Accounting and Financial Reporting Relief for Eligible Financial Institutions under the CARES Act
In response to the ongoing coronavirus (“COVID-19”) pandemic, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) on March 27, 2020. The CARES Act is an emergency stimulus measure providing assistance and relief in a variety of ways to certain individuals, businesses, and industries. Several provisions of the CARES Act provide relief to Eligible Financial Institutions (as defined below) from certain accounting and financial reporting requirements, including permission to (i) suspend the application of U.S. Generally Accepted Accounting Principles (“U.S. GAAP”) with regard to loan modifications related to COVID-19 which would otherwise be categorized as troubled debt restructurings (“TDRs”) (and suspend any determination related thereto), and (ii) delay compliance with the Financial Accounting Standards Board’s (“FASB”) Current Expected Credit Losses accounting standard (“CECL”).
Parties should anticipate further guidance and commentary on the CARES Act, and the contents thereof, from the FASB and the United States Securities and Exchange Commission (the “SEC”) in the coming days.
Suspension of Application of U.S. GAAP for Loan Modifications Related to COVID-19
TDRs require a facts-and-circumstances analysis and typically occur when certain concessions are granted by a lender in a credit arrangement which, but for the circumstances, the lender would not ordinarily consider. If a loan modification is classified as a TDR, additional workstreams are created, including impairment testing and financial statement presentation, among other administrative requirements.
As a result of COVID-19, financial institutions have received, and likely will continue to receive, requests to modify loan terms from their borrowers. Section 4013 of the CARES Act provides (i) insured depository institutions, as defined in Section 3 of the Federal Deposit Insurance Act and (ii) credit unions regulated by the National Credit Union Administration ((i) and (ii) together, “Eligible Financial Institutions”) with the ability to make loan modifications related to COVID-19 without categorizing the loan as a TDR or conducting the analysis to make the determination, which is intended to streamline the loan modification process. Any such suspension is effective for the term of the loan modification; however, the suspension is permitted only for loan modifications made during the effective period and only for those loans that were not more than 30 days past due as of December 31, 2019.
Eligible Financial Institutions who decide to make the election must be certain to maintain records of the volume of loans involved and be prepared to provide their regulators with the data.
The election to suspend the application of U.S. GAAP for loan modifications related to COVID-19 retroactively began on March 1, 2020 and will end on the earlier of either December 31, 2020, or 60 days following the termination of the COVID-19 declaration of national emergency under the National Emergencies Act.
The relief afforded under the CARES Act comes on the heels of interagency guidance for financial institutions issued on March 22, by the five federal bank regulatory agencies [1] and the Conference of State Bank Supervisors (the “March 22 Joint Guidance”). [2] The March 22 Joint Guidance encourages banks, savings associations, and credit unions to make loan modifications for borrowers affected by COVID-19 and, importantly, assures those financial institutions that they will neither receive supervisory criticism for such prudent loan modifications, nor be required by examiners to automatically categorize COVID-19-related loan modifications as TDRs. Consistent with the goal of Section 4013 of the CARES Act, the federal banking regulators have confirmed with FASB that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers who were current (i.e., less than 30 days past due on contractual payments) prior to any loan modification are not TDRs. For more information, please refer to our client alert summarizing the key points of the March 22 Joint Guidance.
Delay of Implementation of CECL
FASB issued Accounting Standards Update 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326), in June 2016 as a response to the credit losses suffered during the “Great Recession.” Regarded as a substantial change to U.S. GAAP, CECL requires credit losses to be recognized over the life of a financial instrument at the onset (as opposed to the “incurred loss” methodology for recognizing such losses which delayed recognition until such losses are “probable” to have been incurred). Financial institutions have been preparing for the CECL transition for several years now. CECL became effective for certain SEC filers in January 2020, but previously was delayed until January 2023 for Smaller Reporting Companies and private institutions.
Section 4014 of the CARES Act provides Eligible Financial Institutions with the option to delay compliance with CECL until the earlier of either December 31, 2020, or the termination of the COVID-19 declaration of national emergency under the National Emergencies Act.
Separately, on March 27, federal bank regulatory agencies issued an interim final rule allowing banking organizations required to adopt CECL effective January 1, 2020 to delay the estimated impact on regulatory capital by up to two years, with a three-year transition period to phase out the cumulative benefit to regulatory capital provided during the two-year delay. On March 31, federal bank regulatory agencies issued a joint statement clarifying the interaction of the March 27 interim final rule and the CARES Act. Importantly, the agencies noted that banking organizations that elect to use the relief provided under the CARES Act to delay compliance with CECL may also elect the regulatory capital relief provided under the interim final rule after the expiration of the relief period under the CARES Act. However, the five-year transition period under the interim final rule will begin on the date it would have been required to adopt CECL under U.S. GAAP, regardless of whether the banking organization elects to use the delay permitted by the CARES Act. Accordingly, only banks that adopt CECL on January 1, 2020 will benefit from the full five-year transition (two-year delay and three-year phase-in) of the interim final rule. For banking organizations that utilize both the CARES Act delay and the interim final rule relief, the initial two-year delay of the interim final rule will be reduced by the number of quarters during which the banking organization uses CARES Act relief.
Additional guidance regarding the impact of these actions on U.S. GAAP and the application to banking entities in various stages of implementation of CECL are expected to be forthcoming from the SEC and FASB.
Regardless of asset size, many banks now find themselves in uncharted territory. The attorneys at Troutman Sanders are here to help answer your questions about the legal and economic impacts of the COVID-19 pandemic.
Please visit the Troutman Sanders LLP / Pepper Hamilton LLP COVID-19 Resource Center for COVID-19-related news and developments, recommendations from leading health organizations, and tools that businesses can use free of charge.
[1] The five federal bank regulatory agencies are: the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the Consumer Financial Protection Bureau.
[2] A copy of the March 22 Joint Guidance is available at: https://www.fdic.gov/news/news/press/2020/pr20038a.pdf.