SEC Corp Fin Staff Examines Loan Loss MD&A Disclosure Issues

The SEC's Division of Corporation Finance has released a sample of a letter sent to public companies' chief financial officers about the issues they may wish to disclose in Management's Discussion and Analysis given the current economic environment. The generally accepted accounting principles relating to allowances for loan losses have not changed, but given the current economic environment, the staff suggested that companies reassess whether the information on which they base their accounting decisions remains accurate given its critical importance to investors' understanding of their financial statements.

One area that may require enhanced disclosure is higher-risk loans, according to the staff. The letter mentions certain types of loans, such as option ARM products, junior lien mortgages, high loan-to-value ratio mortgages, interest-only loans, subprime loans and loans with initial teaser rates, as among those posing higher risk of non-collection. Additional information about these loans may help investors understand the risks associated with companies' loan portfolio and whether known trends could have a material impact on their results of operations.

Companies may wish to consider disclosing the carrying value of their higher-risk loans by loan type and, to the extent feasible, include allowance data. Current loan-to-value ratios could be segregated by geographic location if there are concentrations in certain areas. Companies may want to include the amount and percentage of refinanced or modified loans by loan type. The staff also recommended disclosure of asset quality information and measurements, such as delinquency statistics and charge-off rates by loan type.

Companies should consider whether to disclose their policy for placing loans on non-accrual status when a loan's terms allow for a minimum monthly payment that is less than interest accrued on the loan. This disclosure should include a discussion of how the policy affects the companies' non-performing loan statistics.

Companies may wish to disclose the expected timing of adjustments to option ARM loans and the effect of the adjustments on future cash flows and liquidity. Companies should take into consideration the current trends of increased delinquency rates on ARM loans and the reduced collateral values due to declining home prices. Companies could also disclose the amount and percentage of customers that are making the minimum payments on their option ARM loans.

The staff advised companies to discuss the reasons for any changes in their practices for determining allowances for loan losses. If they change their practices, they should also discuss the historical loss data used as a starting point for estimating current losses and how economic factors affecting loan quality were factored into the allowance estimates. Additional disclosure could include the level of specificity used to group loans for estimating losses, non-accrual and charge-off policies, the application of loss factors to graded loans and any other estimation methods and assumptions that were used.

The staff noted that a decline in the value of assets serving as collateral for companies' loans may affect their ability to collect on those loans. Accordingly, they should consider disclosing the approximate amount or percentage of residential mortgage loans as of the end of the reporting period with loan-to-value ratios above 100%. Companies may also wish to disclose their consideration of housing price depreciation and the homeowners' loss of equity in the collateral in their allowance for loan losses for residential mortgages. The staff suggested that companies include a discussion about the basis for the assumptions on the housing price depreciation.

The staff also urged companies to consider whether investors would benefit from MD&A disclosure about any risk mitigation transactions they used to reduce credit risk exposure, such as insurance arrangements, participation in the U.S. Treasury Home Affordable Modification Program, credit default agreements or credit derivatives.

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