ABA Letter to SEC re: Assessing Legal Isolation Preclearance

Sagar S. Teotia
Accounting Group - Interpretations
U.S. Securities and Exchange Commission
100 F Street, N.E.
Mail Stop 6628
Washington, D.C. 20549-6628

Office of Chief Accountant Division of Corporation Finance
U.S. Securities and Exchange Commission
100 F Street N.E.
Mail Stop 4546
Washington, D.C. 20549-4546

Dear Mr. Teotia:

The American Bankers Association (ABA) is the voice of the nation’s $20.3 trillion banking industry, which is composed of small, regional, and large banks that together employ more than 2 million people, safeguard more than $15.8 trillion in deposits, and extend $11 trillion in loans. We are writing to you on behalf of the banking industry seeking non-objection to the conclusion that legal isolation is met under ASC 860 for the Main Street Lending Program. This letter does not address other attributes of sales accounting under ASC 860.

Background

Using its authority under Section 13(3) of the Federal Reserve Act and funds appropriated through Title IV the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the Federal Reserve and Treasury Department established the Main Street Lending Program (MSLP) to support lending to small and medium sized businesses and nonprofit organizations that were otherwise healthy before the pandemic. Under the MSLP, a loan participation agreement is executed between two parties: (1) An originating bank, which sells a 95% participating interest in a qualifying loan and (2) a special purpose vehicle (SPV) established by The Federal Reserve Bank of Boston (“Boston Fed SPV”), which buys the participating interest.

One important consideration for financial institutions that become a party to the MSLP is the accounting treatment of the sale of a 95% participating interest in a qualifying loan. Namely, the 95% participating interest must qualify for sale accounting in order to be removed from the institution’s balance sheet. Failure to achieve sale accounting would result in the entirety of the loan remaining on the financial institution’s balance sheet, with cash received from the Boston Fed SPV being considered a secured loan from the Boston Fed SPV to the institution.

It is our understanding that the Federal Reserve structured the program with the intention that sales of participating interests in qualifying loans to the Boston Fed SPV meet sale accounting requirements. To assist financial institutions, the Federal Reserve also prepared frequently asked questions applicable to for-profit businesses and non-profit businesses2 (collectively, the FAQs) outlining how MSLP transactions meet the requirements of sale accounting under ASC 860. While this letter does not address all the attributes of sales accounting under ASC 860, it is important to acknowledge that the FAQs highlight entity-specific considerations that must be considered to reach a sales conclusion (e.g., if the Main Street Expanded Loan Facility Upsized Tranche is a separate and distinct unit of account) and thus it is our belief that each entity must evaluate the other sales criteria individually.

The ABA is requesting that the SEC Staff not object to the conclusion that the legal isolation condition in ASC 860-10-40-5(a) has been met when a bank sells a 95% participation interest to the Boston Fed SPV under the MSLP. If the SEC Staff does not object to this conclusion, each individual originating bank would not require a true sale opinion or need to perform additional legal analysis to support their assertion that the legal isolation criterion in ASC 860-10-40-5(a) has been satisfied. We acknowledge that this conclusion is based on the unique facts and circumstances of the MSLP program and that it would be inappropriate to analogize to the conclusion in any other circumstance.

Accounting Analysis

ASC Topic 860, Transfers and Servicing, provides guidance on the accounting for transfers of financial assets (e.g., a participating interest in a loan), which includes criteria that must be met for a transfer of financial assets to be accounted for as a sale. One criterion is that the transferred financial assets have been legally isolated from the transferor – put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership (ASC 860-10-40-5(a)). If legal isolation (or any other criteria in ASC 860) is not met, the transfer will not be accounted for as a sale and the transferor will retain the entire financial asset on its balance sheet and any consideration received from the transferee at the time of the transfer will be accounted for as a secured borrowing (i.e., a loan from the transferee).

The guidance in ASC 860-10-40-7 through 40-14 and the related implementation guidance in ASC 860-10-55-18 through 55-25A outline that derecognition of transferred financial assets is appropriate only if the available evidence provides reasonable assurance that the transferred financial assets would be beyond the reach of the powers of a bankruptcy trustee or other receiver for the transferor or any of its consolidated affiliates (that are not bankruptcy-remote entities). The nature and extent of the supporting evidence required depends on the facts and circumstances. A determination of whether the legal isolation criterion has been met is largely a matter of law and may require assessment from a legal perspective. ASC 860-10-55-18A indicates that a true sale opinion from an attorney is often required to support a conclusion that transferred financial assets are isolated from the transferor, any of its consolidated affiliates, and its creditors. However, ASC 860-10-55-18B indicates that a legal opinion may not be required if a transferor has a reasonable basis to conclude the appropriate legal opinion would be received if requested and provides two examples of when that may be the case.

860-10-55-18B “A legal opinion may not be required if a transferor has a reasonable basis to conclude that the appropriate legal opinion(s) would be given if requested. For example, the transferor might reach a conclusion without consulting an attorney if either of the following conditions exists:

a) The transfer is a routine transfer of financial assets that does not result in any continuing involvement by the transferor.

b) The transferor had experience with other transfers with similar facts and circumstances under the same applicable laws and regulations.”

Condition (a) does not exist since an originating bank in the MSLP as the transferor retains a 5% participating interest and performs servicing on the 95% participating interest sold. ASC 860-10-55-79B defines servicing arrangements as an example of continuing involvement. With respect to condition (b), given that the MSLP is a new program, a transferring bank has not had experience with other transfers with similar facts and circumstances under the same applicable laws and regulations. While the transferor often has significant experience with the laws and regulations governing transfers of participating interests in loans in general, they would not have had prior experience upon the first transfer under the MSLP to the Boston Fed SPV.

The resulting question is whether the two examples in ASC 860-10-55-18B3 are the only examples of circumstances when a transferor would have a reasonable basis to conclude that appropriate legal opinions would be given if requested. In practice, transfers for new programs that do not meet one of the two examples in 860-10-55-18B typically require a true sale opinion. However, the facts and circumstances of the MSLP are unique and may not be analogous to other types of transfers and historical practice. Some examples of factors that exist for the MSLP that are unique indicators that true sale opinions would be given if requested are detailed in the following.

Standard Program with Consistent Documentation/Terms

MSLP was funded by the CARES Act and requires legal documentation that is consistent. The documents required at the time a participation is sold to the Boston Fed SPV (e.g., participation agreement, servicing agreement, etc.) are all standard and available on the Federal Reserve Website4. The underlying loan arrangements are all required to include provisions detailed on the Federal Reserve Website and in Appendix A and B of the FAQs. This consistency in the transaction terms and the governing legal framework (i.e., FDIC receivership) supports that legal opinions available would likely be consistent amongst entities with the same legal governance framework (i.e., regulated banks.) Accordingly a transferor could reasonably expect to obtain a legal opinion for their transfer under the MSLP when considering the incremental factors below.

Level of Involvement of Federal Reserve Program Attorneys, Availability of FAQs, and other Agencies

Federal Reserve program attorneys designed the MSLP with the assistance of other agencies such that sales of participating interests in qualifying loans to the Boston SPV under the program would achieve sales treatment. The staff of these agencies have provided several resources including phone calls with stakeholders, webinars6 to educate external legal counsel on factors relevant to a true sale analysis, and FAQs to assist financial institutions that specifically highlight how the transactions are designed to meet sales treatment including legal isolation.

The Clear Intent and Design of the MSLP to Meet Legal Isolation

The transferee (Boston Fed SPV) has issued FAQ’s that lay out the intent of the program. For example, FAQ (I.7) indicates that the sale of a participation interest in a Main Street New Loan Facility (MSNLF), Main Street Priority Loan Facility (MSPLF), Main Street Expanded Loan Facility (MSELF), Main Street Nonprofit Organization New Loan Facility (NONLF) and Main Street Nonprofit Organization Expanded Loan Facility (NOELF) is structured to be a true sale, and the program transaction terms are consistent with a true sale.

The Availability of Legal Opinions

The ABA is aware that multiple financial institutions are in the process of obtaining legal opinions from different law firms for different MSLP facilities with respect to sales of participating interests in qualifying loans to the Boston Fed SPV. Some of the accounting firms involved with this letter have reviewed drafts of opinions for certain MSLP facilities. These draft legal opinions are prepared by multiple reputable law firms, include adequate “would” level opinions, and reference analysis consistent with the FAQs.

Typically, these legal opinions are restricted use and the auditing literature does not allow entities other than those identified to rely upon the letter7 for audit evidence. However, the availability of acceptable legal opinions provides evidence that corroborates that the appropriate legal opinion(s) would be given if requested by other entities as certain program terms are expected to be standard and consistent from entity to entity.

Conclusion

ABA believes the outlined analysis provides financial institutions with a reasonable basis to conclude that, in these unique facts and circumstances, the participating interests being sold by the originating banks to the Boston Fed SPV as part of the MSLP meet the legal isolation criterion in ASC 860-10-40-5(a). Therefore, separate true sale opinions by each individual institution are not required.

We have discussed our conclusion with BDO, Crowe, Deloitte, EY, Grant Thornton, KPMG, PwC, and RSM. The audit firms have reviewed this letter and acknowledge that practice for transfers in new programs with unique characteristics typically require legal opinions to support the legal isolation criterion in ASC 860-10-40-5(a). However, given the unique facts and circumstances of the MSLP, the audit firms are supportive of the efforts to obtain the views of the Staff and believe that any interpretive guidance from OCA should not be analogized to in other circumstances.

If you need additional information or have questions, please contact the undersigned ([email protected]; 202-663-5318).

Sincerely,

Joshua Stein