Digital assets; environmental, social, and governance (ESG) issues; and other major 2022 trends in financial services are expected to remain prominent in 2023, especially as clarity emerges on the Future Exchanges (FTX) bankruptcy of late 2022, and the SEC applies industry input to the climate disclosure discussion.
The inflationary pressure and rising interest rates negatively affecting the mortgage industry’s origination volumes, coupled with a low unemployment rate, wasn’t widely forecast. These factors contribute to the prevailing sentiment that a recession is imminent.
Below are topics and related strategies that organizations can prepare for in 2023 and beyond.
Current Expected Credit Losses (CECL)
The CECL standard returned to the forefront in 2022 as its adoption became inevitable, with the question of whether a model validation was needed perhaps being among the most frequently discussed.
Entering 2023, companies are putting their final touches on the CECL models they’ve begun adopting, marking an exciting point in a process that began in 2016 when the Financial Accounting Standards Board (FASB) introduced new accounting standards. Many companies worked hard to prepare for its adoption.
In practice, the routes that companies can take to adopt CECL vary greatly depending on size and complexity, from in-house models to sophisticated third-party software solutions with multiple methodologies.
This is driven by CECL being a principal-based standard that provides high-level objectives, such as capturing the life of the loans and incorporating a reasonable and supportable forecast. However, it doesn’t prescribe specific ways to get there. Different approaches are to be expected and are acceptable.
CECL is an iterative process. Models are therefore expected to grow and shift as institutions move forward, especially if companies experience a new economic cycle or a change in underlying risks. The need and frequency for a model validation should be driven by the organizational risk assessment, which considers the materiality of the estimate and the underlying complexity of the model.
Environmental, Social, Governance (ESG)
It’s clear that regulation and disclosure requirements of ESG reporting will be scaled, applying mostly to the largest entities. However, it should still be a priority, as ESG data impacts everyone—including your bottom line.
Reputation and credit risk impact all financial services entities. Customer relationships with entities in controversial industries or those in areas with higher risk for nature-related events such as fires, floods, or hurricanes all create risk.
ESG Next Steps
It’s incumbent on board members and executives to continuously enhance their knowledge and understanding of the topic. Monitoring industry developments of the Sustainability Accounting Standards Board (SASB) and the Taskforce on Nature-related Financial Disclosures (TNFD) will provide a foundation of understanding and allow for leveraging the developments to your organization.
ESG Reporting Execution
Your investors, customers, suppliers, and community all have a stake in your success. Efficient and effective implementation is important. Your risk-management framework needs to be updated regularly so that it’s comprehensive and incorporates emerging developments to keep you on track and enhance your overall risk-management strategies.
Automation
Automation should be considered a business imperative. The pandemic caused a significant shift to businesses delivering service with a remote workforce, with this demand for a remote work environment creating challenges for business owners in hiring and retaining team members.
The stresses of employing the right people in this evolving business environment have caused businesses to look further into how to keep serving their clients while holding or reducing staffing levels. Business automation could be the key.
For organizations attempting to do more with less, automation may be the answer. All tasks that regularly gather large amounts of data for processing or repetitive tasks are prime targets. In the financial services space, reconciliations should be a first step.
There are documented instances where processes that once took all day could now be done in minutes. Workers being freed to perform other tasks could help to move the business forward.
Recaptured time would also allow an organization to delay hiring during economic uncertainty. It can help organizations grow while economic change unfolds while businesses can determine what hiring initiatives they really need to pursue.
Mortgage Outlook
2022 was a challenging year for the mortgage banking industry. Total mortgage originations for 2022 were projected at $2.25 trillion, a decrease of $2.4 trillion from 2021. The decrease in volume was spurred by the rapid increase in mortgage rates, which followed the Federal Reserve (Fed) rate increase aimed at slowing economic demand.
The consumer price index was up 7.1% over the 12-month period ending November 2022, a decrease from the June 2022 peak of 9.1% though well above the Fed’s 2% target. Additional rate increases to combat inflation could further depress the housing market and challenge lenders. The Mortgage Bankers Association projects the average rate on a 30-year fixed rate mortgage will be 5.2% in 2023 with overall origination volume expected to decrease to $1.9 trillion.
Housing Prices
According to the most recent S&P Core Logic Case-Schiller US National Home Price NSA Index median home prices peaked in June of 2022 and have since declined for four straight months. The Federal Reserve Bank of St. Louis reported the monthly supply of new housing to be 8.6%, an increase of over 100% from the low of 3.3% observed in August 2020.
The housing inventory for purchase is low, though declines in price point to Fed rate increases slowing demand. New units are necessary to stabilize home prices and affordability.
Competition: M&A
Rising interest rates continue to pressure gain on sale margins during integrated media blocks (IMBs), while cutting expenses and scaling back operations to weather the downturn in originations. Industry competition among market players remains strong due to excess capacity. Expect M&A activity to emerge as buyers seek out opportunities to increase market share.
Out of all single-family residential mortgages, 1.86% were delinquent at the end of the third quarter of Q3 2022 according to the Federal Reserve Bank of St. Louis, below the COVID-19 high of 2.84% and significantly below the high of 11.48% during the Great Recession of 2007–2009. In this highly competitive environment, watch for possible expansion of credit or an increase in nonconforming loan volumes to drive originations.
Demographics
Based on recent census data, millennials represent the largest group of people in the United States. The millennial cohort is entering its peak home-buying years, though many aren’t buying. They could fuel the purchase market in the future.
Servicing
The rapid increase in mortgage interest rates is accompanied by an increase in servicing valuations. Mortgage lenders that were able to retain servicing at historically low rates are well positioned to benefit as valuations increase, a natural hedge to reduced production, or a source of additional liquidity.
Technology
In today’s competitive mortgage banking environment, a solid technology stack is a core strength and competitive advantage. Fintech companies have emerged with innovative ideas aimed at improving industry customer experience while driving down the cost to deliver.
In 2023 and beyond, expect to see continued technology investment that leverages data and automation to innovate, connect with consumers, and improve efficiency, profitability, and visibility.
Regulatory Landscape
In August 2022, the Federal Housing Finance Agency (FHFA) announced updates to enterprise seller-and-servicer eligibility requirements. Effective date for most requirements is September 30, 2023. Some servicers voiced concern complying with the new Government National Mortgage Association (Ginnie Mae) capital rule requirements causing the agency to extend the date for compliance to December 31, 2024.
In November 2022, the FHFA announced the conforming loan limit value for 2023 which brought the new ceiling above $1 million. Increases in conforming loan limits coupled with a slowing of home price appreciation may shrink the pool of borrowers requiring a jumbo loan and expanding borrower financing options.
Given the shifting landscape in Congress after the elections of 2022, monitoring developments in the legislative and regulatory space will be important.
Tax Planning Strategy Update
Relevant tax issues include the Inflation Reduction Act and new excise tax guidance. On August 16, 2022, the Inflation Reduction Act was signed into law by President Joe Biden, with key provisions that:
Establish Corporate Alternative Minimum Tax (CAMT)
This minimum tax is imposed on adjusted financial statement income (AFSI) for certain applicable corporations with an average annual AFSI in excess of $1 billion over a three-year period. AFSI is generally described as book net income adjusted for certain items, including the use of tax depreciation instead of book, among other items.
This minimum tax generally equals 15% of the corporation’s AFSI and is effective for tax years beginning after December 31, 2022.
Establish 1% Nondeductible Excise Tax
The excise tax is imposed on publicly traded corporations based on the net value of certain stock the corporation repurchases during a tax year. This tax applies to repurchases occurring starting in 2023. Key considerations:
- Covered corporation. The tax is applicable to any covered corporation, which includes any domestic companies that trade stock on an established securities market. Accordingly, covered corporations will include thinly traded stocks, such as over-the-counter traded companies.
- Netting rules apply. The excise tax base is reduced by the fair market value of any issuances of a corporation’s stock during its taxable year.
- Exemptions. If net stock buybacks are less than $1 million, a company is exempt from the excise tax.
With respect to the 1% excise tax, on December 27, 2022, IRS Notice 2023-2 was issued, providing interim guidance pending regulations from the Department of Treasury. Highlights of the notice include:
- Redemptions. Redemptions generally include transactions as defined under Internal Revenue Code (IRC) Section 317(b). However, redemptions may potentially include other economically similar transactions, including certain types of reorganizations, split-offs, and liquidations.
- Qualifying property exception. With regards to the otherwise tax-free transactions, there is a qualifying property exception, which can potentially reduce the repurchase amount to zero, assuming there is no boot involved in the transaction.
- Reporting. The excise tax must be reported annually on Form 720, Quarterly Federal Excise Tax Return. On December 30, 2022, the IRS also issued draft Form 7208, Excise Tax on Repurchase of Corporate Stock that would be a required attachment to the Form720.
Digital Assets
Big changes are foreseen in the world of cryptocurrency and blockchain, as follows.
Cryptocurrency
The FTX bankruptcy filing on November 11, 2022, and the subsequent fallout could easily be the financial services story of the year. Whatever it means for cryptocurrencies, there remains a market demand to move money faster, cheaper, and as securely as possible.
The FASB is expected to require that crypto assets be measured at fair value. Recording through net income or in accumulated other comprehensive income will be addressed in the forthcoming exposure draft, as well as the precise timing of measurement for an asset that can trade 24 hours a day.
Blockchain
With many business applications, from smart contracts to record keeping, from securities activities like raising debt or equity, to digital currency applications for payments and peer lending, blockchain technology is unlikely to go away.
Nonetheless, industry events surrounding FTX and impending and inevitable increased regulations for digital assets, could drive the US industry faster toward a blockchain solution for a Central Bank Digital Currency (CBDC) as decentralized crypto currencies get battered in the marketplace.
Regulation
While the SEC and other regulatory bodies have been historically slow to address rules around new technology, many of the safeguards and regulations that already exist should be examined and applied to the newly created digital spaces. Balance is needed between more regulation to safeguard and keep customers safe without hampering innovation.
Prominent regulator commentary referencing the significance of the FTX fallout is all the telegraphing needed to realize restructuring and regulation around digital assets will likely be extensive.
If the banking industry seizes the opportunity to fill the void and provide the trust element that’s lacking with many digital transactions and the related exchanges, there could be an additional avenue to connect to the unbanked. Financial institutions have historically been better able to profit under increased regulations, but the current incentives to get involved don’t outweigh the present burden or barriers.
Enhanced security measures for transactions that were previously considered cost prohibitive now are likely table stakes, possibly further opening the door to a more regulated landscape.
However, the SEC Staff Accounting Bulletin No. 121 guidance on safeguarding crypto assets still feels onerous to regulated depositories, despite the justification as being a unique risk seemingly validated with recent events.
The prevalent sentiment of finance industry leaders in early 2022 was that significant regulation around digital assets wouldn’t happen without a catastrophic event. Now, the question is whether the regulations will be friendly to existing regulated entities, and who will be doing the regulating.
Possibly regulated depositories will bring the trusted backbone of the current regulated financial system into the fold, as digital assets continue to endure despite many tumultuous events.
Tax Reporting
With the passage of the Infrastructure Investment and Jobs Act (IIJA) in 2022, many crypto exchanges will now be required to issue 1099-Bs to customers effective January 1, 2024, which means many of these exchanges will need to implement procedures for 2023 to be able to track the information required to be reported in early 2024.
The infrastructure bill also had language that would require trade or businesses that transact with more than $10,000 of digital assets to report on Form 8300 or face stiff penalties.
We’re Here to Help
For assistance understanding trends in ESG, technology developments, and the impacts of events like the FTX bankruptcy on Fintech, contact your Moss Adams professional. You can also visit our Financial Services Practice page for more articles and resources.