to discuss:

• Types of concentrations that exist - e.g., geographies, industries, collateral types, product types, or borrower types  - i.e., commercial developers, residential land developers, commercial businesses, etc.);
• Types of collateral securing the loans;
• Amount of total credit exposure;
• Allowance for the impaired loans;
• Whether loans are guaranteed and what procedures they perform to evaluate the guarantors’ ability and willingness to repay the balance owed; and
• Any special circumstances surrounding the loans, such as whether the loans relate to properties out of the registrant’s normal market area and whether the loans are related to the registrant’s participation in a larger loan underwritten by another financial institution.

Troubled Debt Restructurings (TDRs) and Modifications. GAAP defines a TDR as the restructuring of debt when the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor it would not otherwise consider providing.  Guide 3 requires separate disclosure of TDRs that are not included within a registrant’s Guide 3 disclosure of non-accrual loans or loans 90 days past due.  When a registrant appears to have a material amount of TDRs, we may ask it to quantify the total amount of modified loans and discuss:

• Types of programs it uses to modify loans;
• Policy for measuring impairment;
• Why any modified loans are not accounted for as TDRs;
• Its nonaccrual policy for restructured loans; and
• Effects of TDRs on its past-due statistics.

Some registrants remove loans from their TDR Guide 3 disclosures under certain circumstances.  We may ask them to:

• Discuss circumstances under which they would remove loans from their TDR disclosures;
• Quantify the amount of loans removed; and\
• Provide a roll-forward of TDRs, if necessary to provide a transparent analysis of TDR activity.

Registrants may also have significant amounts of TDRs that continue to accrue interest. In such circumstances, we may ask registrants to discuss:

• All of the factors considered when they determined the TDRs should continue to accrue interest; and
• Whether they have determined that they are reasonably assured of repayment and, if so, how they made that determination.

Not all loan modifications will meet the definition of a TDR under GAAP.  Where a registrant has significant amounts of loan modifications that it does not account for as TDRs, we may ask it to quantify the amount of loans it modified - by loan type and workout strategy - in each period presented and to explain:

• Triggers or factors it reviews to identify loans for modification, and reasons why it does not account for modified loans as TDRs;
• Key features of its modification programs, including the usual type and length of modified terms;
• Success rates of its modification programs - i.e. the percentage of modified loans that have not defaulted;
• Accounting basis for its conclusion that the modifications should not be classified as TDRs;
• How modified loans are classified - performing vs. nonperforming - and whether modified loans continue to accrue interest; and
• Impact of modifications on past-due statistics.

Other Real Estate Owned (OREO). Registrants record OREO in their financial statements when they acquire property for debts previously contracted, including through foreclosure or repossession. [C-I SKIPPED SECTION - REFER TO SOURCE DOCUMENT FOR DETAILS] Deferred Taxes. Although deferred taxes is a topic that impacts a wide range of registrants, in recent years, many smaller financial institutions experienced significant operating losses for one or more years, which may have given rise to material deferred tax assets related to net operating loss carry-forwards.  GAAP requires that deferred tax assets be reduced, if necessary through recognition of a valuation allowance, by the amount of any tax benefits that are not more likely than not to be realized.  GAAP indicates that, while there are no bright-lines, cumulative losses in recent years represent a significant piece of objective negative evidence that is difficult to overcome when determining whether or not a valuation allowance is required.  When a registrant that has experienced cumulative losses in recent years appears to have a material deferred tax asset for which a valuation allowance has not been recorded we may ask it to explain:

• Positive and negative evidence it assessed in determining extent of any valuation allowance and how it weighed such evidence;
• Why it believes projections of future income are sufficient to overcome the negative evidence of cumulative losses in recent years;
• Why it believes it is appropriate to exclude items such as loan loss provisions when it evaluates whether it has experienced cumulative losses in recent years;
• Why it believes deferred tax liabilities or tax planning strategies are sufficient to realize all or a portion of its deferred tax asset; and
• Tax planning strategies it expects to utilize.

Federal Deposit Insurance Corporation (FDIC)-Assisted Transactions. Many institutions that were placed into receivership by the FDIC have been reorganized, sold, or transferred by the FDIC to other financial institutions. [C-I SKIPPED SECTION - REFER TO SOURCE DOCUMENT FOR DETAILS] For further details, go to:  [SEC CorpFin Guidance - Topic #5, 4/20/12].