In a preview of the panel discussion he will be moderating at the Sept. 22 PICPA online Financial Institutions Conference, Patrick J. Mulloy, CPA, partner, audit services, for RSM US LLP in Philadelphia, discusses the impact of coronavirus on current expected credit losses. Among the aspects he shares with us are allowances for loan loss calculation and the process for determining Paycheck Protection Program loans and grants.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor

Podcast Transcript

At the 2020 PICPA Financial Institutions Conference on September 22nd, Patrick J. Mulloy, CPA, partner, audit services, for RSM US LLP in Philadelphia, will moderate a discussion that explores the latest in finance industry accounting and auditing developments. Today, he has joined us to review the ways by which the COVID-19 pandemic is impacting the area of expected credit losses.

Can you give us an overview of the potential impacts of COVID-19 on expected credit losses?

[Mulloy] Sure. It did have a major impact on CECL this year. It did provide temporary relief from the CECL standards to financial institutions, which is extremely helpful.

The CARES Act was released on March 13th, 2020, and, under that act, financial institutions were provided the option to defer the adoption of CECL until essentially the act is finalized or no later than December 31st, 2020, and so, what this did, it essentially provided financial institutions a choice or an ability to defer the adoption or to continue with the adoption.

As we look at different SEC entities and clients, some took a different approach. Some decided to go forward and adopt the CECL standard in the first quarter of 2020, which makes sense, because they've been working real hard over the last couple of years in preparing for the standard, preparing for the adoption, and preparing for the impact of the adoption. Some financial institutions felt that it made sense to continue on with the adoption process, but others also decided to defer, which also makes a lot of sense. There was a lot going on during the first quarter, obviously, with COVID-19 and everything that comes along with COVID-19, so the ability to get some flexibility and some ability to defer the adoption just made a ton of sense.

Financial institutions that did defer, as mentioned, they're most likely going to adopt as of December 31, 2020. We don't see that this act is going to be wrapped up before 2020, so we think the CARES Act is going to go beyond 2020. As we look back to other acts that were provided by the U.S. government in years past, there are still many that are open even though the environment is not extreme, so we think the CARES Act will continue.

December 31, 2020, looks like it will be that adoption date for the other public companies that CECL adoption applies to for 2020, but those that did, that decided not to adopt, they received the flexibility of waiting through the fourth quarter to adopt and, plus, they did have the ability to take a look at what the SEC filings looked like both from an adoption standpoint and a disclosure standpoint from the other filers that did adopt in time in the first quarter of 2020. That's just an overview of the two options that the CARES Act provides.

If you did decide to defer, there's some information that came out that requires some information to be disclosed within the quarter of adoption that goes back and takes a look at what that adoption would look like within the first three quarters, but there's also some discussion right now whether that is required or not. We're definitely going to touch upon this at the conference. This is our main topic at the conference, and we have a great group of panelists, and we have a few folks actually from industry from WSFS Bank that are going to talk through their adoption and their approach. So we're going to spend a lot of time with this at the conference coming up on September 22.

What would you say determines whether a lender accounts for a loan modification as a troubled debt restructuring?

[Mulloy] There was a lot of information that came out this year related to that essentially. Just a little bit of a background: troubled debt restructuring is a loan modification that requires certain accounting and disclosure parameters, and that also includes looking at the loan for impairment, potential reserves, and, as I mentioned, certain disclosure parameters.

What the CARES Act did is they provided relief to financial institutions in a very broad manner. They basically say that any loan modification that occurs during the CARES Act and during 2020 would essentially not be required to be classified as a troubled debt restructuring, which provides flexibility to the financial institutions. In turn, the financial institutions then apply that flexibility to the borrowers. They're more inclined to help borrowers as far as being flexible with principal and interest payments because the stricter accounting ramifications and disclosure ramifications are being relieved throughout the year based on the CARES Act.

As a result of the CARES Act, there were several interagency statements that were released by the banking regulators that essentially helped to clarify the CARES Act and helped to clarify existing GAAP and also provide parameters around loan modification. So, for instance, even though the CARES Act provides very broad guidance, they have several reminders that help financial institutions make decisions under very safe and sound thought processes, and then they also remind the financial institutions and the readers that there is existing GAAP that also covers insignificant loan modification.

For instance, if you make a loan modification, and let's just say you defer P&I for six months, but you fully expect to receive the complete P&I under the original loan parameters. If you were to cash flow that model through the life of the loan and basically there's an insignificant impact on that value that's being determined and comparing that to the current value of your loan at this point in time, it would be deemed insignificant. If it's deemed insignificant through that process, then it doesn't require TDR retreatment. The policies do a nice job of walking us through safety and soundness reminders, as well as the current GAAP literature that exists.

Obviously, COVID-19 has had an impact on so many aspects of the accounting profession. How has it impacted the allowance for loan loss calculation?

[Mulloy] It's had a significant impact this year. For years leading into 2020, historical losses and the impact of losses have been very low in the allowance for loan loss calculations of financial institutions, and then obviously this year, starting in the first quarter, with all the uncertainty associated with COVID-19, it required basically an increase in reserve to respond to the risk within that environment, and that really results in the enhancing or the increasing of the environmental factors within the allowance for loan loss calculation.

In the first quarter, when this unfolded, financial institutions were mostly increasing their environmental factors based on what they expected a result would be based on COVID-19, which is very difficult. How can you forecast what the impact would be with such a short time back in the first quarter of dealing with this pandemic? However, after the first quarter passed, the public companies had their 10-Qs out there, and also the call reports were filed, so then you start getting some peer information to see what your peers are doing, and that really helped financial institutions in the second quarter.

Now that we're in the third quarter essentially, obviously there's a continued sense of uncertainty that exists in the environment, and that makes a lot of sense, but there's also some positive trends out there. There are positive trends out there that, as these financial institutions are making loan modifications and as they're coming up for renewal, each time the renewal period comes up, it seems like less loan modifications are renewing their modified terms, or perhaps some customers, when the pandemic hit and the loan modification option was available, perhaps they took it, forecasting tough times ahead.

Now that some industries are adapting to the pandemic, perhaps they're coming back and saying, "Hey, listen, we've adapted. We're doing okay. We'd like to get back to our normal structure." Now, obviously, it impacts. This still has a significant impact on a number of industries. Hospitality, hotel, restaurants, tourism, these industries are going to continue to struggle under this pandemic, but other industries seem to be adapting a bit, so that could impact. The Q3 reserves, and how the allowance reacts to Q3, could really have an impact on what industries and what type of borrowers the financial institutions are focused on. If they're seeing less and less credit impact, then perhaps they're pumping the brakes on the reserving at the level they were in Q1 or Q2, or perhaps there's a focus in some of those trouble industries that we just discussed which would require some continuing reserving. It definitely had a major impact this year, and each quarter was impacted in a different way.

It'll be interesting at the conference next week. We have a couple of technicians from Deloitte and RSM that are going to be going through the impact on the allowance, and that'll be great. We have these folks from WSFS that are going to be a part of the panel, and to hear what they went through as it relates to the allowance for loan loss this year is going to be very, very informational.

The Paycheck Protection Program is something that's certainly affected how CPAs work with their clients and, also to some extent, it's affected CPA firms themselves. What are the Small Business Administration origination fees for Paycheck Protection Program loans?

[Mulloy] This had a major impact on financial institutions this year because these fees were a positive. If a financial institution was involved with the PPP program, receiving these fees helps. It was income. It helped to give in some additional provisioning that's occurring during these uncertain periods. For every PPP loan, the financial institution gets a fee from the SBA. Essentially, there is a form that was developed, and the financial institution tabulates the loans that were originated, and that gets submitted with the SBA, and then the SBA will send one large payment to the financial institution that covers these fees for the multiple loans that were initiated.

This created some questioning in the industry at first on how to account for these fees, but recently there's been a fantastic Q&A that was issued by the PICPA in June of this year where they really clarify the fact that these fees are essentially considered fees under FASB ASC 310-20 and, as a result, they should really be offset against loan costs and then deferred over the life of the loan. So there's been some good clarity that came out over the last couple of months, but, at first, this concept was a bit confusing and there were some questions in industry on whether these fees should be deferred or not.

Staying on the topic of the PPP, how are our PPP loans determined to be loans or grants? What's the process there?

[Mulloy] There's really two options that a company has in order to account for a PPP loan that they have received. Option one is they could account for the loan as a financial liability in accordance with FASB ASC 470, and that loan is in substance a loan that is repayable. The initial recognition would be a loan payable on the balance sheet, and then from a forgiveness standpoint you would record this as a write-off to the outstanding loan payable balance. You would also have a gain on debt extinguishment when the company is notified that the loan is forgiven, and then, on top of that, there's no need to impute additional interests at a market rate since the interest rates for the PPP loans are prescribed by the governmental agencies.

That's one option entities have, but then the other option is option number two, that they can essentially account for the loan as a grant under ASC 958-605. In order to take this stance, the company must substantiate that they expect to meet the PPP's eligibility criteria for forgiveness, and then your initial recognition would be to record a refundable advance, which would be a liability on the balance sheet on day one, and then, when forgiveness occurs, you would then reduce the advanced balance and you would recognize revenue under other income once these forgiveness conditions have been substantially met, and, of course, you want to disclose the accounting policy for these loans and the related impact on the financial statements within your financial statement disclosures.