IMPORTANT ACCOUNTING AND TAX CONSIDERATIONSTHAT WILL IMPACT GROWTH AND CAPITAL DECISIONS

Bill Reilly, Financial Services National Tax PartnerMarkus Veith, Financial Services Audit Partner

March 6, 2013

Disclaimer

This presentation is not a comprehensive analysis of the subject matters covered and may include proposed guidance that is subject to change before it is issued in final form. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this presentation. The views and interpretations expressed in the presentation are those of the presenters and the presentation is not intended to provide accounting or other advice or guidance with respect to the matters covered.

MEET YOUR PRESENTERSCONTACTS

Markus VeithFinancial Services National Audit PartnerT: 212-624-5370E: markus.veiths@us.gt.com

Bill ReillyFinancial Services National Tax PartnerT: 212-624-5420E: bill.reillyl@us.gt.com

AGENDA

• BASEL III and Deferred Tax Assets

• FASB Exposure Draft of Impairment

Abbrev. Description

DTAs Deferred tax assets

DTLs Deferred tax liabilities

NOL Net operating loss

VAs Valuation allowances

DEFERRED TAX ASSETSBACKGROUND• Deferred tax assets (DTAs) and liabilities (DTLs) occur when there is a difference between the

accounting and tax treatment of an asset or liability. Generally, DTAs represent a future tax benefit, while DTLs represent a future tax liability.

• DTAs are usually calculated by taking the tax effect of:

i. the difference between the book carrying value and tax basis (temporary difference DTA), or

ii. the carryover of a tax benefit (carryover DTA).

• A common DTA is a NOL carryforward. This DTA is calculated by multiplying the tax NOL carryforward by the tax rate (combined federal and state).

Temporary Deferred Tax Assets (DTAs)

Tax Basis minus Book Carrying Value

Tax rate (federal and state)

Carryforward Deferred Tax Assets (DTA)

e.g., NOLS

Carryforward Amount

Tax rate (federal and state)

DEFERRED TAX ASSETSBACKGROUND

• The question as to how much of these DTAs should be included in Bank's Tier 1 capital has been a hot debate, especially during and after the financial crisis. Regulators worry about the risk of realizing DTAs.

• One large Bank's DTA exceeded its market capital at one point during the financial crisis.

• University of North Carolina study concluded that Banks with a larger proportion of DTA in their asset mix were more likely to fail.1

1John Gallemore, Deferred Tax Assets and Bank Regulatory Capital, University of North Carolina, January 2012

PRE-BASEL IIITREATMENT OF DTAs (U.S.)• Generally, DTAs cannot represent more than 10% of a Bank's Tier 1 capital.

• DTAs are netted against DTLs and valuation allowances (DTA – DTLs – VAs). Netting of DTLs is not done on a jurisdiction by jurisdiction basis.

• Carryback claims (e.g. NOL carrybacks) are considered good (count for Tier 1 capital) DTAs because their realizability can be determined.

• The DTA that is left after subtracting DTLs, VAs, and any DTA related to a carryback claim can be further used as asset for Tier 1 capital if it can be used to offset projected taxable income within the next 12 months (12 months from the date of the report).

• Again, the DTA stated above (based on 12 months taxable income) cannot exceed 10% of the Bank's Tier 1 capital.

GAAPRULES

• Under the GAAP rules, DTAs can be booked if it is more likely than not that they will be realized.

• This realization is based on future income. A valuation allowance is booked where future income is questionable.

• Projections can be used to predict future taxable income. In addition, tax planning strategies can be used to rationalize DTAs.

IFRSRULES

• International: Generally, IFRS books DTAs in an amount the management thinks they can realize. This amount is typically considered a good asset for Tier 1 capital in foreign jurisdictions.

BASEL IIIDEFERRED TAX ASSETS (DTAs)

• Subject to change and interpretation.

• NOL carrybacks allowed for Tier 1 capital subject to 100% risk weighting.

• DTLs and VAs will be subtracted from DTAs. However, they will be allocated (guidance needed) between carryforward type DTAs (e.g. NOLs) and Temporary difference DTAs.

• After allocating DTLs and VAs, the net carryforward DTAs must be subtracted in full from the good DTA allowed as Tier 1 capital. They are completely removed from the Tier 1 capital calculation. (No more 12-month income projection)

BASEL IIIDEFERRED TAX ASSETS (DTAs)

• After allocating DTLs and VAs, the net temporary difference DTA is subject to a 10% and 15% limitation. Note: In addition to the 10% limitation on temporary difference DTAs, there is a separate 10% test for mortgage servicing rights (MSRs) and minority investments in other financial institutions.

• A 15% limitation is applied to three items collectively:

– temporary difference DTAs.– MSRs– minority investments in other financial institution

• 250% risk weighting on allowable temporary difference DTAs.

BASEL IIIDEFERRED TAX ASSETS (DTAs)

• VAs are allocated to the DTA to which they relate.

• DTLs netted against specific assets first (Goodwill, MSRs), remaining DTL Allocated pro-rate to remaining DTAs. DTLs netted on a jurisdiction by jurisdiction basis were offset is permitted (this is a new restriction).

• *Transitional Rules (Delay the pain over 5 years):

– Net carryforward DTAs:

• phased in 2014 (20%) to 2017 (80%) [20% per year]

• Whatever is allowed for common equity Tier 1 (CET1) is fully deducted for Tier 1. So, as of 2013 no carryforward DTAs allowed for Tier 1 capital. Risk weighing of allowed amount for CET1 not mentioned.

– Net Temporary Difference DTAs

• same 20% phase in as above

• 15% limit only on CET1

• 100% risk weighing of allowed amount

* BASEL III, capital rules postponed in November 2012 (indefinitely?)

PLANNING & STRATEGY

• Banks are looking at strategies to accelerate income to reduce DTAs where applicable.

• Banks are looking for strategies that convert an NOL carryforward DTA (that BASEL III will subtract 100% of from Tier 1 capital) to another asset (security) DTA that will not be subtracted from Tier 1 capital.

FASB EXPOSURE DRAFT ON IMPAIRMENT

FINANCIAL INSTRUMENTS: IMPAIRMENTBACKGROUND

• Identified weaknesses in today's model

– "Incurred" loss threshold that was seen as delaying recognition of losses

– Complexity with multiple existing credit impairment models for debt instruments such as

• Other-than-temporary impairment

• ASC 310-30 (SOP 03-3)

FINANCIAL INSTRUMENTS: IMPAIRMENTSCOPE• Financial assets that are debt instruments classified at:

– amortized cost

– FV-OCI

• Receivables that result from revenue transactions within the scope of Topic 605

• Reinsurance receivables that result from insurance transactions within the scope of Topic 944.

• Lease receivables recognized by a lessor in accordance with Topic 840

• Loan commitments

FINANCIAL INSTRUMENTS: IMPAIRMENTCurrent Expected Credit Loss (CECL) Model • Single measurement objective: current estimate of all contractual cash flows not

expected to be collected

– would remove "probable" threshold– neither a best case or worst case scenario

• Broadens information that must be considered

– internal and external– past events, including historical loss experience– current conditions– reasonable and supportable forecasts

• No specific guidance as to whether credit losses should be measured on an individual or collective (pool) basis

FINANCIAL INSTRUMENTS: IMPAIRMENTCurrent Expected Credit Loss (CECL) Model • Estimate shall reflect time value of money

– Example: discounted cash flow

– Other approaches implicitly consider time value of money such as loss-rate methods, roll-rate methods, and probability-of-default methods

– FV of collateral permitted for collateral dependent financial assets

• Intended to leverage existing internal credit risk management tools and systems; however, inputs to the measure will change

FINANCIAL INSTRUMENTS: IMPAIRMENTCurrent Expected Credit Loss (CECL) Model

• Purchased credit impaired (PCI)

– Follow same measurement approach as originated and non-PCI assets

– Bifurcate discount between credit and non credit components

– Day 1 – recognize ALLL based on management's current estimate of contractual cash flows that the entity does not expect to collect

– Day 2 - favorable and unfavorable changes in the ALLL recognized immediately through provision for loan losses

FINANCIAL INSTRUMENTS: IMPAIRMENTOTHER CONSIDERATIONS• An entity may elect, as practical expedient, not to recognize expected credit losses for

FV-OCI financial assets if both:

– FV > amortized cost

– Expected credit losses are insignificant

• Retains troubled debt restructuring concept

• Nonaccrual when it is not probable that the entity will receive substantially all of the principal or interest

• Charge-off when determine that there is no reasonable expectation of future recovery

• Expanded disclosures

• Interaction with BASEL III and other regulatory changes

FASB EXPOSURE DRAFT ON IMPAIRMENTFASB vs. IASB MODEL

FASB proposal IASB proposal

Measurement objective Single measurementobjective – all expected credit losses

Two different measurement objectives • 12 months of expected credit

losses• All lifetime expected losses

Proposal includes criteria to decide which measurement objective should be followed

FASB EXPOSURE DRAFT ON IMPAIRMENTEFFECTIVE DATE

• Effective date: To be determined

• Transition: cumulative-effect adjustment to the statement of financial position as of the beginning of the first reporting period in which the guidance is effective

• Comments on proposal due by April 30, 2013

ASU 2013-3FAIR VALUE DISCLOSURE OF NON-PUBLIC ENTITIES• ASC 825-10-50-10(d) requires an entity to disclose the level of the fair value

hierarchy within which the fair value measurements are categorized in their entirety (Level 1, 2, or 3) for items that are not measured at fair value in the statement of financial position but for which fair value is disclosed.

• It was not the Board's intent for this disclosure requirement to apply to nonpublic entities

• On February 7, 2013, the FASB issued ASU No. 2013-03, which clarifies that the above mentioned disclosure requirement does not apply to nonpublic entities

PRACTICE ISSUES

• Mortgage Purchase Programs

• Chapter 7 bankruptcy

REGULATOTY UPDATEREGULATORS' HIGH EXAM FOCUS• Banking Regulators have identified high exam focus areas:

– Strategic

– Credit and Price

– Compliance and Reputation

– Operational

REGULATOTY UPDATEREGULATORS' HIGH EXAM FOCUSStrategy

Summary Potential Impact

§ Challenging banking environment

ü declining loan demand

ü margins under pressure due to lack of

investment alternatives

ü diminishing opportunities for fee income

ü increasing overhead

Regulators are concerned that decisions made today may create problems of tomorrow.

Banks should place specific emphasis on processes for managing risks associated with new products, services or locations.

Also there is a need to ensure that interest rate and/or credit risk assumed by higher yielding or longer term maturity assumptions is fully assessed. Appropriateness of model assumptions and multiple rate scenarios are important .

REGULATOTY UPDATEREGULATORS' HIGH EXAM FOCUSCredit and Price

Summary Potential Impact

§ Supervisory Focus Points ü quality of new underwriting

ü adequacy of post-funding monitoring (problem loan identification)

ü concentration risk – vulnerability assessments, appropriateness of risk limits and capital planning

ü directional consistency of ALLL (risk appetite changing?)

Regulators believe CRE and OREO exposure remains high in the system but risk is now largely identified. Pre-funding analysis by banks is generally good but regulators' emphasis is on post-funding attention. They believe this is an integral component to the timely identification of potential or emerging problem loans.

Concern also over competitive pressures and declining loan demand and the possibility that this could lead to loosened underwriting and/or risk/return concerns.

REGULATOTY UPDATEREGULATORS' HIGH EXAM FOCUSCompliance and Reputation

Summary Potential Impact

§ Supervisory Focus Points • Assess adequacy of bank’s processes to comply

with new consumer requirements – compliance

officer, audits, etc.

ü Place particular emphasis on new sources of

interest or fee income from new products or

services

ü Assess compliance with the Foreclosure

Management Supervisory Guidance

Risk is increasing due to the large number of regulatory changes as well as the heightened attention on consumer protection issues.

Other areas of emphasis:

• Fair lending

• Overdraft/deposit related products

• Consumer mortgage foreclosure processes

• BSA/AML

REGULATOTY UPDATEREGULATORS' HIGH EXAM FOCUSCompliance and Reputation

Summary Potential Impact

§ Supervisory Focus Points • Assess the adequacy of internal controls and audit

coverage relative to the complexity of products and

services offered.

ü ensure sufficient resources are devoted toward

fraud detection systems

ü perform sufficient penetration testing at least

annually

ü periodic testing of business continuity plans

Advances in technology create new risks. Delivery of new products and services must have requisite risk management.

Losses from internal and external perpetrated fraud continue to be a big concern.

Concern is that there are no fundamental breakdowns in internal controls or adequacy of audit programs..

QUESTIONS ANDANSWERS

PRESENTERBIOGRAPHY

Bill ReillyFinancial Services National Tax PartnerGrant Thornton LLP

Bill has more than 25 years of professional tax experience serving the financial services industry.

Bill has extensive experience in providing a variety of tax planning services to commercial banks, investment banks and asset managers. Bill provides assistance to banks in tax return compliance matters, tax accounting, and tax treatment of complicated transactions. He consults both international and domestic banks.

He also provides consultation to clients on tax issues related to mergers and failed bank acquisitions (FDIC), reorganizations and establishing the most efficient structures.

Bill has worked extensively in providing tax planning and effective tax rate management for federal, international, state and local taxes, accounting for income taxes (FIN 48 and FAS 109), and tax return matters.

Bill has a Bachelors degree in English and Political Science and a Masters of Accountancy from The State University of New York.

PRESENTERBIOGRAPHY

Page 8

Markus VeithFinancial Services National Audit PartnerGrant Thornton LLP

Markus is a Partner in the New York Financial Services Practice and an IFRS specialist. Markus has over 20 years of experience inbanking and public accounting.

Markus has led audit engagements of both public and private financial services organizations ranging from large multinationalinstitutions to local FDIC-insured banks and federal credit unions. He also led consulting projects on loan reviews, operational processreviews, post-merger integration, due diligence and asset securitization. Other areas of concentration include capital raises and IPOs.He also works and assists other offices with IFRS audits, reviews and conversions. He has worked with banks, securities andcommodities broker/dealers, REITs, BDCs, private equity groups, finance and investment companies. His clients include companieswith multistate and multinational operations.

Prior to joining Grant Thornton LLP, Markus worked for Deloitte and McGladrey. He began his career in Europe with a regionalsavings bank affiliated with DZ BANK AG – one of Europe’s leading financial organizations. Markus presents frequently to industrygroups and at internal training courses. He also regularly speaks to trade groups and the business press. Markus was quoted extensivelyon the Financial Reform Act in a July 2, 2010 article titled “The Shape of Things to Come,” in The Deal. One of his articles on theFinancial Reform Act was also published in 2010 in an industry newsletter.

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