The CARES Act: What Banks Need to Know

Banks will play a critical role in providing capital and liquidity to American businesses and consumers, and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) includes several provisions that benefit depository institutions. The implications for bank directors and officers are significant; they may need to make major decisions quickly.

Expanded SBA Lending
The CARES Act appropriates $349 billion for “paycheck protection loans” to be made primarily by banks that will be 100% guaranteed by the Small Business Administration (SBA) through its 7(a) Loan Guaranty Program. The SBA issued an interim final rule on the program on April 2 and has issued additional formal and informal guidance since that date. Application submissions began on April 3. Banks and borrowers will want to move quickly, due to the limited funds available for the program.

Provisions Benefitting Depository Institutions Directly

Troubled Debt Restructuring Relief. A financial institution may elect to suspend the requirements under generally accepted accounting principles and federal banking regulations to treat loan modifications related to the COVID-19 pandemic as troubled debt restructurings. The relief runs through the earlier of Dec. 31 or 60 days after the termination date of the national emergency, and does not apply to any adverse impact on the credit of a borrower that is not related to the COVID-19 pandemic.

CECL Delay. Financial institutions are not required to comply with the current expected credit losses methodology (CECL) until the earlier of the end of the national emergency or Dec. 31.

Reduction of the Community Bank Leverage Ratio. Currently, a qualifying community banking organization that opts into the community bank leverage ratio framework and maintains a leverage ratio of greater than 9% will be considered to have met all regulatory capital requirements. The CARES Act reduces the community bank leverage ratio from 9% to 8% until the earlier of the end of the national emergency or Dec. 31. In response to the CARES Act, federal banking regulators set the community bank leverage ratio at 8% for the remainder of 2020, 8.5% for 2021 and 9% thereafter.

Revival of Bank Debt Guarantee Program. The CARES Act provides the Federal Deposit Insurance Corp. with the authority to guarantee bank-issued debt and noninterest-bearing transaction accounts that exceed the existing $250,000 limit through Dec. 31. The FDIC will determine whether and how to exercise this authority.

Removal of Limits on Lending to Nonbank Financial Firms. The Comptroller of the Currency is authorized to exempt transactions between a national bank or federal savings association and nonbank financial companies from limits on loans or other extensions of credit — commonly referred to as “loan-to-one borrower” limits — upon a finding by the Comptroller that such exemption is in the public interest.

Provisions Related to Mortgage Forbearance and Credit Reporting

The CARES Act codifies in part recent guidance from state and federal regulators and government-sponsored enterprises, including the 60-day suspension of foreclosures on federally-backed mortgages and requirements that servicers grant forbearance to borrowers affected by COVID-19.

Foreclosure and Forbearance on Residential Mortgages. Companies servicing loans insured or guaranteed by a federal government agency, or purchased or securitized by Fannie Mae or Freddie Mac, must grant up to 180 days of forbearance to borrowers who request and affirm financial hardship due to COVID-19 through the period ending on the later of July 25, or the end of the national emergency.

Servicers are not required to document the borrower’s hardship. The initial 180-day forbearance period must be extended up to an additional 180 days at the borrower’s request., Servicers of federally backed mortgage loans may not assess fees, penalties, or interest beyond the amounts scheduled or calculated during this forbearance period, as if the borrower made all contractual payments on time and in full under the terms of the mortgage contract. The law also imposes a foreclosure moratorium on federally backed mortgage loans of at least 60 days, beginning on March 18.

Forbearance on Multi-Family Mortgages. Multifamily borrowers with a federally backed multifamily mortgage loan that was current on its payments on Feb. 1, may request forbearance for a 30-day period with up to two 30-day extensions, during the covered period. Servicers are required to document borrower’s hardship. Borrowers must provide tenant protections, including prohibitions on evictions for non-payment and late payment fees, in order to qualify for the forbearance, and servicers are required to document the borrower’s hardship.

Moratorium on Negative Credit Reporting. Any furnisher of credit information that agrees to defer payments, forbear on any delinquent credit or account, or provide any other relief to consumers affected by the COVID-19 pandemic must report the credit obligation or account as current if the credit obligation or account was current before the accommodation.

Loan Modification Rules Suspended in Race to Minimize Pandemic Losses

The suspension of accounting rules on modified loans is another dramatic measure that regulators and lawmakers have taken in the struggle to limit pandemic-related loan defaults.

The question of how — and increasingly, whether — to account for, report and reserve for modified loans has taken on increasing urgency for banks working to address borrowers’ unexpected hardship following the COVID-19 outbreak.

Regulators homed in on the treatment for troubled debt restructurings, or TDRs, in late March, as cities and states issued stay-at-home orders and the closure of nonessential businesses sparked mass layoffs. The intense focus on the accounting for these credits comes as a tsunami of once-performing loans made to borrowers and businesses across the country are suddenly at risk of souring.

“The statements from regulators and the CARES Act are trying to reduce the conversations that we have about TDRs by helping institutions minimize the amount of TDR challenges that they’re dealing with,” says Mandi Simpson, a partner in Crowe’s audit group.

TDRs materialize when a bank offers a concession on a credit that it wouldn’t have otherwise made to a borrower experiencing financial difficulties or hardship. Both of those prongs must exist for a loan to be classified as a TDR. Banks apply an individual discounted cash flow analysis to modified credits, which makes the accounting complicated and tedious, Simpson says.

“You can imagine, that could be pretty voluminous and cumbersome” as borrowers en mass apply for modifications or forbearance, she says.

Late last month, federal bank regulators provided guidance on TDRs to encourage banks to work with borrowers facing coronavirus-related hardship. Still, Congress intervened, broadening both the relief and the scope of eligible loans.

The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, which went into effect on March 27, suspended the requirements under U.S. generally accepted accounting principles for coronavirus loan modifications that would have otherwise been categorized as TDRs. It also suspended the determination that a loan that has been modified because of the coronavirus would count as a TDR, “including impairment for accounting purposes.” This applies to any loan that receives a modification that was not more than 30 days past due as of Dec. 31, 2019.

The law encourages banks to record the volume of modified loans. It also specified that bank regulators can collect data about these loans for supervisory purposes.

Bank regulators issued their revised interagency statement on April 7 to align with Congress’ rule. Bankers should maintain appropriate allowances and reserves for all loan modifications. It adds that examiners will exercise judgment when reviewing modifications and “will not automatically adversely risk rate credits that are affected by COVID-19.”

Importantly, the U.S. Securities and Exchange Commission’s chief accountant issued an opinion accepting the CARES Act treatment of TDRs as GAAP on April 3. The statement reconciled U.S. accounting policy and federal law, and spared auditors from issuing modified opinions for institutions that adopt the TDR relief.

But the accounting relief could create longer-term issues for banks, says Graham Steele, staff director of the Corporations and Society Initiative at Stanford Graduate School of Business. He previously served as minority chief counsel for the Senate Committee on Banking, Housing and Urban Affairs and was a member of the staff of the Federal Reserve Bank of San Francisco.

He understands the imperative to provide forbearance and flexibility, but he says the modifications and concessions could lead to diminished cash flows that could erode a bank’s future lending capacity. He points out that it’s also unclear what would happen to balance sheets once the national emergency ends, and how fast those modifications would be reclassified.

“This seems like an ‘extend and pretend’ policy to me,” he says. “Congress and regulators have offered forbearance, but they’re changing mathematical and numerical conventions that you can’t just assume away.”

Simpson says that as part of the tracking of modified loans, institutions may want to consider those credits’ risk ratings and how their probability of default compares to performing loans. She is encouraging her clients to consider making appropriate and reasonable disclosures to share with investors, such as the amount and types of modifications. The disclosures could also give bank executives a chance to highlight how they’re working with borrowers and have a handle on their borrower’s problems and financial stress.

“I think proactively helping borrowers early on is a good move. I know banks are challenged to keep up with the information, just I am, and the timing is challenging,” Simpson says. “They’re needing to make very impactful decisions on their business, and you’d like to be able to do that with a little bit more proactivity than reactivity. Unfortunately, that’s just not the place that we find ourselves in these days.”

Banks Brace for Exploding SBA Loan Demand

It’s hard to run a small business in the best of times. Right now, it’s all but impossible.

“It took me 11 years to get comfortable and make enough money to create a cushion so I didn’t have to worry if the pub had a slow period,” wrote Natasha Hendrix in a recent Facebook post. Hendrix owns McCreary’s Irish Pub & Eatery in Franklin, Tennessee; she’s also my sister-in-law. Business was doing so well that she closed the restaurant to remodel its bathrooms in advance of St. Patrick’s Day — the Super Bowl for Irish pubs.

The complete evaporation of revenue for a small business like McCreary’s is mind-boggling. In 2016, a JPMorgan Chase & Co. study found that the median small business can survive without cash flow for a little less than a month; a quarter of them can make it just two weeks.

Small business owners are left questioning whether they can survive this severe and sudden downturn. “Everyone in this position has to START OVER. Build again,” wrote Hendrix. “Sure, people CAN do it but the real question I have for myself is … do I WANT to?”

“It’s a time for banks to be heroes,” said Curt Queyrouze, CEO of $827 million TAB Bank Holdings, during a recent digital conference hosted by MX.

A number of banks have announced deferrals on loan payments and are offering additional loans; Queyrouze tells me loan growth for term loans to small and mid-sized businesses had already tripled by late March at Ogden, Utah-based TAB, mostly to bridge expenses to weather the crisis.

But a lot of the relief — up to $349 billion — promises to come through the “Paycheck Protection Program,” a special Small Business Administration loan created through the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

Small businesses can access PPP loans through existing SBA lenders and other participating financial institutions effective April 3; independent contractors and self-employed people can take advantage of the program beginning April 10. The terms are the same for all borrowers — two-year terms at 0.5% interest — and loan payments are deferred for six months. Use of the loans are restricted to payroll costs, including benefits; rent or interest on mortgage obligations; and utilities. The U.S. Treasury has supplied an information sheet for borrowers. (In a late press conference on April 2, Treasury Secretary Steve Mnuchin announced the interest rate on these loans would be raised, to a still-low 1%. The SBA then released an interim final rule with more information.)

Demand promises to be strong for these new SBA loans — many small businesses need cash now. But implementation is proving to be a challenge, and there’s a limited amount of time for small businesses to apply; June 30 is the deadline for the PPP loans. Additionally, there’s concern that the $349 billion in available funds won’t be enough.

At $239 million Farmers State Bank, Small Business Lending President Chris Healy has put in long hours to stay abreast of these changes and get information out to the small businesses in his markets, using email marketing, the bank’s website and videos on its social media channels.

The bank, based in Alto Pass, Illinois, is already an SBA lender and is familiar with the intricacies of the agency’s process. It has also shifted its technology to prioritize these new loans. The process has been iterative, with Healy uploading and sharing new requirements with customers as information provided by the SBA and Treasury evolves. The entire process is digital; Farmers was able to pivot quickly because it already had the technology in place.

Healy tells me roughly 300 small business customers started applications before April 3. That’s 12 times the volume in a normal year — the bank typically closes around 25 SBA loans. However, some worry the industry won’t be able to meet this influx of demand.

In a statement released April 2, the Independent Community Bankers of America cited key barriers for financial institutions. The low interest rate means banks won’t be able to break even on the loans, the two-year terms are incredibly short, and the guidelines are restrictive.

The low interest rate and abbreviated term could limit the availability of these loans, said Chris Hurn, the CEO of Lake Mary, Florida-based Fountainhead Commercial Capital, a nonbank commercial lender, in a recent webinar. Secondary markets won’t be interested in purchasing the loans. The U.S. Treasury has indicated it will purchase them, but a mechanism for doing so hasn’t been made clear.

“We’re still awaiting the final rules of how to do this, but being an experienced SBA lender already, we’re familiar with following their intricate procedures and guidelines and so forth, and this is going to be a significantly stripped-down version of that,” Healy says. However, “the Treasury did shock us … with laying out the terms on the two-year basis and a 0.5% interest [rate].”

A key provision for small businesses is that these loans can be forgiven under certain conditions: if the proceeds are used as required, and employee and compensation levels are maintained over the eight-week period after the loan is made. The intent is to ensure Americans still have jobs after nearly 10 million have filed for unemployment in the past two weeks alone. (Small businesses employ 47% of working Americans, according to the SBA.)

However, guidance is needed on the documentation and calculations that will be required to determine loan forgiveness, said Hurn.

But without the new SBA program, Healy says Farmers wouldn’t be able to support small businesses to the degree necessitated by the crisis. He expects the government to ultimately buy these loans back. “If we do a $5 million loan to help a small business, that’s a big loan for us but we can sell it back to SBA immediately, and they’ll buy it from us at the principal value of the loan,” says Healy.

Small businesses need relief. Long after this crisis has passed, those that survive will remember how banks helped them through it.

Coronavirus Underlines Digital Transformation Urgency

The passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act means up to $350 billion in loans guaranteed by the Small Business Administration is set to flow to small businesses by the June 30 funding deadline.

Community and regional institutions are, of course, the logical partners for distribution of this capital. But a challenge remains: How will those financial institutions reach out to the market when their lobbies may not be open, and businesses may not be comfortable with face-to-face interactions?

Banks have done little to change the way they interact with their business customers in the digital age. In good times, this lack of transformation allowed large technology companies like Amazon.com, PayPal Holdings and Square to siphon customers away. The current environment complicates efforts for banks that have not already transformed to be responsive to their customers immediate needs.

Customers prioritized convenience — now banks will be forced to. Even prior to social distancing, consumers prioritized speed and convenience, whether it came to new technology or where they banked.

Winning at business banking was always going to require banks to offer business customers a frictionless experience. But the ability to operate business banking functions digitally has taken on new meaning — from defining quality service to becoming a necessity during a pandemic.

Three Critical Points of Friction in Business Banking
Now more than ever, it should be every institution’s goal to make working with businesses as easy as possible, especially when distribution of SBA dollars is at stake.

To meet this moment, banks need to remove three critical friction points from their business banking experience:

  • The Application: Paper applications are long and tedious, and the process is even more difficult for SBA 7(a) loans. To remove friction, institutions need to focus on data and access. They should use available data and technology to pre-fill applications as much as possible, and provide them digitally either for self-service or with banker assistance.
  • The Decisioning: Underwriting loans is a labor-intensive process that can delay decisions for weeks. An influx of Paycheck Protection Program loan applications will only compound the inefficiencies of the underwriting process. Banks need to automate as much of the underwriting and decisioning process as possible, while keeping their risk exposure in mind. It’s critical that banks select companies that allow them to use their own, unique credit policies.
  • The Account Opening: Banks also need to think about long-term relationships with the businesses they serve during this time. That means eliminating common obstacles associated with opening a business deposit account. For example: If a business has already completed a loan application, their bank should have all the information they need for a new account application and shouldn’t ask for it twice. They need to ensure businesses can complete as much of this process remotely as possible.

At Numerated, the sense of urgency we hear from bank leaders is palpable. Our team has been working overtime — remotely — to provide banks with a quick-to-implement CARES Act Lending Automation solution. Banks have been working just as fast to understand the current environment and build strategies that will help them meet their customers’ rapidly shifting needs.

In many ways, the COVID-19 pandemic has forced banks to consider digital transformation as a solution to this problem. Still, many firms have held off for any number of reasons. Institutions that have focused on digital transformation will be the most successful in improving the business banking customer experience and will lead the way during this pandemic as a result.

From Eastern Bank Corp. in Boston that used digital lending to become the No. 1 small to midsized business lender in their competitive market, to First Federal Lakewood, in Lakewood, Ohio, that is using digital experiences to retain and grow strategic relationships, institutions of all sizes have launched new digital capabilities, better positioning them to face what’s ahead.

As the nation’s businesses grapple with this new reality, these financial institutions are examples for others exploring how to serve business customers when they can’t see them face to face. Doing so will require a reimagining of the way we do business banking.