Activity in the financial services industry in 2021 encompassed numerous trends, challenges, and opportunities. While conversations of digital assets dominated much of the first half of the year, environmental, social, and governance (ESG) initiatives later emerged as a top concern—serving as a reminder that shareholder and stakeholder interests aren’t necessarily one in the same.
The Great Resignation and the related challenges of an ever-evolving working environment, organizational fatigue, the proliferation of fintech, supply chain issues, and housing matters were also major topics.
Though the Current Expected Credit Losses (CECL) took a back seat for many in 2021, 2022 will likely see a flurry of activity no later than the second quarter in terms of accelerating readiness as organizations come to terms with adopting the standard—at least for those for which the standard will ultimately apply.
Below, we look to 2022 and beyond with potential next steps organizations can take to prepare for changes related to the following trends:
Environmental, Social, Governance (ESG)
Relevant Issues: ESG Best Practices
As ESG initiatives gain traction, organizations slowly move past recognizing and understanding the need for ESG strategies to implementing best practices.
Financial services companies that have yet to define their ESG goals and objectives will need to undertake readiness assessments. Human capital, social, and governance matters will likely be a top priority. Evaluating an organization’s data inventory related to these areas can help serve as a cornerstone.
Climate impact remains a complex factor for many organizations. The convergence of investor and consumer demand with the overarching possibility of mandated reporting for some companies will likely propel deployment of resources to advance corporate ESG programs.
Next Steps
Each company is unique; there isn’t a one-size-fits-all solution.
Align, Plan, and Execute
No matter the size and scope of your ESG program, aligning goals and incentives, and correlating the framework to consistent ESG reporting, can help move you a step ahead.
Your investors, customers, suppliers, and community all have a stake in your success. Your employees have both a stake and a responsibility to make these efforts impactful. Planning and insight, followed by execution, can help produce results for your institution.
Fintech: Non-Digital Assets
Relevant Issues: Investments and Regulations
Global venture capital investment in fintech companies exceeded $200 billion in 2021. The pace of traditional non-venture capital investment is roughly as high as well.
With such large amounts of capital invested, fintech companies are succeeding in challenging the traditional business models of old-line brick and mortar financial institutions.
This results in a convergence of fintechs in the market that traditional banks serve. In addition, many fintechs service markets that traditional banks have been unable to service.
Fintech companies in the Americas received roughly half of these investments, while companies in the rest of the world received the rest. Pre-money valuations of fintech companies continue to increase substantially.
Fintech companies are subject to various levels of regulation. The regulatory environment depends upon the jurisdiction in which each company operates. However, most regulators and governments around the world have been slow to keep up with the quickening pace of these companies’ activities.
Next Steps
Prepare for Investment Growth
The pace of investment in fintech companies isn’t expected to slow, at least in the short term. Consolidation and mergers and acquisitions (M&A) are expected to surge, some of which will be international.
Fintech companies that focus in the cryptocurrency area are expected to continue their explosive growth.
Digital Assets
Relevant Issues: Reporting and Tracking Requirements
The infrastructure bill attempts to redefine the definition of a broker. This could possibly push cryptocurrency exchanges like Coinbase and others to begin reporting 1099 information to the IRS on behalf of their customers, similar to requirements for traditional brokerages.
That’s a starting point, but it will be difficult to assess what regulations will help track information without being overly burdensome to the cryptocurrency space and effectively slow down innovation.
1099 Tracking
Some traditional rules will be hard to follow, especially in the decentralized finance (DeFi) space where customers interact directly with a protocol rather than a human service provider.
Forcing 1099 tracking or Know Your Client (KYC) rules on these types of platforms may be a near impossible ask. If 1099 tracking is possible, it could be overly burdensome to the industry.
Investors who buy and hold as a long-term investment may see similar treatment to buying and selling stock. Those who mine or stake cryptocurrency will likely end up with ordinary income treatment under Tax Notice 2014-21.
No specific guidance currently exists for the treatment of non-fungible tokens (NFTs). Digital art purchases may be deemed to fall under the IRS’s definition of a collectible, which has an even higher tax rate than stock or other cryptocurrency if held long-term.
Tracking Software Applications
Those who trade cryptocurrency probably engage in numerous other activities in the DeFi space such as staking, liquidity pools, or yield farming.
Many third-party cryptocurrency tracking software applications now exist to help aggregate and track various transactions, including activity on DeFi platforms and NFTs.
Transfer of Funds from Banks to Cryptocurrency Exchanges
The potential decline in customer deposits is a major issue the traditional banking sector faces.
Customers are pulling out a percentage of, or in some extreme cases all, their funds from traditional banks and moving funds to centralized and decentralized cryptocurrency exchanges like Coinbase.
Visa announced a new service to help banks determine how to provide services for cryptocurrency and digital asset holders. A Visa study also found that 40% of consumers who already own cryptocurrency would be willing to switch from banks to banks that offer cryptocurrency products.
Next Steps
Watch for New Regulations
The IRS will likely need to release further guidance.
The amount of IRS examinations on cryptocurrency will likely expand with the Biden administration approving an increase in funding to the IRS and the creation a new digital assets task force.
Understand Tracking and Reporting of Digital Assets
When you have discussions with your tax preparer, they will want to fully understand your activities. It’s highly recommended to have this information gathered prior to tax time, otherwise you could face a daunting task trying to track historical data and pull tax basis information.
Tracking is necessary and important as signified by the question on page one of Form 1040, requiring taxpayers to check a box if they sold or exchanged any cryptocurrency during the year.
Many centralized and possibly even decentralized platforms that act as a medium of exchanging digital assets may suddenly be required to undergo information reporting, such as issuing 1099s similar to requirements for traditional brokerages. This may help alleviate the burden of taxpayers having to find third parties to help track their crypto transactions.
The infrastructure bill also amended Internal Revenue Code (IRC)Section 6050i to also include digital assets. This means trades or businesses may now be required to include Form 8300 reporting if more than $10,000 of value in digital assets is exchanged. The prior version didn’t include digital assets.
Remote Work Environment and Culture
Relevant Issues: Technology, Productivity, and Mental Health Challenges
Historically, the financial services industry has been one of relationships built and maintained on face-to-face interaction. The impact of the COVID-19 pandemic greatly disrupted the industry and necessitated the restructuring of how professionals conduct business.
Technology, productivity, and the mental health of teams remain among the biggest challenges as organizations continue in a remote work environment.
Technology and Infrastructure
While the economy is technologically progressive, the dispersion of teams due to COVID-19 requires managing and providing infrastructure for hundreds, if not thousands, of locations and people as opposed to the limited physical locations offices were typically grouped prior. This explosion of physical locations will continue to provide technical challenges for everyone moving forward.
Productivity and Distractions
Productivity is always top of mind for managers.
The deployment of teams to a virtual workforce will continue to challenge the ability to maintain productivity at an acceptable level. Distractions such as shared workspaces with a significant other, roommate, or children and miscellaneous daily tasks and nonwork-related activities can erode productivity.
Mental Health
The impact of social isolation provides a major unseen challenge to all team members.
Studies show everyone needs alone or down time, but there can be significant side effects when this time isn’t wanted or is forced. These effects should be a top concern for managers as they may go unnoticed until something drastic happens.
Next Steps
Analyze, Plan, Implement, Test, and Optimize
Every process has a lifecycle. These phases include analyze, plan, implement, test, and optimize.
For many years, businesses paid less attention to the test and optimize phases. Businesses that continue to deploy a remote work culture should continuously test, then strip down the process of how the business runs, to reanalyze and create a new plan and implementation of their workforce.
A successful program starts with governance at the top and includes strategies to keep your workforce engaged and productive, as well as physically and mentally healthy.
Mortgage Banking Outlook
Relevant Issues: Housing Shortages, Supply Chain, and Appreciation
The mortgage banking industry experienced another strong year in 2021.
Historically low interest rates allowed the refinance wave to continue. COVID-19-related legislative and regulatory action aimed at keeping homeowners in their homes largely succeeded. In a true testament to the industry, forbearance and delinquency rates continue to fall from 2020 peaks, highlighting the hard work of lenders to assist borrowers.
Total mortgage originations for 2021 are projected to exceed $4 trillion, the second highest year on record, according to the Mortgage Bankers Association (MBA). A forecasted rise in rates for 2022 is expected to drive a purchase origination market. However, critical housing shortages, supply chain constraints, and home price appreciations are headwinds to growth in 2022.
Mortgage Banking Industry Risks and Opportunities in 2022 and Beyond
Housing Supply and Price Appreciation
US housing market inventory levels are at historical lows. The MBA origination projections hinge on the ability to construct sufficient housing to meet the growing demand.
Supply chain constraints coupled with labor shortages in the construction industry pose serious risk to constructing housing.
These factors contribute to the significant home price appreciation experienced in the United States. Price appreciation presents a risk to growth as many buyers are first-time home buyers.
An expected rise in rates due to Federal Reserve tapering may slow price appreciation, though additional housing is needed to calm price increases and stabilize affordability.
Demographics
Based on US census data, millennials represent the largest demographic in the United States. The millennial cohort is entering their peak home-buying years and will likely fuel the purchase market moving forward.
Servicing
Federal Reserve taper of bond purchases is generally expected to put upward pressure on mortgage rates.
Mortgage lenders, who were able to retain servicing at historically low rates, are well positioned to benefit as valuation increases and extended cash flow provide a natural hedge to reduced production income.
Technology
Of the nonbank mortgage companies completing initial public offerings (IPOs), many referenced their investment in technology as a core strength.
Fintech companies emerged on the scene with innovative ideas aimed at improving the customer experience while driving down delivery costs.
Into 2022 and beyond, expect to see continued investment in technology that leverages data and automation to innovate and connect with consumers.
Private Label Securitization
Agency mortgage-backed securities (MBS) continue to dominate securitization volume; however, recent data from the Urban Institute indicates a rise in non-agency MBS. A jumbo mortgage exceeds the government-sponsored enterprise (GSE) conforming loan limits; a larger share of mortgages qualify as jumbo as prices rise.
The private-label securities (PLS) market presents an opportunity for nonbank lenders as banks look to grow loan portfolio amid a rise in deposits.
Regulatory Roundup
Suspension of the Federal Housing Finance Agency adverse market fee adjustment may prove a welcome sign of recovery. The Biden administration, however, paused talks about ending GSE conservatorship.
Under new leadership, the Consumer Financial Protection Bureau (CFPB) is prioritizing fair lending and racial equality. The CFPB’s priced-based qualified mortgage (QM) loan definition became mandatory as of July 1, 2021. The impact on GSE involvement in the QM market remains unclear, though it could provide an opportunity for PLS market expansion.
Finally, the Coronavirus Aid, Relief, and Economic Security (CARES) Act and pandemic-related regulation remain in place; however, its impact wanes as mortgage-related forbearances and delinquencies decrease.
Next Steps
Prepare for a Purchase Mortgage Market
The forecasted increase in interest rates is likely to continue to put pressure on profit margins.
Millennials entering peak homebuying years are expected to drive a purchase mortgage market in 2022 and beyond.
Invest in Technology
It’s critical to invest in technology to meaningfully connect with today’s consumer while maximizing profitability.
Anticipate Growing Demand
Mortgage lenders retaining servicing are well positioned to benefit from expected increases in value.
However, housing price appreciation coupled with a significant housing supply shortage are real headwinds to growth. More affordable housing is needed to meet anticipated demand.
Monitor New Legislation and Regulations
Continue to monitor developments in the legislative and regulatory landscape and the impact on mortgage lending.
Tax Update
Relevant Issues: Build Back Better Act Proposals
The US House of Representatives passed The Build Back Better Act (BBBA) on November 19, 2021. The bill includes numerous provisions related to health care, climate change, immigration, education, social programs, and, of course, taxes.
While the bill still faces hurdles and is subject to change should it make its way through the senate, it’s important to understand the notable proposals that may impact financial services businesses and owners.
Notable highlights of the House version of BBBA include:
- Expansion of the 3.8% net investment income tax base to include active business income from pass-through entities
- Increase in the cap on state and local tax deduction from $10,000 to $80,000 through 2031
- Permanent implementation of the limitation on excess business loss deduction for noncorporate taxpayers; the limitation under the current law is set to expire after 2026
- Changes to the international tax regime, including Global Intangible Low-Taxed Income (GILTI) tax rate increase, requirement to calculate GILTI on a country-by-country basis, and reduction in Foreign-Derived Intangible Income (FDII) deduction
- 1% excise tax on the value of stock repurchases and net of new issuance; stock contributed to retirement accounts, pensions, and Employee Stock Ownership Plans (ESOP) are excluded from being taxed
- 5% surtax on individuals with modified adjusted gross income that exceeds $10 million
- Delay in the effective date for R&D expense amortization requirement over five years—versus immediate deduction—from beginning in 2022 to 2026
- Extension and expansion of green energy related tax credits
Next Steps
Monitor Developments
Current proposals don’t include an increase in corporate tax rate; however, the final legislation could look different as lawmakers continue to negotiate as the bill moves through the chambers.
Monitor the developments in the legislation and consider tax planning strategies as the final legislation takes effect.
CECL
Relevant Issues: Adoption of CECL
Adoption of the Current Expected Credit Losses (CECL) model is imminent. Currently only around 200 depository institutions have adopted, notwithstanding the rekindled efforts to scope out smaller community institutions in Q1 2022, leaving over 9,000 to adopt the model on January 1, 2023, along with thousands of other entities in the financial services sector.
The readiness of institutions preparing to adopt varies greatly and covers the spectrum, from ready-to-implement to those still in the preliminary planning phases.
However, it’s not all additional work and increased complexity related to adopting a new model. A current Financial Accounting Standards Board (FASB) exposure draft would eliminate troubled debt restructuring (TDR) accounting under CECL.
While the proposal includes increased disclosure requirements, the simplification of the accounting and removal of TDRs may be beneficial.
Next Steps
If your organization is still in the early phases, you’re not alone, but it’s important to know that remaining time wanes and waiting for a potential adoption exemption is a dangerous proposition.
Not only is adoption an issue for internal timelines, but vendors are also reaching capacity in their ability to onboard new users.
Prepare and Adopt CECL
For institutions further along, there’s still a focus on parallel runs, finalizing documentation, controls, policies, and procedures, as well as evaluating model validation requirements. As such, all institutions should start the year with a proactive stance.
We’re Here to Help
For guidance in navigating challenges your organization is facing or how to implement next steps, contact your Moss Adams professional. You can also visit our Financial Services Practice page for more articles and resources.