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April 9, 2020

First Quarter Disclosure Considerations for Publicly Traded Financial Institutions

Coronavirus: Corporate and Finance Advisory

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The coronavirus disease (COVID-19) pandemic has caused significant disruption and deterioration in economic conditions, including record levels of unemployment, as federal and state governments have taken unprecedented actions to slow the spread of the disease. These actions have resulted in substantial challenges for individuals and businesses, including financial institutions and their borrowers. In addition, there have been a number of recent bank regulatory actions and legislative changes to mitigate these adverse economic conditions, including certain mandates requiring financial institutions to work constructively with borrowers affected by COVID-19.

On April 3, 2020, recognizing the impact that COVID-19 will have on reporting companies, the SEC's Office of the Chief Accountant (OCA) issued a statement stressing the importance of continued high-quality financial reporting to keep capital markets functioning properly. This follows recent guidance setting for the views of the SEC's Division of Corporate Finance regarding disclosure and other obligations that reporting companies should consider with respect to COVID-19.1 Consistent with that guidance, and existing law, financial institutions must evaluate and take into account the effects of COVID-19, as well as the response of federal and state governments (including regulatory actions and changes in law) when preparing disclosures for first-quarter earnings releases, earnings conference calls, quarterly reports, investor presentations and other disclosure documents, as well as disclosures for future periods, at least for the foreseeable future.

In that light, we recommend that publicly traded financial institutions consider these factors in preparing first-quarter disclosures, including the MD&A and risk-factor disclosures for upcoming 10-Qs.

Disclosure Related to Recent Statutory Changes and Regulatory Actions

  • Loan Forbearance and Foreclosure Moratoriums

    • Under Section 4022 of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), until the earlier of December 31, 2020 and the date the national emergency declared by the President terminates, a borrower with a federally backed one-to-four family mortgage loan experiencing a financial hardship due to COVID-19 may request forbearance, regardless of delinquency status, for up to 180 days (which may be extended up to an additional 180 days). Section 4022 also prohibits servicers of federally backed mortgage loans from initiating foreclosures during the 60-day period beginning March 18, 2020.
    • Under Section 4023 of the CARES Act, until the earlier of December 31, 2020 and the date the national emergency declared by the President terminates, a borrower whose payments were current as of February 1, 2020 on a federally backed multifamily mortgage loan, but who has since experienced financial hardship due to COVID-19, may request a forbearance for up to 30 days (which may be extended up to an additional 60 days). Borrowers receiving such forbearance may not evict or charge late fees to tenants for its duration.
    • Many state governors have issued orders prohibiting residential eviction proceedings and foreclosures during the COVID-19 emergency. For example, New York's governor issued an order prohibiting the enforcement of an eviction of any residential or commercial tenant or a foreclosure of any residential or commercial property for a period of 90 days.
    • Disclosure of forbearance programs put in place should be considered for risk factors and MD&A.
    • Loans in forbearance as a result of COVID-19 should be separately tracked and disclosure of the aggregate amounts of such loans should be considered for the second quarter 10-Q.
  • Loan Modifications and Troubled Debt Restructuring (TDR) Treatment

    • Section 4013 of the CARES Act allows financial institutions to elect, for loans that were current as of December 31, 2019, to (i) suspend requirements under GAAP for loan modifications related to COVID-19 that would otherwise be categorized as a TDR, and (ii) suspend any determination whether a loan modified due to COVID-19 is a TDR, including whether a loan is thus impaired for accounting purposes. Financial institutions may make these elections until the earlier of December 31, 2020 and 60 days after the national emergency declared by the President terminates, and such elections will be applicable for the term of the loan modification.
    • Federal and many state banking regulators have confirmed with FASB staff that good faith, short-term loan modifications (including payment deferrals, fee waivers, extensions of repayment terms or other insignificant delays in payment) for borrowers whose loans are current are not considered TDRs under applicable accounting standards.
    • Banking regulators also confirmed that modifications or deferral programs required by state governments will not be considered TDRs under applicable accounting standards. Efforts to work with borrowers of one-to-four family mortgage loans that are prudently underwritten and not past due or carried in nonaccrual status will also not result in the loans' treatment as restructured or modified under the risk-based capital rules.
    • Loans modified in response to COVID-19 and loans for which Section 4013 treatment has been elected should be separately tracked and disclosure of the aggregate amounts of such loans should be considered for the second quarter 10-Q.
  • Relief from CECL Implementation

    • Federal banking regulators issued an interim final rule allowing banking organizations that are required (as of January 1, 2020) to adopt Accounting Standards Update No. 2016-13, Financial Instruments – Credit Losses, Topic 326, Measurement of Credit Losses on Financial Instruments (CECL) during 2020 to delay an estimate of CECL's impact on regulatory capital in regulatory filings for up to two years (followed by a three-year transition period to phase out the capital benefit provided by the two-year delay).
    • The CARES Act gives all banking organizations optional temporary relief from complying with CECL, ending on the earlier of December 31, 2020 and the date the national emergency declared by the President terminates.
    • Banking organizations that use the temporary relief under the CARES Act may also rely on the regulator's interim final rule on capital impact, which extends beyond the expiration of the relief under the CARES Act.
    • Financial institutions should affirmatively disclose whether or not they plan to take advantage of the relief provided under the CARES Act or the interim final rule.
    • For financial institutions taking advantage of the CARES Act relief, updated risk factors should address the risk of the temporary nature of the relief and that adoption of CECL will be required on the date the relief expires, with application retroactive back to the beginning of the fiscal year.
  • Paycheck Protection Program

    • The CARES Act also established the Paycheck Protection Program (PPP).2 The PPP piggybacks on the Small Business Administration's 7(a) loan program, authorizing financial institutions to make federally backed loans to qualifying small businesses and nonprofits on the terms set forth in the CARES Act and related regulations.
    • Financial institutions that intend to discuss their PPP participation in their earnings conference call should include appropriate disclosures in the earnings release and investor deck.

Additional Disclosure Considerations Relating to COVID-19

  • The impact on various loan portfolios of the massive economic dislocation that has resulted from COVID 19:

    • Commercial business loan portfolios, particularly loans to small- and mid-sized businesses, likely have been significantly adversely affected due to governmental and public protective responses to COVID-19, including shelter-in-place and similar stay-at-home orders, that have caused numerous businesses to close, resulting in a substantial increase in unemployment.
    • The pandemic has had a particularly acute impact on certain industries, such as hospitality, including restaurants and hotels, and retail, including clothing stores and boutiques. Updated risk disclosures may be appropriate for those with portfolios concentrated in those and other sectors experiencing real difficulty.
    • Office and retail vacancies, rent forbearance, and the financial instability of other tenants will adversely affect commercial real estate loan portfolios.
    • Massive increases in unemployment will have a material effect on residential and multi-family loan portfolios.
  • The financial impact from governmental actions to protect consumers, such as loan forbearance programs, fee waivers, extension of payment due dates, other repayment accommodations, and increases in credit card and ATM withdrawal limits
  • Steps taken by the reporting financial institution to respond to COVID-19, including contingency planning if members of the Board or management become ill (the occurrence of which could potentially result in additional disclosure obligations)
  • Borrower relief programs and other customer accommodations and steps being taken by the reporting financial institution to continue to meet the financial services needs of customers
  • Steps taken by the reporting financial institution to address operational challenges due to staffing issues or other effects of COVID-19, including state and local stay-at-home orders, and the risks of operating under this current environment
  • The impact on net interest income, net interest spread and net interest margin of the response of the Federal Reserve in cutting the federal funds rate in response to the economic crisis, as well as the related market interest rate environment
  • If 1st quarter results are significantly affected by COVID-19, whether a preannouncement of earnings should be made ahead of full earnings release (if such results have satisfied internal disclosure controls and procedures and are otherwise ready for public announcement)
  • If the company's actions in response to regulatory announcements or other response to COVID-19 will be discussed during the earnings conference call, appropriate disclosures should be included in the earnings release and investor deck; Reg FD disclosures may be needed to avoid selective disclosure issues
  • Whether to take advantage of the SEC order giving public companies a 45-day extension to file certain disclosure reports that would otherwise have been due between March 1 and July 1; the extension is subject to conditions, including the requirement to file a Form 8-K by the original filing deadline describing the reasons for not filing on time and a risk factor explaining, if material, the impact of COVID-19 on the filer's business

For many institutions, the COVID-19 crisis and the government's response may not materially affect first quarter results due to the impact coming late in the first quarter. However, the SEC's requirements that the MD&A disclose known trends and uncertainties and that risk factors be updated for material changes, together with the statement from the SEC's Office of the Chief Accountant noted at the outset of this Advisory, should result in extensive discussion of the current crisis in upcoming first quarter disclosures.  Both the SEC and the investing public are expecting financial institutions to be transparent about the impact of COVID-19 both on financial results and ongoing operations. The upcoming first quarter earnings season will be the first formal opportunity for this transparency.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.