In August, the Securities and Exchange Commission’s Division of Corporation Finance sent letters to public financial institutions recommending that the companies consider additional disclosures regarding risks in their loan portfolios and trends in loan losses in Management Discussion and Analysis (MD&A) in future filings.

In its correspondence, the SEC noted that although generally accepted accounting principles (GAAP) rules regarding how to account for loan losses have not changed in recent years, the current economic environment may require companies to reevaluate their disclosures under Regulation S-K Item 303 regarding material trends and uncertainties of higher-risk loans, changes in accounting practices regarding loan loss allowances, declines in collateral value and other related matters. The SEC letter further cautioned that delaying recognition of estimable credit losses would be inconsistent with GAAP, and that the SEC will take appropriate action in such cases.

For companies which hold portfolios of higher-risk loans (such as option adjustable rate mortgage (ARM) products, high loan-to-value (LTV) mortgages, interest-only loans and subprime loans), the SEC suggested additional MD&A disclosures to allow investors to understand the particular risks associated with the company’s portfolio. Specific recommended disclosures included the carrying values of such loans by loan type and corresponding allowance data, LTV ratios and information regarding calculation of such ratios and geographic concentration, amounts and percentages of refinanced or modified loans, delinquency statistics and charge-offs, non-accrual policies and expected timing of option ARM loan adjustments and their effects on future cash flows.

For companies which have instituted changes in their allowance practices, the SEC requested that companies explain why such changes were instituted and quantify the result of such changes. The SEC also recommended disclosure of changes in historical loss data, incorporation of economic factors affecting loan quality, grouping of loans for estimating losses, non-accrual and charge-off policies, application of loss factors and other estimation methods and assumptions.

With respect to declines in collateral values, the SEC recommended disclosures regarding the approximate amount of residential mortgage loans with LTV ratios exceeding 100%, how housing price depreciation is considered in the allowance for loan losses and the timing, frequency and sources of appraisals for such loans.

In addition, the SEC asked companies to consider disclosing any material risk mitigation transactions a company has entered into to reduce credit risk exposure, reasons why key loan ratios have changed from period to period and how accounting for any acquisitions has affected trends in allowance for loan losses.

Click here for the full illustrative SEC letter sent to certain public companies.