The recent turmoil surrounding Deutsche Bank, and speculations that one of the largest European banks may not survive without a bailout, yet again bring to light the importance of capital reserves that banks are required to hold.
It should come as no surprise then that US regulators are closely monitoring the accuracy of disclosures surrounding capital ratios.
In a recent comment letter to BNY Mellon (BK), the SEC requested clarification regarding the capitalization status of one of the bank’s subsidiaries. In its Fiscal 2015 annual report, BNY Mellon stated that, as of December 31, 2015, BNY Mellon and all of its bank subsidiaries were “well capitalized”. In the subsequent Q1 2016 filing, however, the disclosure stated that one of the subsidiary’s capital ratios fell short of the “well capitalized” status – back in December 2015:
As of March 31, 2016 and Dec. 31, 2015, BNY Mellon and our U.S. bank subsidiaries, with the exception of BNY Mellon, N.A., were “well capitalized”. As of Dec. 31, 2015, BNY Mellon, N.A. was not “well capitalized” because its Total capital ratio was 9.89%, which was below the 10% “well capitalized” threshold.
The SEC further requested clarification about the implications of the error, including regulatory and contractual impact, effectiveness of disclosure controls, and potential need to expand the risk factors section. (Capital ratios are not defined under GAAP but, as we have discussed previously, might still be subject to the general SOX 302 disclosure controls requirements).
Form 10-Q for the Quarterly Period Ended March 31, 2016
Capital Adequacy, page 36
1. We note your disclosure on page 36 that BNY Mellon N.A. was not “well capitalized” as of December 31, 2015 because its total capital ratio was 9.89%, which was below the 10% “well capitalized” threshold. However, we note your disclosure on pages 58 and 83 of the Form 10-K for the year ended December 31, 2015 that BNY Mellon and all of its bank subsidiaries were “well capitalized” based on the ratios and rules applicable to them. In view of this change in your capital adequacy disclosure, please tell us:
- How you concluded that you did not need to amend your 10-K disclosure. In doing so, please describe any significant regulatory or contractual impacts that occurred, or could have occurred, as a result of your bank subsidiary not meeting the “well capitalized” criteria.
- How you determined you needed to change your capital adequacy disclosure, including who identified the need for change and when it was identified. Whether there have been any changes in your procedures that resulted from the facts and circumstances surrounding the changes in your capital adequacy disclosure.
- What consideration you gave to changing your disclosure controls and procedures disclosure as a result of the facts and circumstances surrounding the changes in your capital adequacy disclosure.
- What consideration you gave to expanding your risk factor disclosure as a result of the facts and circumstances surrounding the changes in your capital adequacy disclosure.
In response, BNY Mellon argued that, based on a SAB 99 materiality analysis, the errors were isolated, they did not affect the capitalization status of the bank, and did not change the overall assessment of their disclosure controls and procedures. Moreover, the bank explained, the changes that were made to address the identified deficiencies “were not significant enough to warrant disclosure in our discussion of disclosure controls and procedures”. The letter was heavily redacted, and most of the SAB 99 analysis is to remain confidential.
This is not the first case of the SEC commenting on the accuracy of capital ratios. On April 28th 2014, in a regulatory filing, Bank of America (BAC) disclosed a $4 billion error in the calculation of its capital reserve. The error did not affect compliance with capital requirements, yet the disclosure sent the stock tumbling by more than 6%. As a result of this error, Bank of America had to resubmit its capital plan, curb dividends, and scale down stock buybacks.
At the time, there was speculation that the error might have been caused by a control deficiency. However, their subsequent quarterly report filed May 1, 2014 did not disclose any deficiencies. Disclosure controls were reported to be effective and there had been no changes that were reasonably likely to materially affect the bank’s internal control over financial reporting. Investors, however, were not impressed; by mid-May Bank of America lost an additional $2 billion in market capitalization.
The error of such a scale, as immaterial as it might have been to Bank of America’s capital reserves, would warrant some attention from management. In a May 27th 8-K filing, Bank of America disclosed that it engaged a third party to “perform certain procedures related to the Corporation’s 2014 CCAR resubmission processes and controls regarding reporting and calculation of regulatory capital ratios”. The review focused on the periods ended September 30, 2013 and March 31, 2014, and identified immaterial adjustments to the capital ratios for those periods. The resubmission plan sent the stock up sharply on higher than average volume to close at $15.22.
Yet, on June 2nd, Bank of America disclosed another error. This time, relating to data reported to FINRA regarding volume on the bank’s alternative trading system. As with the previous errors, the bank reported that its disclosure controls were not affected, and the quarterly report for the period ending June 30, 2014 did not disclose any changes that were likely to affect internal controls.
Three errors in quick succession are a bit much to go unnoticed. In a comment letter dated July 2, 2014, the SEC requested clarifications about the impact that the errors had on the effectiveness of ICFR. The SEC suspected that “there may be common root causes to the errors in Bank of America regulatory capital ratio reporting”. The responses to the letter must have been satisfactory, since no further follow-up letters were issued.
Interestingly, in September 2014, the SEC imposed a $7.65 million fine on Bank of America for violating internal controls provisions. The regulator also noted that “Bank of America self-reported its regulatory capital overstatements, remediated the issues quickly and cooperated with our investigation”.
The $7.65 million fine paid by Bank of America dwarfs in comparison to some other fines and penalties paid by financial institutions in recent years, and the error discovered by BNY Mellon is admittedly fairly small. Yet, capital ratio accuracy – and the SEC’s inquiries into their disclosure – is definitely something investors should be aware of.
SEC Comments on a BNY Mellon Capital Ratio Error
The recent turmoil surrounding Deutsche Bank, and speculations that one of the largest European banks may not survive without a bailout, yet again bring to light the importance of capital reserves that banks are required to hold.
It should come as no surprise then that US regulators are closely monitoring the accuracy of disclosures surrounding capital ratios.
In a recent comment letter to BNY Mellon (BK), the SEC requested clarification regarding the capitalization status of one of the bank’s subsidiaries. In its Fiscal 2015 annual report, BNY Mellon stated that, as of December 31, 2015, BNY Mellon and all of its bank subsidiaries were “well capitalized”. In the subsequent Q1 2016 filing, however, the disclosure stated that one of the subsidiary’s capital ratios fell short of the “well capitalized” status – back in December 2015:
The SEC further requested clarification about the implications of the error, including regulatory and contractual impact, effectiveness of disclosure controls, and potential need to expand the risk factors section. (Capital ratios are not defined under GAAP but, as we have discussed previously, might still be subject to the general SOX 302 disclosure controls requirements).
In response, BNY Mellon argued that, based on a SAB 99 materiality analysis, the errors were isolated, they did not affect the capitalization status of the bank, and did not change the overall assessment of their disclosure controls and procedures. Moreover, the bank explained, the changes that were made to address the identified deficiencies “were not significant enough to warrant disclosure in our discussion of disclosure controls and procedures”. The letter was heavily redacted, and most of the SAB 99 analysis is to remain confidential.
This is not the first case of the SEC commenting on the accuracy of capital ratios. On April 28th 2014, in a regulatory filing, Bank of America (BAC) disclosed a $4 billion error in the calculation of its capital reserve. The error did not affect compliance with capital requirements, yet the disclosure sent the stock tumbling by more than 6%. As a result of this error, Bank of America had to resubmit its capital plan, curb dividends, and scale down stock buybacks.
At the time, there was speculation that the error might have been caused by a control deficiency. However, their subsequent quarterly report filed May 1, 2014 did not disclose any deficiencies. Disclosure controls were reported to be effective and there had been no changes that were reasonably likely to materially affect the bank’s internal control over financial reporting. Investors, however, were not impressed; by mid-May Bank of America lost an additional $2 billion in market capitalization.
The error of such a scale, as immaterial as it might have been to Bank of America’s capital reserves, would warrant some attention from management. In a May 27th 8-K filing, Bank of America disclosed that it engaged a third party to “perform certain procedures related to the Corporation’s 2014 CCAR resubmission processes and controls regarding reporting and calculation of regulatory capital ratios”. The review focused on the periods ended September 30, 2013 and March 31, 2014, and identified immaterial adjustments to the capital ratios for those periods. The resubmission plan sent the stock up sharply on higher than average volume to close at $15.22.
Yet, on June 2nd, Bank of America disclosed another error. This time, relating to data reported to FINRA regarding volume on the bank’s alternative trading system. As with the previous errors, the bank reported that its disclosure controls were not affected, and the quarterly report for the period ending June 30, 2014 did not disclose any changes that were likely to affect internal controls.
Three errors in quick succession are a bit much to go unnoticed. In a comment letter dated July 2, 2014, the SEC requested clarifications about the impact that the errors had on the effectiveness of ICFR. The SEC suspected that “there may be common root causes to the errors in Bank of America regulatory capital ratio reporting”. The responses to the letter must have been satisfactory, since no further follow-up letters were issued.
Interestingly, in September 2014, the SEC imposed a $7.65 million fine on Bank of America for violating internal controls provisions. The regulator also noted that “Bank of America self-reported its regulatory capital overstatements, remediated the issues quickly and cooperated with our investigation”.
The $7.65 million fine paid by Bank of America dwarfs in comparison to some other fines and penalties paid by financial institutions in recent years, and the error discovered by BNY Mellon is admittedly fairly small. Yet, capital ratio accuracy – and the SEC’s inquiries into their disclosure – is definitely something investors should be aware of.