On Wednesday, March 25, 2020, the Senate unanimously passed a $2 trillion economic stimulus package. Called the Coronavirus Aid, Relief, and Economic Security (or CARES) Act, this unprecedented bill is expected to be passed by the House this Friday and quickly become law.
There is much in the Act for the financial services industry to celebrate, including hundreds of billions of dollars for new loans to pump up the economy and provide credit to businesses. Bankers will also welcome the temporary relief from regulatory requirements and accounting rules, which encourage loan modifications for distressed borrowers and delay the potential hit to bank balance sheets. There are also some new restrictions that require lenders to grant up to a year in automatic forbearance on federally insured mortgages and a short-term prohibition on foreclosures. All-in-all, there’s something in the stimulus package for lenders and borrowers alike.
New and Enhanced Loan Programs
The Act includes nearly $350 billion in stimulus for small businesses. Under the so-called “Paycheck Protection Program,” the Small Business Administration (SBA) is authorized to expand its Section 7(a) lending program to support payroll and other operational expenses, including payment of preexisting debts. The Program also contains provisions for loan forgiveness for certain amounts incurred in the first eight (8) weeks of the loan for payroll, interest (though not principal) on mortgage debt, rent, and utility payments. These forgiveness amounts are reduced, however, if employee headcount or compensation is reduced. For further details on the Program, read my partner Kellen Hade’s article, linked here.
The Act also earmarks $500 billion for the Department of Treasury to make loans (or guarantee them) to distressed American businesses. The Act is short on detail, and has been criticized by some as giving Treasury Secretary Steven Mnuchin unfettered authority to spend this money without much oversight. Certainly, Treasury will still need to build out the program terms, but a few required features of these loans include:
- Borrower stock buybacks are prohibited during the loan and for 12 months after;
- Dividends and capital distributions on common stock are prohibited during the loan and for 12 months after;
- Compensation of highly paid officers and executives is curtailed; and
- Businesses must be established in the United States and have “significant operations” and “a majority of employees” located here.
In spending the $500 billion fund, the Act further specifically directs Treasury to build programs that provide financing to banks that make loans to mid-sized businesses with employees between 500 and 10,000 employees. Though program details are not yet final, these loans must include:
- Interest rate of not more than 2% annually.
- Interest and principal deferred for six (6) months.
- Businesses must certify that they will use the funds to retain at least 90% of their workforce and restore “all compensation and benefits” to workers not later than four (4) months after termination of the COVID-19 declaration of emergency.
- Businesses must certify they will not engage in stock buybacks and must also agree not to pay dividends on common stock during the loan.
- Businesses must certify they will not outsource or offshore jobs during and for 2 years after repaying the loan.
- Businesses cannot abrogate existing collective bargaining agreements and will remain neutral in any union organizing effort during the loan.
Industry experts largely expect the burden of implementing these sweeping programs to fall on banks. The Act authorizes Treasury to designate financial institutions as “financial agents of the United States” to perform “all reasonable duties” that Treasury finds necessary to respond to COVID-19. And while that includes payment for their duties, the Act specifically limits the appropriations for administrative expenses of these loan programs at $100 million. Congress is applauded for being thrifty in allocating only 0.02% of the $500 billion in relief to administrative costs, but a skeptical observer might wonder how exactly that math will pencil.
Relaxed Regulatory and Accounting Requirements
The Act also relaxes various regulatory requirements to provide greater flexibility to the banking industry as we work through this crisis. For instance, it gives the Office of the Comptroller of the Currency authority to temporarily ease federal lending limits. And federal banking authorities are directed to temporarily reduce the leverage ratio requirement for qualifying community banks to 8% and to allow a reasonable grace period for compliance.
Banks were already trying to adapt to and implement the interagency guidance on COVID-19 loan modifications issued over the weekend. The Act goes a step further and authorizes banks to elect to suspend GAAP for loan modifications relating to COVID-19 that otherwise would be classified as a troubled debt restructure (“TDR”). It also authorizes banks to suspend any determination of TDR status as relates to impairment, for accounting purposes. Similarly, the Act authorizes banks not to comply with FASB 2016-13 regarding “Measurement of Credit Losses on Financial Instruments” in calculating allowances for credit losses.
These elections give financial institutions flexibility to take some or all of the losses now, to more gradually take the loss, or to “kick the can down the road” until the temporary relief ends. But institutions should be cautious in how they approach this decision—under the Act, the music stops no later than December 31, 2020, and earlier if the national emergency ends before then. Financial institutions will then need to pony up, if they have not previously taken losses to that point, and assuming the borrower’s credit has not rebounded. Assuming, of course, there is not further Congressional intervention. Institutions may find the risk of not taking at least some of the losses now to be too big of a gamble on an improved economy before year-end.
Restrictions on Foreclosure, Evictions, and Credit Reporting
All of these benefits under the stimulus package come with some limitations on the industry. For government-backed mortgages on 1- to 4-family housing,[1] borrowers need only utter the magic words that they want a forbearance (and attest that they are suffering financial hardship during the COVID-19 crisis) and they are entitled to up to 180 days’ forbearance, with another 180 days upon the borrower’s request. Apart from the borrower certification of financial hardship during the COVID-19 emergency, the lender may not ask for any other documentation at all. And during this forbearance period, no fees, penalties, or interest (other than as scheduled if the borrower made all payments on time) can be accrued on the borrower’s account. The Act also generally bans foreclosures on these loans for the 60 days beginning March 18, 2020 (notably excepted are vacant and abandoned property).
The Act also prohibits landlords from initiating evictions on residential dwellings[2] for 120 days if their property is covered by a federally backed mortgage loan. During the 120-day moratorium, property owners may not begin eviction proceedings for a tenant’s failure to pay rent or other charges. Owners also may not charge any fees, penalties, or other charges for nonpayment of rent. In addition, owners cannot issue a notice to vacate until the moratorium concludes and may not require the tenant to vacate the property until 30 days after such a notice (meaning landlords can expect, at a minimum, going 150 days without rent or relief). Nothing in the Act requires the tenant to establish or even certify that they have been affected by COVID-19 to qualify for protection during the moratorium.
Additionally, if lenders make accommodations to a consumer borrower affected by the COVID-19 pandemic, the Act requires lenders to alter their current credit reporting practices. Loans that perform according to COVID-19 modification plans must be reported as “current” unless they were delinquent before the accommodation was made. This does not apply to charged-off accounts, however.
A Work in Progress
Still much work must be done before the government and financial institutions can implement the Act and its programs can stimulate the economy. And in the coming weeks or perhaps longer, we can expect the program rules and requirements will start to become clearer and more refined. For now, though, Congress has given a strong economic signal that it fully intends to move mountains (and trillions of dollars) to keep the American economy strong.
For more information about ongoing developments related to COVID-19, visit Miller Nash Graham & Dunn’s resource library.
[1] The Act imposes similar requirements on federally backed multifamily mortgage loans. The forbearance period is somewhat less generous (30 days, plus 2 additional 30-day periods). But the same structure of “ask and ye shall receive” remains.
[2] Somewhat more precisely, the Act includes all dwellings under the Fair Housing Act, including vacant land offered for sale or lease for such a dwelling. It also includes certain dwellings that are exempt from the Fair Housing Act.
