The COVID-19 pandemic has caused widespread disruption to business operations across all industries. In the face of unprecedented uncertainty, financial institutions have a pivotal role in the urgent response to the crisis. There are also specific measures to take that can mitigate the impact of the crisis on financial institutions themselves.

Here are answers to some of the most frequently asked questions for financial institutions and specialty finance organizations, along with relevant resources to help businesses in their response to the pandemic and in planning for the future.

 

How does this impact CECL adoption?

The effects of COVID-19 could complicate how banks and other financial institutions comply with the current expected credit loss (CECL) accounting standard, given the impact on forecasting credit losses and underlying economic fundamentals, as well as partial relief offered under the CARES Act. For example, unemployment, which has risen significantly, is a driver of credit risk. Management should consider impacting factors just like any other significant estimate, which must be based on reasonable and supportable estimates and not on speculative information.

As a result of the financial reporting uncertainty, the CARES Act allows banks and other financial institutions to suspend applying CECL rules until December 31, 2020, or whenever the deferral is lifted, whichever comes first. The SEC also issued a public statement that applying the provisions of the CARES Act is in accordance with GAAP.

What is the impact to our supply chain?

As an “essential business,” banks and other financial institutions are mandated to stay open, even with a limited worker presence. However, the COVID-19 outbreak has disrupted supply chains due to the forced closure of nonessential businesses and related workforce shortages. For banks and other financial institutions, this has caused a sharp increase in delays for supplies from vendors (including sanitizer, disinfectant and gloves that may be required to continue retail branch operations safely), and it has impacted the array of service providers that support banking operations. Some of these necessary vendors and service providers may also be in danger of financial default themselves due to business interruption and revenue losses.

Banks and other financial institutions should also bear in mind that when business survival is on the line, organizations tend to be less transparent and more focused on finding workarounds, which can result in an uptick of fraudulent activity that impacts the entire supply chain system. In the longer term, it’s prudent to consider diversifying the supply chain where possible, which can help expand options during future periods of scarcity. While product cost is typically a determining factor in choosing a vendor or service provider, availability and stability take on greater importance when the usual supply chain has been disrupted. By optimizing current inventory and developing a more dynamic sourcing footprint, financial institutions can mitigate some key aspects of disruption to supply chains.

Should we be thinking about re-tooling our business strategy to capture new business opportunities?

Financial institutions have seen significant disruption as employees work from home, and even “late-adopter” customers have turned to mobile apps and online channels to conduct routine financial transactions. The COVID-19 pandemic has forced banks and other financial institutions to innovate in a very short period of time, and as a result, the ‘new normal’ may look very different to pre-crisis operations. The development or acquisition of proprietary fintech applications to support customer conversion and servicing will likely accelerate at an even faster rate.

The industry also stands to benefit financially as an administrator of loans under the Paycheck Protection Program (PPP), a forgivable loan program included in the CARES Act, which significantly expands the types of organizations that are eligible for Small Business Administration (SBA) loans. To manage a backlog of applications, banks and other financial institutions are competing with other fintech entities to process these and additional small business loans.

It’s clear that banks and other financial institutions have a lot to consider when it comes to new business opportunities in the long term. They will need to think creatively about value-add to appeal to customers, especially as the fintech industry continues to gain market share at their expense in managing consumers’ financial transactions.

How can I prevent data loss while employees are working from home?

Many banks and other financial institutions have rapidly shifted their employees from an office-based work environment to a remote one. As a result, organizations have been forced to urgently review their security practices. When IT professionals set up a business’ network, they implement numerous controls that are designed to prevent data leakage and loss. However, many popular platforms that enable remote work do not align easily with these controls. For example, while corporate controls might enforce a policy that prohibits the remote sharing of desktop files and USB connections, remote working tools may allow such actions. Moreover, employees who use their own devices for work instead of company-issued devices could unwittingly introduce malware to the network. This endangers the security of all network data, with particular concern regarding proprietary and sensitive information, especially related to revenues, costs, cash flow and new business opportunities.

Increasing the number of entry points to a network raises serious issues for data protection and increases the possibility of data loss. Security teams have also observed an increase in phishing attempts that could expose a network to ransomware. For this reason, employees should receive additional training for cybersecurity while working remotely. Not only could a company lose important data and be unable to retrieve it, but that data could also be shared improperly outside the organization or breached by a malicious third party, thereby exposing the business to potential violations of data privacy laws.

To mitigate data security and privacy risks, financial institutions and specialty finance organizations should use cloud computing for all files and require employees to connect using a cloud VPN. This provides secure access to the organization’s network and shared files, and it encrypts all data. Two-factor authentication further strengthens these controls. Companies should also consider implementing specific data loss prevention (DLP) solutions, which give the network administrator control over the data that employees handle, and they should enforce policies around what data can be transferred and who can receive transfers. Advanced detection tools may also be deployed to prevent improper remote access. These technologies use machine learning to identify and respond to suspicious activities. Overall, network access for remote workers should be protected by numerous robust controls and barriers and actively monitored for any issues in real time.

How do I keep my workplace safe?

Banks and other financial institutions are deemed “essential businesses,” meaning that branches are allowed to remain open during the COVID-19 pandemic. To minimize the risk of the virus’ transmission, they have been encouraging customers to use drive-through facilities to conduct routine business transactions, and to make appointments to avoid crowds gathering in common branch areas such as lobbies.

Banks and other financial institutions should also refer to federal, state and local government requirements to inform social distancing and remote working protocols at branches. For example, San Francisco mandates that workers must work from home if they can do so, and only be ‘on-site’ if they are unable to perform their job functions from home.

Furthermore, social distancing best practices include maintaining at least six feet between people, regularly disinfecting high-touch areas and having a stock of hand sanitizer available to promote personal hygiene. Various shelter-in-place orders throughout some states also help to reduce foot traffic as citizens are required to stay indoors unless they have a justifiable reason or extenuating circumstances. For reference, a list of banks’ COVID-19 response plans can be found on the American Bankers Association website.

What does IT need to do to prepare for remote working? What remote working issues should I anticipate?

Even as an “essential business” at the branch level, banks and other financial institutions have been forced to rapidly shift operations so that all non-essential employees work remotely, from HQ office workers to branch employees that can perform job functions independent of the facility. As a result, their IT departments are crucial to maintaining business continuity in the wake of these unexpected disruptions. IT should ensure that employees have the training to use collaboration, communication and conferencing technology—whether this is Microsoft Teams, Slack, Skype, Cisco Webex or another option.

For security, staff also need training on how to identify suspicious activity, such as phishing emails, and promptly report such activity to the IT department. This is especially critical for banks and other financial institutions that conduct transactions of a highly sensitive nature on a regular basis.

Cloud computing is another vital tool that facilitates remote working by providing secure access to the organization’s network and shared files. Decision support systems in the cloud can also help employees be more productive. Using a cloud VPN can ensure that data is encrypted when employees access the cloud, and two-factor authentication strengthens that security. Employees should also be required to use company-issued devices for work purposes whenever possible, because personal devices may have unknown vulnerabilities or more lax privacy settings.

However, the widespread deployment of collaboration tools and cloud computing also increases demands on core network infrastructure. So, it’s important to ensure the network architecture can support these demands and that IT has the necessary resources. The expansion of virtual teams also introduces more potential points of failure between end users and the network, and it creates more user support needs as well. Management can assist the IT department with employee training resources and change management initiatives to encourage the ongoing success of remote teams.

What tax strategies should I consider changing in light of the current environment?

In the short term, banks and other financial institutions should consider leveraging any tax strategies that can help offset costs and increase cash flow. These include provisions in the various stimulus bills like payroll tax credits and delays in payment due dates for both income and payroll taxes, AMT credits, net operating loss carrybacks and tax-deductible charitable contributions.

Outside of the existing stimulus bills and other response measures, financial institutions and specialty finance organizations should also consider measures to reduce their total tax liability that were already available prior to the start of the pandemic, such as state and federal Research and Development (R&D) tax credits that can offset the costs associated with, for example, developing fintech applications to service customers. Companies that operate internationally should also assess the tax relief options being offered in the countries in which they operate.

While there are many tax savings opportunities available, eligibility for some provisions is dependent on company size and other factors, and many benefits are mutually exclusive or have other tax implications that could affect an organization’s total tax liability. Given the level of complexity in tax planning during this time, it is critical that banks and other financial institutions consult with tax professionals in order to maximize their savings and understand the long-term impacts of their tax strategies.

How is COVID-19 impacting deal flow?

Most management teams and investors are hitting the pause button on deal activity. The economic realities are changing fast, and so too are deal threats and opportunities. For banks and other financial institutions, COVID-19 has introduced significant risk and led to fewer lenders willing to facilitate deals. Furthermore, some borrowers are struggling to repay loans due to their own deteriorating financial situation, impacting the bottom line for potential deal targets. Valuations have also dipped as the market downturn has affected EBITDA and financial projections for sellers.

Parties in M&A deals—buyers, sellers and lenders—are currently assessing the situation and will be making decisions to proceed, adjust or discontinue deal processes based on critical factors including crisis management, performance outlook, valuation changes and COVID-19’s lasting impact on the economy. Deal activity in certain in-demand sectors—such as technology, healthcare, and those facilitating essential services like distribution logistics—are likely to rebound sooner than other industries. Ultimately, and hopefully sooner rather than later, the path forward will become clearer and many sellers will resume sale processes. However, some will have to modify their approach or even take longer pauses as the uncertain outlook persists.

 

How can we help?

Our team is closely monitoring updates regarding the programs and relief efforts surround the COVID-19 pandemic. Please contact our Financial Institutions Group with questions. We are always here to help.

To assist with the U.S. response to the 2019 novel coronavirus (COVID-19), the IRS has released two notices providing greater flexibility for employers who maintain Internal Revenue Code Section 125 cafeteria plans for their eligible employees. Notice 2020-29 relaxes the rules regarding mid-year election changes during calendar year 2020 for employer-sponsored health plan coverage, health Flexible Spending Arrangements (FSAs), and dependent care assistance programs (DCAPs). It also allows a special grace period to apply unused amounts in health FSAs and DCAPs to expenses incurred through December 31, 2020.

In addition, Notice 2020-33 permanently increases the carryover limit of unused amounts remaining as of the end of a plan year in a health FSA that may be carried over to pay or reimburse a participant for medical care expenses incurred during the following plan year, from $500 to $550 (20% of the deferral amount). That notice also clarifies that a health plan can reimburse individual health insurance policy premium expenses incurred before the beginning of the plan year for coverage provided during the plan year (which will help implement individual coverage health reimbursement arrangements (HRAs)).

Background

Due to the COVID-19 pandemic, the amount of pre-tax salary deferrals elected by many employees into their Section 125 cafeteria plans have not matched their needs. Perhaps the most obvious are amounts set aside for dependent care for parents to work or attend school. With most U.S. schools and day care centers closed since mid-March and likely to remain closed for months, many employees are not paying qualifying child care expenses and therefore will not incur the expenses that were projected when they made their elections. Similarly, employees who had to postpone scheduled medical procedures might have contributed more to their health FSAs than they can spend. Any employee whose expenses are going to be less than their salary reduction election may wish to reduce future reductions. Others who are furloughed or working reduced hours might need to make a less expensive election for their health plan coverage. On the other hand, employees who contract the COVID-19 virus will have extraordinary expenses and might need increased benefits.

Yet, strict rules under Section 125 require participants to make cafeteria plan salary deferral elections before the start of the plan year and prohibit mid-year changes, except in very narrow circumstances.

Health FSAs and DCAPs also impose a “use it or lose it” rule, where employees generally forfeit unused amounts after the plan year ends. Some health FSAs give employees a grace period (which cannot be later than 2 ½ months after the end of the plan year) during which they may use amounts deferred in the prior year or allow a carryover of up to $500 (but plans generally cannot allow both the grace period and the carryover).

Insight:

The IRS created the carryover and grace period concepts to soften the impact of a general prohibition against a Section 125 plan deferring compensation across tax years (i.e., the “use it or lose it” rule).

Notice 2020-29

Special 2020 Mid-Year Changes. To provide greater flexibility in response to the public health emergency posed by COVID-19, Notice 2020-29 provides that employers may (but are not required to) permit employees who are eligible to make salary reduction contributions under the plan to take any of the following actions as a mid-year election made during calendar year 2020.

Employer-sponsored health coverage

• Make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage.
• Revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis.
• Revoke an existing election on a prospective basis, provided that the employee attests in writing that the employee is enrolled, or will immediately enroll, in other health coverage not sponsored by the employer.

Health FSAs

• Revoke an election.
• Make a new election.
• Decrease or increase an existing election on a prospective basis.

 

Dependent Care

• Revoke an election.
• Make a new election.
• Decrease or increase an existing election on a prospective basis.

 

Insights:

• The amendment to make mid-year election changes will be effective only to changes made during 2020 as a temporary tool that allows employees to respond to changes in their personal needs. However, there is no requirement in Notice 2020-29 that an individual must be adversely affected by COVID-19 to be eligible to make an election change.
• Under Section 125(i), the maximum amount an employee could contribute to a health FSA was $2,700 for 2019 and $2,750 for 2020.
• Section 3702 of the CARES Act (which became law on March 27, 2020) expanded health FSAs to include over-the-counter (non-prescription) medications as well as menstrual supplies.

 

Extended Claims Period. For unused amounts remaining in a health FSA or DCAP as of the end of the plan’s allowable grace period (i.e., up to 2 ½ months after the end of the plan year) or plan year ending in 2020 (including plans that allow for a carryover of unused amounts), the plan may permit employees to apply those unused amounts to pay or reimburse medical or dependent care expenses, respectively, incurred through December 31, 2020.

Insights:

• As an example, for a plan year that ended on December 31, 2019, but had a grace period that ended on March 15, 2020, instead of forfeiting unused amounts on March 16, 2020, the plan may permit participants to apply those amounts to expenses incurred through December 31, 2020. Accordingly, employers may need to coordinate with their flex plan and payroll providers to reverse any forfeitures that have already been made.
• The extended claims period may help employees who had to postpone elective medical, dental or vision procedures.

 

Retroactive Relief for High Deductible Health Plans (HDHPs). Notice 2020-29 allows the previously announced temporary relief for HDHPs to be applied retroactively to January 1, 2020 (i.e., with respect to HDHPs covering expenses related to COVID-19 and giving HDHPs a temporary exemption for telehealth services).

Notice 2020-33

Increased Health FSA Carryover Amount. In Notice 2020-33, the IRS increased the maximum unused amount from a health FSA plan year starting in 2020 that is allowed to be carried over to the immediately following plan year beginning in 2021, so that it is 20% of the maximum deferral amount. For 2020, this means an increase from $500 to $550.

Insights:

• The maximum carryover ($500 for 2019 and $550 for 2020) does not count against the annual health FSA salary deferral limit ($2,700 for 2019; $2,750 for 2020).
• An employer may specify in its plan document a lower amount for the health FSA carryover or may decide to not permit any carryover at all.
• Carryover amounts can be used to pay or reimburse a participant for medical care expenses incurred during the following plan year. For example, amounts deferred under a health FSA in 2020 can be carried over to pay expenses

 

Health FSAs that use the IRS’s maximum carryover amount generally would need to be amended by the end of the 2021 plan year to reflect the increased carryover amount for plan years that begin in 2021. However, Notice 2020-33 also allows plans to be amended for the 2020 plan year. Such amendments may be retroactively effective to January 1, 2020, provided that the employer informs all individuals eligible to participate in the plan of the changes.

Individual coverage Health Reimbursement Arrangements (HRAs). Notice 2020-33 also clarifies that a health plan can reimburse individual insurance policy premiums incurred before the beginning of the plan year for coverage provided during the plan year (which will help implement individual coverage HRAs).

Action Items for Employers

1. Determine which provisions of Notices 2020-29 and 2020-33 will be allowed.
2. Contact your Section 125 cafeteria plan administrator to coordinate:
   1. The process to handle the increased volume of mid-year employee election changes.
   2. The impact of the retroactive adoption date on previously forfeited amounts and employee contributions that need to be refunded as employees retroactively decrease a pre-tax deduction amount.
   3. The process to draft and distribute employee notices of the plan changes and their ability to make mid-year election changes.
3. Notify employees of the specific elections they can change and how to do so, as well as whether they will have additional time to use plan balances at year end.
4. Set up a reminder to make sure the written plan amendment is executed by December 31, 2021.

 

Our team continues to monitor the programs and changes surrounding COVID-19. Please contact us with any questions. We are always here to help.

On Wednesday, June 3^rd, the Senate passed the Paycheck Protection Program Flexibility Act of 2020. The bill was passed in the House last week with large bipartisan support and eases the strict guidelines currently in place to qualify for forgiveness of PPP loan funds. It will now move to President Trump for his signature.

As many recipients of PPP loans are approaching the end of their 8-week Covered Period, the bill offers important guidance and relief to borrowers looking to qualify for forgiveness of the funds. If the bill becomes law, recipients of PPP loans will now have an additional 16 weeks to use the funds for eligible expenses. The bill also provides more flexibility for use of the funds on “non-payroll” expenses.

A few of the major changes to forgiveness requirements appear to be:

• Extension of the Covered Period from 8 weeks to 24 weeks (or the end of the year, whichever comes first)
• Lowers the portion of PPP loan funds that must be used for payroll from 75% to 60%, allowing 40% to be used toward other non-payroll, eligible costs such as rent and utilities. There is a potential for no forgiveness (loan to be repaid) if 60% of the loan proceeds is not spent on payroll costs.  This could be a significant change.
• Increases the maximum payroll amount for the extended Covered Period from $15,385 to $46,154 per employee
• Extends the Full Time Equivalent (FTE) and Salary/Wage Reduction safe harbor date from June 30, 2020 to December 31, 2020, which allows employers more time to restore their FTE count and Salary/Wage amounts to pre-COVID-19 numbers.
• Outlines additional FTE reduction exemptions for changes in business activity and allowing exemptions for borrowers who are unable to hire similarly qualified employees
• Extends the loan term of any funds not forgiven to 5 years from 2 years. Please note that for existing loans prior to the passing of this bill, both lender and borrower must agree to the change in loan terms through a refinance of the loan. The interest rate remains 1%.
• Allows businesses who qualify for loan forgiveness to also defer the employer portion of payroll tax, which would be paid in two installments (50% by 12-31-2021 and 50% by 12/31/2022)
• Changes the loan repayment deferral period to the date forgiveness is decided rather than 6 months from disbursement
• The Forgiveness Application must be submitted no later than 10 months from the end of the recipient’s Covered Period.

If President Trump signs the bill into law, PPP loan borrowers will now have to choose to either adopt the new 24-week Covered Period or continue with their original 8-week option. We would advise to look closely at your eligible expenses to date, payroll costs, and your FTE count, among other factors, when making this decision.  There could be more changes forthcoming to the PPP loan program through additional legislation, as well as SBA and Treasury Department guidance.

Due to the changes the bill would introduce, the SBA Forgiveness Application will have to be updated, as well as other specific regulations/calculations from the original law. As the requirements for PPP loan forgiveness continue to evolve, we would suggest submitting your SBA Forgiveness Application at a time where it is most advantageous to your business.

Please contact your trusted Scheffel Boyle team member with questions. We are continually monitoring this situation and will provide updates as news is released. We are always here to help.

On Thursday, May 28^th, the House passed a bill with large bipartisan support to make it easier for recipients of Paycheck Protection Program (PPP) loans to qualify for forgiveness of the funds. The Paycheck Protection Program Flexibility Act (H.R. 7010) will effectively eliminate many of the hurdles that recipients of PPP loans face.

A few of the major changes to forgiveness requirements include:

• Extension of the Covered Period from 8 weeks to 24 weeks (or the end of the year, whichever comes first)
• Lowers the portion of PPP funds that must be used for payroll from 75% to 60%, allowing 40% to be used toward other non-payroll, eligible costs such as rent and utilities.
• Increases the maximum payroll amount for the extended Covered Period from $15,385 to $46,154 per employee
• Extends the Full Time Equivalent (FTE) safe harbor date from June 30, 2020 to December 31, 2020, which allows employers more time to restore their FTE count to pre-COVID-19 numbers.
• Outlines additional FTE reduction exemptions for changes in business activity and allowing exemptions for borrowers who are unable to hire similarly qualified employees
• Extends the loan term of any funds not forgiven to 5 years from 2 years
• Allows businesses who qualify for loan forgiveness to also defer the employer portion of payroll tax, which would be paid in two installments (50% by 12-31-2021 and 50% by 12/31/2022)

The changes included in this bill will provide some much needed guidance and relief to PPP loan recipients, many of which are small businesses. While this bill has not yet passed the Senate, we remain hopeful that the legislation will be enacted sometime over the next week. The AICPA has released a statement applauding the bill saying, “it looks forward to further action on a final bipartisan bill as the Senate has demonstrated interest”.  There is also a separate bill that has been introduced in the Senate with some variations compared to the bill that passed in the House.

However, we do advise that if you are approaching the end of your 8-week Covered Period to continue complying with the forgiveness requirements that are currently in place.

Our team is monitoring this situation closely and will send out additional information as it is released. Please contact your trusted Scheffel Boyle team member with questions. We are always here to help.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, and similar measures taken by countries around the world, will have significant impacts on companies’ financial reporting. There are many accounting areas that entities will need to evaluate to determine if adjustments to the financial statements are required or whether additional disclosures are necessary. This is particularly true of accounting for income, taxes and potentially forgivable loans. The following descriptions highlight some of the key financial statement areas that are impacted by the CARES Act to date, pending additional guidance from the federal government and standard setters on implementing the relief provisions:

Download a printable PDF of this information by clicking here!

Highlights of the CARES Act for qualifying entities (FDIC-insured banks and credit unions):

• Section 4013 of the CARES Act provides the option to not apply ASC 310-40 (TDRs) to a loan modification related specifically to COVID-19 hardships, including the flexibility to not classify the loan as impaired for accounting purposes.
• Section 4014 of the CARES Act provides optional temporary relief from being required to comply with ASU 2016-13, including the CECL method for estimating allowances for credit losses. For calendar year-end public companies, the election of the deferral must be made in the Form 10-Q for the first quarter of 2020 and would be effective as of January 1, 2020.
• Section 4012 of the CARES Act directs federal banking regulators to issue an interim rule lowering the Community Bank Leverage Ratio (CBLR) from 9% to 8%, which would be effective until the national emergency is lifted or the end of the 2020 calendar year, whichever comes first.
• Section 4008 of the CARES Act authorizes the FDIC to guarantee debt issued by banks in excess of the $250,000 limit, effectively reviving a program that was enacted during the 2008 financial crisis.

Highlights of the CARES Act for financial institutions and specialty finance entities:

• For income tax reporting, the effects of the CARES Act should be recognized in the period of enactment (Q1 2020 for calendar year issuers). Careful consideration should be given to the projections being used for the Annualized Effective Tax Rate (AETR) criteria for the discrete treatment of items versus inclusion in the AETR computation, as well as the impact of ASU 2019-12 and ASU 2017-4.
• Adjustment to the 2018, 2019 and 2020 net operating loss carryback period from zero to five years and removal of the 80% taxable income limitation for the portion of the respective net operating loss utilized before 2021 are provisions in the CARES Act that may trigger tax accounting implications for financial institutions.
• Section 4011 of the CARES Act authorizes the OCC to temporarily waive the limit on lending by national banks to non-bank financial firms, effective until the national emergency is lifted or the end of the 2020 calendar year, whichever comes first.

 

Troubled Debt Restructurings:

Section 4013 of the CARES Act provides qualifying entities, insured deposit institutions and credit unions with the option to forgo applying ASC 310-40 to a loan modification related specifically to COVID-19 hardships, including the flexibility to not classify the loan as impaired for accounting purposes. In its April 3, 2020, statement, the SEC clarified that an election to waive application of ASC 310-40 to qualifying entities and loan modifications as described in the CARES Act would be in accordance with GAAP. Therefore, the provisions of Section 4013 for troubled debt restructurings (TDRs) can be applied to both public and private entities that meet the scope described in the CARES Act.

The following are characteristics of loans that are eligible for the Section 4013 TDR relief:

• Not more than 30 days past due as of December 31, 2019;
• Qualifying Modification made between March 1, 2020, and ending on the earlier of December 31, 2020 or 60 days after the president terminates the National Emergency issued on March 13, 2020; and
• Qualifying Modification applies to forbearance agreements, interest modifications, repayment plans and any other similar arrangement that defers or delays the payment of principal or interest.

However, the relief does not apply to borrowers experiencing financial difficulty where concessions may be granted that are not related to COVID-19. We believe the law is to be applied as written and is not to be interpreted or analogized to other situations. For example, a borrower that is delinquent at 12/31/2019 and becomes current before March 1, 2020 is not eligible for Section 4013 election.

On April 7, 2020, the banking regulators issued an Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised) (“Statement”). The Statement includes a discussion on Section 4013 of the CARES Act and clarifies guidance in the Interagency statement issued on March 22, 2020. Loans that do not meet the criteria in Section 4013 should be evaluated as to whether the modified loan is a TDR in accordance with ASC 310-40.

The Statement notes that working with current borrowers on existing loans as part of a program, or individually for creditworthy borrowers experiencing short-term financial or operational issues due to COVID-19, would generally not be considered a TDR. The FASB agreed with these interpretations.

No further TDR analysis is required when the following conditions are met:

• The modification is in response to the COVID-19 national emergency;
• The borrower was current (i.e., less than 30 days past due) on its contractual payments at the time the modification program is implemented; and
• The modification is short term (six months or less).

The Statement includes the following example modifications as meeting the above expedient:

• Payment deferrals;
• Fee waivers;
• Extensions of repayment terms; and
• Delays in payments that are insignificant.

The Statement also notes that government-mandated modification or deferral programs related to COVID-19 are not in the scope of ASC 310-40. The Statement uses the example of a state program that requires mortgage payment suspension for a specified period of time. The Statement also clarifies that deferrals granted due to COVID-19 should not be reported as past due and/or placed on nonaccrual status because of the deferral, and therefore would not result in a charge-off at that time. However, if additional information becomes available indicating a loan will not be repaid in whole or in part, banks should consider whether the loan is impaired and keep in mind their charge-off policies and the regulatory charge-off guidance.

We have interpreted “at the time a modification program is implemented” to mean when a program is implemented by the institution, and not at the time the specific loan modification occurred.

Note that while Section 4013 is available only to certain private and public entities (e.g., insured deposit institutions, bank holding companies, and affiliates), the Statement is an interpretation of GAAP. As such, entities outside the scope of Section 4013 of the CARES Act (e.g., public and private non-bank financing companies) can also apply the interpretive guidance in the Statement.

Allowance for loan loss considerations:

Loan modifications that are not deemed to be TDRs are also not deemed to be impaired due solely to the modification. Therefore, entities that have not yet adopted ASC 326 (CECL), should first determine if there are other indicators of impairment as noted in ASC 310-10-35 that would require individual credit impairment evaluation. If the loan is not deemed to be impaired, it should be accounted for in accordance with ASC 450. Entities that have adopted CECL will need to evaluate the impact on the loans’ contractual terms, among other considerations.

It’s critical that management considers whether the ALL model assumptions should be updated. For example, due to the widespread deferral programs being implemented, loans will not “track” as past due. If past due reports are usually a significant factor in the ALL model, they may no longer be useful indicators and other data may be considered. Additionally, since loans may appear to be performing, this may have an impact to the loss emergence period (e.g. increasing emergence period).

Interest income recognition on loans with payment deferrals:

At its April 8, 2020, meeting, the FASB staff discussed a technical inquiry where a creditor provided a loan payment deferral to a borrower during which it also waived the accrual of interest. In the fact pattern presented, the loan modification did not represent a TDR under ASC 310-40 and was not accounted for as an extinguishment. Rather, it was considered a continuation of the existing loan. This raises the question as to whether the creditor should establish a new effective interest rate in accordance with ASC 310-20 and continue to recognize interest income during the holiday period, or if it should follow the contractual terms (i.e., not recognize interest income during the holiday period). The staff expressed its view that, in this situation, either method would be acceptable.

Loan servicing and bankruptcy remote securitization trusts:

Servicers of Ginnie Mae or Freddie Mac loan pools are required by the servicing agreements to remit the borrower’s scheduled principal and interest payments to the investors. When borrowers do not make a payment, the servicer advances cash to make up for the difference between the scheduled principal and interest that is remitted to the investor vs. the actual principal and interest payments received from the borrower.

When loans are modified as described above, the borrower may not make payments for up to six months. This situation results in the servicer funding advances to Ginnie Mae and Freddie Mac as required by the servicing agreement, even though the borrower has not made a payment. Depending on the volume of modification activities carried out under the CARES Act or the Statement, there could be significant increases in advances for Ginnie Mae and Freddie Mac servicers.

Additionally, servicers of Ginnie Mae loans have the option to purchase loans out of pools when the borrower has not made payments for three consecutive months (referred to as an Early Pool Buyout, or EPBO). This option is provided to the servicer so that they can make the decision whether to continue to make advances for scheduled principal and interest payments (i.e., advancing cash at the loan pool’s coupon interest rate), or funding the loan using their own cost of funds (which may be less than the loan pool’s coupon interest rate). If the servicer was the transferor of the loan into the Ginnie Mae loan pool, this EPBO is a contingent removal of accounts provision that causes them to regain control over the transferred loan (regardless of whether the option to repurchase is exercised or not). In this situation, the transferor/servicer must account for the loans that are eligible for EPBOs, regardless of whether they actually exercise the option. This may cause a significant increase to the balance sheet of a servicer and may have regulatory capital implications.

 

The Paycheck Protection Program’s impact on financial reporting:

The Paycheck Protection Program (“PPP”) authorized federally guaranteed forgivable loans through the Small Business Administration (SBA) for qualifying small businesses to pay their employees during the COVID-19 crisis. Because the applications for PPP funding began on April 3, 2020, it’s important to note that, for businesses that received a loan, it’s a Q2 2020 event for financial reporting purposes. While we know that 100% of the principal balance is guaranteed by the SBA, there are several questions that regulatory authorities have not addressed at this time:

• How should the loans be classified on the balance sheet?
• Is interest guaranteed by the SBA?
• How should the origination fees received from the SBA be accounted for?
• How should income be recognized on these loans?

 

Other financial reporting considerations

Temporary Relief to comply with Current Expected Credit Losses (CECL):
Section 4014 of the CARES Act provides an optional temporary relief from being required to comply with ASU 2016-13, including the CECL method for estimating allowances for credit losses. That is, the CARES Act provides for an optional temporary deferral of the required adoption date of ASU 2016-13 until the earlier of the date when the president terminates the COVID-19 national emergency or December 31, 2020. However, the relief only applies to insured depository institutions, as defined in the CARES Act, bank holding companies and their affiliates. The effective date for other entities, including companies in the consumer and retail industry, manufacturing entities and other non-financial institutions, is not affected by the CARES Act.

For calendar year-end public companies, the election of the deferral must be made in the Form 10-Q for the first quarter of 2020 and would be effective as of January 1, 2020. In other words, the option to elect the deferral is not available after the first quarter. On the date that the deferral ends, the provisions of ASU 2016-13 would apply retroactively to January 1, 2020. For example, if the COVID-19 national emergency is declared over on November 5, 2020, ASU 2016-13 would be adopted on that date retroactively to January 1, 2020. If the COVID-19 national emergency is not declared over by December 31, 2020, ASU 2016-13 will be adopted on December 31, 2020 retrospectively to January 1, 2020. As such, reserves for loans existing at January 1, 2020 would be reflected in the cumulative effect adjustment to retained earnings, whereas reserves on loans originated during 2020 will be recognized through the income statement. All calendar year-end public companies (both those electing the deferral and those that do not) would report the adoption of ASU 2016-13 for the full year in their 2020 Form 10-K. During 2021, all 2020 quarters would need to be recast to assume ASU 2016-13 had been adopted as of January 1, 2020.

Considering that the deferred effective date is through an act of Congress, the SEC staff clarified in a public statement dated April 3, 2020, that they would not object to the conclusion that electing the deferral is in accordance with GAAP. Also, on March 27, 2020 (i.e., the effective date of the CARES Act), the Federal Reserve, the FDIC and the OCC issued a joint statement that addresses the interaction between CECL and the CARES Act for purposes of regulatory capital requirements. The joint statement provides an optional extension of the regulatory capital transition for the new credit loss accounting standard, with the issuance of an interim final rule that allows banking organizations to delay the estimated impact on regulatory capital stemming from the implementation of ASU 2016-13 for a transition period of up to five years.

For more information, the FDIC has released a “FAQ for Financial Institutions Affected by the Coronavirus Disease 2019,” including commentary on operational matters surrounding the ALL in the first quarter of 2020.

An excerpt of question 7 in the Operational Matters section has been included below:

First Quarter 2020 Allowance for Loan and Lease Losses or Allowances for Credit Losses. How should financial institutions with borrowers affected by the effects of COVID-19 determine the appropriate amount to report for their allowance for loan and lease losses (ALLL) or allowances for credit losses (ACLs), if applicable, in their first quarter regulatory reports?

For financial institutions that have not adopted FASB Accounting Standards Update (ASU) No. 2016-13, “Measurement of Credit Losses on Financial Instruments,” with loans to borrowers impacted by the effects of COVID-19, it may be difficult at this time to determine the overall effect that the situation will have on the collectability of these loans. Many of these financial institutions will need time to evaluate their individual borrowers, assess the repayment capacity, and other available sources.

For its first quarter regulatory reports, management should consider all information available prior to filing the report about the collectability of the financial institution’s loan portfolio in order to make its best estimate of probable losses within a range of loss estimates, recognizing that there is a short time between the beginning effects of COVID-19 and the required filing date for the first quarter regulatory report. Consistent with generally accepted accounting principles (GAAP), the amounts included in the ALLL in first quarter regulatory reports for estimated credit losses incurred as a result of the effects of COVID-19 should include those amounts that represent probable losses that can be reasonably estimated. As financial institutions are able to obtain additional information about their loans to borrowers affected by COVID-19, estimates of the effect of COVID-19 on loan losses could change over time and revised estimates of loan losses would be reflected in financial institution’s subsequent regulatory reports.

For financial institutions that have adopted FASB ASU No. 2016-13, with financial assets impacted by the effects of COVID-19, it may also be difficult at this time to determine the overall effect that the situation will have on the collectability of these assets. Many of these financial institutions will need time to evaluate their collective assessments on the net amount expected to be collected.

For its first quarter regulatory reports, management should consider all information available prior to filing the report about the collectability of the financial institution’s financial assets in order to make a good faith estimate on the net amount expected to be collected. Furthermore, management should ensure the measurement of expected credit losses includes forward-looking information, such as reasonable and supportable forecasts, in assessing the collectability of financial assets. The FDIC expects financial institutions to make good faith efforts to include its best estimate of expected credit losses within a range of expected loss estimates, recognizing that there is a short time between the beginning effects of COVID-19 and the required filing date for the first quarter regulatory report.

Consistent with generally accepted accounting principles (GAAP), the amounts included in the ACL in first quarter regulatory reports for expected credit losses as a result of the effects of COVID-19 should include those amounts that represent expected credit losses over the remaining contractual term of the financial asset, adjusted for prepayments. As financial institutions are able to obtain additional information about their financial assets affected by COVID-19, estimates of the effect of COVID-19 on credit losses could change over time and revised estimates of credit losses would be reflected in financial institution’s subsequent regulatory reports.

Income tax reporting considerations:

The effects of the CARES Act should be recognized in the period of enactment (Q1 2020 for calendar year issuers). Careful consideration should be given to the projections being used for the Annualized Effective Tax Rate (AETR) criteria for the discrete treatment of items versus inclusion in the AETR computation (e.g., direct and indirect impacts of carryback, change in tax law and movement in the valuation allowance), as well as the impact of ASU 2019-12 and ASU 2017-04.

• Book recognition of reserves, accruals and impairments related to COVID-19 will likely impact the recognition and measurement of temporary differences and related tax accounting. Accordingly, the following entity fact patterns may trigger material tax accounting implications that management may need to focus on:
• Impairments to book goodwill with or without an underlying tax basis.
• Impairments to book intangibles that have historically depended upon reversing taxable temporary differences related to the underlying book intangibles with no tax basis as a source of income to realize existing deferred tax assets.
• Adoption of ASU 2017-04.
• Material book adjustments (both individually and in aggregate) to areas outside of goodwill and intangibles to which the applicable tax accounting treatment would differ.

 

How We Can Help

In conclusion, while the COVID-19 pandemic has created significant uncertainty for financial institutions and specialty finance entities, the CARES Act provides some financial reporting and tax relief for those who know how to access it. To that end, CFOs and financial leaders can help their organizations on the path back to growth by leveraging all applicable CARES Act provisions in their accounting strategies, including having familiarity with all relevant financial reporting requirements and deadlines in order to maximize benefits.  Our Financial Institutions Group is always here to help.