The CARES Act: Temporary Help for Community Banks

Global markets rallied significantly last week as unprecedented intervention by central banks calmed dysfunctional credit markets and equities reacted favorably to the discussion of the historic government stimulus plan. The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) represents $2.2 trillion in spending to support the US economy. The CARES Act is the other piece of the one-two punch of monetary and fiscal stimulus that began with the actions of the Federal Reserve. Investor confidence had plummeted as the US economy was shut down. Investment grade bonds have only traded hands at steep discounts , and less creditworthy companies have been unable to borrow.

Bond markets settled down last week, thanks to unprecedented Federal Reserve action, including for the first time, a secondary market purchase program for corporate bonds. The Federal Reserve signaled that it would do almost anything to maintain the flow of credit, including extending loans directly to corporations for the first time in its history and bond purchasing well in excess of any steps taken in the wake of the credit crisis. While this “whatever it takes” stance had an immediate effect, with spreads on riskier bonds declining and gyrating treasury yields exhibiting more stable behavior, it still was not enough to convince the markets that the US economy could regain traction. It was clear from the subprime crisis in 2008/2009 that all the liquidity in the world would not matter if no one was interested in borrowing. The purpose of the CARES Act is to put sufficient cash in business and consumer pockets to restore spending and business activity.

While the government response was eventually robust in the wake of the last crisis, it was slow moving and largely left the economic recovery to the private sector. The current package is much faster, much more targeted and much greater in scale. Perhaps most importantly, it is backed by a “whatever it takes” bipartisan attitude in Congress matching that of the Federal Reserve.

Of course, there are three key elements of a sustainable recovery. Two of them arrived this past week: Federal Reserve action and federal government fiscal support. The most important, however, is the duration of the economically debilitating measures in place to seek to weather this health scare. That remains very much in the air as the numbers of people sickened by the virus continues to grow, and the media drumbeat continues in unrelenting fashion.

Now, the baton has been handed to the private sector to implement the plans for the use of the government largess. One of the CARES Act’s core provisions is assistance to small business through the Small Business Administration’s loan programs. Such matters are covered in a separate client alert. In this client alert, we discuss Congressional actions to assist community banks in facilitating the economic return to normalcy.

The relief for banking includes the following temporary measures:

1. CECL Delay. The CARES Act allows financial institutions to delay the implementation of the current expected credit loss (“CECL”) methodology to the earlier of (i) the termination of the COVID-19 national emergency or (ii) December 31, 2020. Ideally regulatory authorities would provide some greater definition to the end date. Moreover, for entities that choose the deferral, guidance would be helpful regarding the transition out of such optional deferral.
   
   On March 27, 2020, the federal banking regulators issued an interim final rule allowing lenders required to adopt CECL effective January 1, 2020, to delay the estimated impact on regulatory capital by up to two years. The bank regulators would provide for a three-year transition period after 2022 to phase out the “capital benefit” provided during the two-year delay in CECL. For banks that have already adopted CECL, they will have the option of choosing a three-year transition period (which was made available under the 2019 rule), or the five-year option, including the two-year delay.
2. TLGP. The CARES Act also granted the FDIC authority to reinstitute the liquidity guarantee programs that were in place for banks and their holding companies during the recession through December 31, 2010. In 2008, the Temporary Liquidity Guarantee Program (“TLGP”) provided holders of noninterest-bearing checking accounts at banks with unlimited deposit insurance. The CARES Act repealed Dodd-Frank’s cessation of liquidity guarantee programs through December 31, 2020 and established a maximum amount of the guarantee, which will be established by the FDIC. Accordingly, businesses holding commercial checking accounts (and nonprofits and others holding such accounts) will see FDIC protection in the event the bank were to fail. Thus, the CARES Act eliminated yet another of the ill-thought-out Dodd-Frank Act restrictions on the ability of bank regulators to respond to the crisis.
   
   Importantly, the recession-era TLGP also offered bank holding companies the ability to issue indebtedness guaranteed by the FDIC. During the subprime crisis, the FDIC reserved such guarantees for banks that were 1- or 2-rated and were not deemed to be in a “troubled condition.” Initially, the FDIC allowed holding companies that owned 3-rated banks to issue FDIC guaranteed indebtedness, but later eliminated such parties from the equation. It is now up to the FDIC to adopt rules to define how these programs will work under the CARES Act.
3. Lending Limits. The CARES Act also gave the Office of the Comptroller of the Currency the authority to waive national bank lending limits. Interestingly, a number of states provide, through their “wild card” authority, the ability of state banks and thrifts to opt for national bank lending limits. Putting aside the wisdom of putting “more eggs in one basket,” this temporary exemption may allow for larger loans to a bank’s best customers.
4. Securities Purchases. The CARES Act provides that $454 billion of the funds directed to Treasury be used for programs implemented by the Federal Reserve by repurchasing obligations of issuers directly or in the secondary market and making new loans. These programs may be a continuation of the programs that the Federal Reserve implemented over the past few weeks or newly-implemented programs. The CARES Act provides that no later than 10 days after enactment the process for applying the minimum financial requirements will be published.
5. TDRs. Building on regulatory initiatives released over the past two weeks, the CARES Act provides that financial institutions may elect that any modifications to loans will not be classified as troubled debt restructurings (“TDRs”) under US generally accepted accounting principles (“GAAP”), subject to certain conditions. The loan must not have been more than 30 days past due as of December 31, 2019, and the modification must be made between March 31, 2020 and the earlier of December 31, 2020 or 60 days after the end of COVID-19 national emergency. Frankly, such time period could be short of what is needed if the regulators define the end as coming too soon.
   
   The TDR exception does not apply if circumstances that give rise to the modification are unrelated to COVID-19. Accordingly, financial institutions should document that the reasons giving rise to the forbearance related to COVID-19 in their loan records.
   
   In this regard, the CARES Act covers much of the same ground as the interagency pronouncement of March 22, 2020. Specifically, the regulators provided that if a borrower is experiencing short term cash flow difficulties from COVID-19, then a “prudent” modification (thought to be six months) would not be deemed a TDR. Moreover, the regulators determined that modifications or deferral programs required by state governments, such as the New York State Department of Financial Services, would also not be considered TDRs.
   
   The measuring date for whether the borrower is past due under the CARES Act is December 31, 2019. In contrast, the regulators used a “less than 30 days” past due test. Absent further regulatory clarification, bankers should use the regulatory 30 day test because it was developed in conjunction with the Financial Accounting Standards Board (“FASB”).
6. Community Bank Leverage Ratio (“CBLR”). The CARES Act requires federal bank regulators to issue an interim final rule establishing the CBLR at 8%, along with a “reasonable grace period” (anticipated to be two quarters as in the present rule) for institutions that fall below 8%. The 8% ratio begins on the date the regulators issue the rule and ends on the earlier of December 31, 2020 or 60 days after the end of COVID-19 national emergency. A financial institution that falls below the CBLR is presumed to satisfy the capital and leverage requirements during the grace period.

The summary above describes the provisions of the CARES Act impacting community banks, many of which will not be effective until bank regulatory agencies issue rules and guidance on how the programs will be implemented. We anticipate that these will be fast-tracked in order to provide the necessary details for banks and businesses to act on and benefit from the programs.