Individuals that serve in an executive and leadership capacity at banks are making important operational and business decisions to keep their employees’ wellbeing a priority while mitigating organizational risk during the novel coronavirus (COVID-19) pandemic.
Within the coming months, data will begin to demonstrate the human and operational impact, but without a doubt, the impact on financial institutions will be significant.
As leaders are tasked to make crisis management, business continuity, liquidity, capital, and revenue/cost management decisions at a rapid pace, it can be easy to lose sight of some of the critical accounting and financial reporting decisions banks must address amid this unpredictable environment. Below, we’ve outlined four considerations for senior management at financial institutions to consider as they continue to develop and execute on crisis management plans:
1. Asset quality & impairment
The economic impact of the COVID-19 pandemic will be felt by companies large and small, but many have a heightened concern for small business owners and their support staff. As a result, banks are sure to see credit issues arise as borrowers are no longer able to make timely loan repayments. As just about every state in the U.S. has issued a state of emergency, a recent Interagency statement encouraged, “financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19. ” Two of the primary concerns for banks are troubled debt restructurings (TDR) and current expected credit loss (CECL) under ASC, 326, Credit Losses.
Troubled Debt Restructuring:
Providing loan payment flexibility naturally raises questions on how to account for loan modifications (e.g. troubled debt restructurings). GAAP states that a loan is a TDR when a borrower is troubled and the bank grants a concession to the borrower it would not otherwise consider. While Interagency Statements are not authoritative GAAP[1], some are taking comfort in knowing that the banking agencies stated that they will, “not criticize financial institutions that mitigate credit risk through prudent actions consistent with safe and sound practices.” On March 22, 2020, the agencies released that they have confirmed with staff of the FASB that, “short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not TDRs.”
Management should consider the need for establishing internal policies and practices in applying the interagency recommendations. While modifications of loan terms do not automatically result in TDRs, careful evaluation is required to determine if a modification results in a TDR. Management should ensure consistent criteria, practices, and policies are in place
CECL implications
The Current Expected Credit Losses (CECL) standard has long been debated by accounting and business professionals, and has even drawn interest from political factions for several years up through its effective date of January 1, 2020[2]. COVID-19 has exacerbated the debate with commentary from the chairwoman of the FDIC urging delay and exclusions of the final rule from FASB. CECL requires entities to consider what is known and knowable, as well as, reasonable and supportable forecasts. The determination of when events became known or knowable and the periods beyond which the entity is able to make or obtain reasonable and supportable forecasts will be critiqued by bank regulators and auditors alike.
While this facet of the standard is sure to cause challenges in the current environment, consideration of confirming and contradictory evidence will go a long way in supporting management’s conclusion
March 25 stimulus package provides TDR and CECL relief
On March 25, 2020, the Senate passed a stimulus package that provides temporary TDR relief beginning March 1, 2020 and extending for 60 days after the end of the COVID-19 national emergency. The bill will allow banks to suspend requirements under GAAP for loan modifications related to COVID-19. Additionally, the relief extends to CECL, delaying the implementation to the conclusion of the national emergency or December 31, 2020, whichever comes first. The bill has not been signed into law as of the time of this publication.
Senior management is urged to be vigilant in ensuring proper analysis is performed over modifications and to avoid making sweeping approvals without understanding the specific facts and circumstances for each individual borrower
2. Internal controls over financial reporting
Commonly deemed “essential businesses” banks will likely remain open during the crisis, however, back office personnel may have the flexibility to work remotely. While remote working environments are critical to maintaining the safety of employees, it may impact the company’s internal control structure as normal routines are disrupted.
One example may be in the area of loan modification approvals. To respond to the inundation of calls and requests for refinance due to the Fed introducing rate cuts, COVID-19’s disruption of the normal working environment may necessitate a change in internal controls to accommodate remote work environments. There may be instances where internal controls are not operating as originally designed and may require temporary enhancement to cope with challenges related to working remotely and managing an increase in transaction volume.
Therefore, it’s critical that management re-evaluate their internal control structure and make any necessary adjustments as they conduct business for the foreseeable future.
3. Disclosures
The magnitude of the novel coronavirus continues to evolve, leading to uncertainty of the impact on the financial condition, liquidity and future results of bank operations. Although the fallout is still developing, the financial disclosure requirements have not been alleviated and, for many reasons, additional and more detailed disclosures may be necessary.
Management’s disclosures in the financial statements are to inform the shareholders, public, and/or regulatory authorities on the active monitoring on its financial condition, liquidity, operations, suppliers, industry and workforce. For those with SEC filing requirements, risk factors and trends should consider the effects of the novel coronavirus.
The length of time of these disruptions is currently unclear, and while they are anticipated to be temporary, banks should consider disclosing the following (not exhaustive):
- Markets: How the bank is monitoring the fluctuations in the markets (e.g. interest rates, and fair value of investments for other than temporary impairment).
- Material adverse effect: Outcomes if disruptions continue and how/if there is any material adverse effect on the bank’s results of future operations, financial position, liquidity, and strain on the bank’s capital reserve ratios.
- Concentrations: Concentration that present greater risk (e.g. borrowers, geographic locations, etc.).
- Goodwill, Intangible Impairment: Evaluate if triggering events require an interim impairment assessment.
- Going Concern: Banks may face difficulty collecting from borrowers and/or other events that negatively affect operating cash flows and liquidity, and capital. If management concludes there is substantial doubt, then disclosure in the financial statements is required, even if management’s plans alleviate that substantial doubt.
- Subsequent Events: It is possible information may be received after the balance sheet date about factual conditions that existed at the balance sheet date (e.g. payment delinquencies or an appraisal about the fair value of loan collateral), which would need to be accounted for and considered at the balance sheet date (e.g. December 31, 2019). Other events occurring after the balance sheet date may require disclosure only as to the subsequent impact on the bank’s business through the date the financial statements were issued or available to be issued.
4. Cybersecurity strategy for remote employees
With vast amounts of consumer information and cash reserves, banks and financial institutions have always been a rich target for cybercriminals. The COVID-19 pandemic has only exacerbated this threat, as many employees are now working in remote environments that are not necessarily subject to the same cybersecurity safeguards that are standard procedure in a secure office space. According to Gartner, 40% or more of cyber vulnerabilities are directly linked to employee behavior, so it’s critical that banks adopt cybersecurity plans now that applies to remote locations.
While bank CFOs are supporting their leadership team on specific crisis management deliverables related to financial management, they must also be the voice in the room guiding the organization on the critical accounting and financial reporting rules that the bank must comply with in order to meet their financial reporting obligations. While we’re in unprecedented times, keeping abreast of guidance from FASB and reviewing internal control changes and other accounting procedures now will help streamline operations during the COVID-19 pandemic.
[1] Authoritative GAAP related to TDRs can be located within ASC 310-40
[2] For SEC issuers that do not meet the definition of a smaller reporting company and are a December 31 year end.