Jim Vaughn, CPA | Mauldin & Jenkins, LLC
Ever since the COVID-19 pandemic hit last winter, much of life feels somewhat unreal. With normal workplace routines disrupted, kitchen tables transformed into classrooms, and social distancing everywhere, it’s easy to assume that this strange period exists outside in its own world. But while 2020 is certainly not a typical year, how banking institutions respond to current conditions creates a very real impact on the strength of their future positions.
Bank leaders should carefully monitor the following areas as they determine next moves and try to safely navigate their organizations through turbulent waters.
Commercial Mortgage-backed Securities
While the overall CMBS delinquency rate has dropped somewhat from its June peak, the rate is still worrisomely elevated at around 9%. That represents a slight decrease from August numbers. However, the share of newly delinquent loans edged up, which does not portend well for autumn. Lodging remains the hardest hit, with retail loans also exceeding average default rates by a big margin.
Virus Vulnerability by Industry
As certain industries are much more sensitive to the economic effects of the virus, banking institutions should carefully review outstanding loans by sector. Hotels and shopping centers that lack grocery, pharmacy, or discount anchor tenants top the list of most vulnerable. Restaurants are hurting too, particularly as colder weather approaches and brings with it an end to outdoor dining, although many take-out concerns are doing quite well. Recreation facilities, fitness centers, country clubs, and churches are also especially exposed to financial loss.
Current Expected Credit Loss Allowances
In comparing 2020 CECL allowances for certain public banks to the more familiar incurred loss model used last year, some differences leap out. First, we note that 23% of issuers who would have been subject to CECL chose to delay adoption. Those issuers that did adopt had an average increase of 36.4% in their allowance. Additionally, those who adopted the new standard have a higher allowance to total loans and also have higher provision expenses for the first two fiscal quarters, illustrating the earlier recognition of estimated and potential future losses. Bank leaders should be aware of potential changes as they move to the new standard.
Economic turmoil makes it more critical than ever for banks to be on the lookout for potential impairments to goodwill, MSRs, and deferred tax assets. For many, COVID-19 may itself constitute a triggering event. Management should evaluate potential triggers early and often to determine whether any have in fact resulted in impairment:
- Macroeconomic conditions (Note that the August unemployment rate was 8.4% vs. January’s rate of under 4%)
- Industry and market conditions
- Overall financial performance
- Sustained decrease in Share Price A
Subsequent Event Rules
Events that take place after balance sheets are created can have a meaningful impact on the organization’s financial picture. These subsequent events occur in two basic types, which should be governed by the following rules, respectively:
Paycheck Protection Program loans raise numerous questions and concerns for banks. In accounting and reporting these loans, banks should be aware that:
- Advances from PPP should be accounted for as a loan
- SBA guaranty is embedded and should be considered in estimating credit loss
- Accounting for loan origination fees is under ASC 310-20, which updates SFAS 91
In regard to loan forgiveness, lenders must request payment from the SBA when the lender issues its decision to the SBA. Banks should account for the loan as an interest-bearing loan through receipt of payment from either the borrower or the SBA.
The CARES Act passed by Congress temporarily reinstates the carryback provision on net operating losses for corporations, allowing a 5-year carryback for NOL generated in up to three tax years beginning between January 1, 2018, and December 31, 2020. Also, changes in tax rates may create book income or losses as a result of shifting valuation of DTAs. Bank leaders should be aware that the new lease and loan loss allowance accounting standards are likely to create larger DTA valuations.
The OCC Reference Guide is a valuable resource to help bank managers distinguish between loans for which section 4013 of the CARES Act applies and those where the Revised Statement is more appropriate. For others, the Guide advises banks to follow existing policies in determining whether loan modifications should be treated as a TDR.
Besides specific provisions to help residential and commercial mortgage borrowers experiencing financial distress, the CARES Act also encourages banks to work with borrowers “prudently” and offer flexibility throughout this (limited) time. The way banks interpret this responsibility and handle interactions with borrowers will affect not only the financials of the institution, but also the health of these client relationships. Goodwill fostered here (or not) can help or hurt banks as the nation leaves the pandemic behind and enters a post-COVID period.
From market and industry disruptions to government efforts to mitigate the financial hit on businesses and consumers, unique conditions this year call for thoughtful decisions and sound strategy. More than ordinary caution is warranted as banks meet the challenges of this sensitive time, and the experienced advisors at Mauldin & Jenkins are here to help you find solutions.