6.3 Financial Services

In a June 2024 statement, Division Director Erik Gerding discussed CRE as a disclosure priority for the SEC staff. Given this statement, we would expect to see a continuation of recent comment letter trends associated with CRE loans and related allowance for credit losses.

As shown in the comment examples above, the SEC staff may ask registrants to provide additional quantitative disclosures related to loans and allowance for credit loss balances. For loan balances, the staff may ask registrants to provide further disclosure on the nature of loan portfolios, especially those related to CRE, including multifamily properties. In addition, the staff may request more granular disclosure about the types and concentrations of loans held, especially in portfolios that may be subject to increased scrutiny and stress as a result of current macroeconomic factors. Registrants should consider the various types of loans held and evaluate whether current disclosures are sufficient.

The SEC staff has continued to focus on disclosures about a registrant’s allowance for credit losses related to loans. The staff frequently asks registrants to enhance policy disclosures to better explain how their estimate is determined and how their policy is in accordance with the relevant accounting guidance. As registrants evaluate for changes in market conditions, exposure to assets with increased risk, and updates to their policy, they should be cognizant of ensuring that their new disclosures align with the requirements of ASC 326 and provide adequate information to users of the financial statements.

For more information about disclosure considerations related to CRE, see Deloitte’s April 16, 2024, Financial Reporting Alert.

The SEC staff may ask registrants to provide additional qualitative disclosures related to how they will manage risks, including interest rate, liquidity, and market risks, in the current macroeconomic environment. It may also request additional disclosures about the challenges facing registrants and management’s current plans to measure and mitigate those risks. In 2023, the staff frequently focused on interest rate risk as rates remained elevated in comparison with what they had been in recent past years, forcing registrants to manage changes in their net interest margin. Further, in response to banking sector developments in March 2023, the staff increasingly asked for additional disclosures related to sources of liquidity, available capacity, and total available liquidity. The staff has also challenged registrants who have not updated risk factors to reflect changes in circumstances from previous years. Registrants should consider whether they have disclosed a complete list of new or changed risk factors arising from the current economic environment to provide adequate information to users of the financial statements.

For more information about disclosure considerations related to risk factors in the current macroeconomic environment for registrants in the banking and capital markets industry, see Deloitte’s April 16, 2024, Financial Reporting Alert.

Given the importance of deposits to banks as a funding source, in addition to the current economic environment, the SEC staff may ask registrants to provide additional quantitative and qualitative disclosures related to their deposit portfolios. The staff may ask registrants to provide more granular disclosure of the types of deposits held. In addition, the staff may request disclosures about a registrant’s policies related to the use of different types of deposits and the metrics that management uses to monitor risk in the registrant’s deposit portfolio.

The SEC staff may continue to place importance on providing adequate disclosure in the MD&A section to allow financial statement users to better assess the liquidity needs of an investment manager, any restrictions related to the investment manager’s current capital structure, and the investment manager’s future access to capital resources.

As noted above, the SEC staff has continued to focus on non-GAAP financial measures in its recent comments to registrants in the real estate industry. Issues addressed in such comments have included (1) the presentation of non-GAAP financial measures more prominently than GAAP measures, (2) pro rata consolidation adjustments, (3) clearer labeling, (4) the reconciliation of non-GAAP per-share measures to the most directly comparable GAAP measures, (5) the use of misleading adjustments and application of tailored accounting principles, and (6) clear disclosure of how the presentation of chosen non-GAAP measures provides useful information to investors. In recent years, the SEC staff has heightened its focus on adjustments that remove normal, recurring cash operating expenses from non-GAAP measures. See Section 3.4 for additional information.

Registrants in the real estate industry should also be aware of Questions 102.01 and 102.02 of the C&DIs on non-GAAP financial measures, which indicate that FFO as defined by NAREIT as of May 17, 2016,1 as well as FFO per share, will continue to be accepted as a performance measure. The presentation of any FFO measure in a manner that departs from NAREIT’s 2016 definition (e.g., adjusted FFO, core FFO), or as a per-share amount based on such a modified measure, is subject to the prohibitions in Regulation S-K, Item 10(e), and should be treated as a performance measure or a liquidity measure. If modified FFO is considered a performance measure, it may be presented on a per-share basis; if a modified FFO per share is, in substance, a liquidity measure, presentation on a per-share basis is prohibited. Acceptability of FFO per-share measures, or modified FFO per share, does not override the prohibition against the presentation of cash flow per-share data and other per-share measures of liquidity.

FFO may be reported gross or net of noncontrolling interest adjustments. When the FFO calculation takes into account noncontrolling interest adjustments, the registrant should clearly label the measure to reflect “FFO attributable to common stockholders” or “FFO attributable to the company.”

Registrants in the real estate industry should consider the SEC staff’s most recent C&DIs, issued in December 2022, on how the staff evaluates non-GAAP measures. The guidance in these C&DIs provides greater insight into, and examples of, misleading measures and the use of tailored accounting principles. It also further clarifies when a non-GAAP measure is considered to be more prominent than a GAAP measure. For more information, see Section 3.4 and Deloitte’s December 18, 2022, Heads Up.

In addition, registrants in the real estate industry should be aware of the new segment disclosure requirements of ASU 2023-07, specifically those related to the disclosure of non-GAAP financial measures as the chosen measures of a segment’s profit or loss. At least one of the reported segment profit or loss measures should be the measure that is most consistent with the measurement principles under GAAP. For more information, see Deloitte’s Roadmap Segment Reporting and its November 30, 2023 (updated September 10, 2024); December 10, 2023; and August 28, 2024, Heads Up newsletters.

The SEC staff has focused on various disclosures related to fair value. Specifically, it has issued comments on disclosures required under ASC 820, including comments on (1) the need to provide quantitative information about inputs to fair value measurement of assets and (2) the appropriateness of classifying fair value measurements as Level 1, 2, or 3 in the footnotes to the financial statements. Registrants should ensure consistency of disclosures about the fair value of assets in their portfolios.

In its comments to registrants in the real estate industry on fair value disclosures, the SEC staff has also focused on disclosures about NAV. The staff has asked registrants that disclose NAV to expand their disclosures to include further discussion of the methods and inputs used in their calculations. When registrants have disclosed qualitative information elsewhere in filings or in other filings, the staff has asked for such information to be included in the financial statements. In addition, the staff has issued comments addressing the allocation of NAV to different classes of shares.

An acquisition by a registrant is treated as either an asset or a business for SEC reporting purposes. The definition of a business in Regulation S-X, Rule 11-01(d), for SEC reporting purposes differs from that in ASC 805 for accounting purposes. If an acquiree meets the definition of a business in Rule 11-01(d), the acquiree would be within the scope of Regulation S-X, Rule 3-05 or Rule 3-14. Rule 3-05 requires a registrant to provide full financial statements (and pro forma financial information) for significant acquired or to be acquired businesses. However, Rule 3-14 requires a registrant to file only abbreviated income statements (and pro forma financial information) for significant acquired or to be acquired real estate operations that meet certain requirements. Because the requirements of Rules 3-05 and 3-14 are different, it is important for a registrant to determine whether it acquired a real estate operation (which is subject to Rule 3-14). As a result, from an SEC reporting standpoint, the SEC staff may ask a registrant to provide an analysis supporting its conclusion that its acquisitions are real estate operations under Rule 3-14. When a registrant has not provided financial statements for an acquired or to be acquired real estate operation under Rule 3-14, the staff may ask the registrant to provide an analysis in support of its conclusion that the acquisition or potential acquisition did not trigger the Rule 3-14 significance test requirement to file the related financial statements.

In addition, from an accounting standpoint, the SEC staff has asked registrants with material acquisitions to elaborate on their process and policies for determining whether the acquired assets, including acquired real estate that is subject to a lease, qualify as a business or an asset acquisition under U.S. GAAP (ASC 805). This determination is important, especially in the real estate industry, because the accounting for an asset acquisition differs from the accounting for a business combination and can require management to use judgment, especially when assessing the screen under ASC 805, to determine whether substantially all of the fair value of the acquired assets is concentrated in a single asset or asset group. In acquisitions accounted for as business combinations, all transaction costs must be expensed as incurred. In asset acquisitions, however, transaction costs are capitalized as part of the purchase price. The SEC staff has asked registrants to enhance their disclosures to discuss the accounting policies they apply to property acquisitions, including policies for allocating value to identified intangible assets and for recognizing acquisition-related costs.

For more information, see Chapter 3 of Deloitte’s Roadmap SEC Reporting Considerations for Business Acquisitions and Deloitte’s Roadmap Business Combinations.

The SEC staff may ask registrants to enhance their disclosures about the capitalization of real estate development, construction, and leasing costs (including their accounting for these costs). For example, the staff has asked registrants to clarify their accounting policy for capitalizing or deferring costs in accordance with ASC 835-20, ASC 842-10, and ASC 970-10. It has also requested quantitative disclosures of certain expenses that are being capitalized, such as soft costs (e.g., interest and payroll).

In addition, the SEC staff has asked registrants to expand their disclosures about capital expenditures (either on the face of the statement of cash flows or in MD&A) to disclose expenditures related to new properties (e.g., acquisitions, new development) separately from expenditures related to existing properties (e.g., redevelopment, improvements, construction-in-progress). Registrants should ensure consistency of disclosures about capital expenditures in all of their communications, including earnings calls, press releases, supplementals, periodic filings, and any other broader company communications. The SEC staff may ask registrants to consider whether certain expenses should be classified as operating expenses. Registrants should consider Regulation S-X, Rule 5-03, in determining the appropriate classification of expenses.

The SEC staff has also asked registrants to enhance their disclosures about the capitalization of tenant improvements. Specifically, the staff has asked registrants how they determined (1) whether the lessee or the lessor is the owner of the improvements and (2) whether the improvements are capitalizable or should be accounted for as lease incentives. Registrants should consider the definition of lease incentives in ASC 842-10-55-30.

From registrants in the real estate industry, the SEC staff frequently requests disclosures that investors can use to evaluate the registrant’s ability to maintain or increase its historical distribution yield, especially in light of the macroeconomic conditions. When GAAP cash flow from operations is insufficient to cover the total distributions paid during a particular period, the staff may inquire about the cash resources used to cover the shortfall, such as borrowings or offering proceeds. Registrants should adequately disclose the risks associated with paying distributions in excess of GAAP cash flow from operations. In addition, the staff may request disclosures that compare earnings (or FFO) with paid distributions, including amounts reinvested through a distribution reinvestment plan. The staff asks registrants to disclose these items on a current as well as a cumulative basis so that financial statement users can better understand the relationship between earnings (or FFO) and distributions. Further, the staff may ask how the presentation of distributions complies with U.S. GAAP.

Given the current macroeconomic conditions, including fluctuations in interest rates and inflationary impacts, the SEC staff has requested expanded disclosures about the impact of these conditions on the registrant, with a renewed emphasis on CRE and the office sector. Specifically, the staff has requested disclosures of known trends or uncertainties that affect the registrant’s cash flows, financial position, and results of operations. These include disclosures related to default risk, liquidity issues, debt maturity, and mitigating efforts, as well as leasing and impairment considerations discussed in Section 6.3.3.7. Registrants in the real estate industry are also expected to provide more granular disclosure related to their exposure to specific CRE risks. Such risks include heightened vacancy rates, changing interest rates, extended loan maturities, loan delinquencies, breach of covenants, concentrations, loan-to-value ratios, loan modifications, lease term schedules, trends in lease renewals, major tenant rollovers, financial viability of tenants, property dispositions, asset impairments, and tenant receivables. See the CRE section of Division Director Erik Gerding’s June 2024 statement on the state of the SEC staff’s disclosure review, in which Mr. Gerding encourages registrants to provide more granular information in their disclosures to improve investors’ understanding of the material risks inherent in the registrants’ CRE portfolios.

From banking and mortgage REIT companies, the SEC staff has also requested (1) expanded disclosures about the composition of loan portfolio by borrower type (e.g., office, hotel, multifamily, owner-occupied, non-owner-occupied) and geographic concentration, (2) enhanced discussion of changes in provisions and allowances for credit losses, and (2) more disaggregated disclosure related to maturities for higher-risk loan portfolios. Further, the staff has emphasized increased disclosure of risk management policies in response to the current macroeconomic conditions.

The SEC staff has commonly focused on registrants’ involvements with VIEs and joint ventures and has inquired about consolidation assessments.

The SEC staff may also ask for additional information and disclosures about non-VIE joint ventures, particularly when (1) a registrant uses the equity method of accounting and either has a majority ownership interest or is the general partner or managing member or (2) the qualitative disclosures about such arrangements are not robust. Disclosures about these arrangements should include a discussion of the ownership structure as well as the governance provisions that led the registrant to conclude that it does not have a controlling financial interest in the joint venture. In addition, the staff routinely asks for clearer qualitative disclosures when there are amendments to management agreements or changes in ownership structure or percentages that do not result in a change to a registrant’s consolidation conclusion.

For additional discussion of consolidation, see Section 2.2.

The SEC staff has frequently asked registrants in the real estate industry to enhance their disclosures about the inputs used in their asset recoverability tests and the valuation techniques used to develop nonrecurring measurements of fair value. The staff has also asked such registrants to clarify the timing of impairment charges when their filings indicate that the carrying value of an asset will not be recovered. SEC comments on this topic are consistent with those discussed in Section 2.11.

Also, over the past few years, as circumstances in certain real estate subsectors have deteriorated and as macroeconomic conditions evolve, the SEC staff has asked registrants in the real estate industry that lease property to entities in certain subsectors to enhance their disclosures related to rental performance, leasing activities, and the impact of tenants’ financial difficulties and market conditions on the registrants’ current and future operations. The trend of tenants’ financial difficulties has affected all sectors of the real estate industry given the macroeconomic effects of inflationary conditions, worldwide conflicts, changes in tenant workplace preferences, and supply-chain disruptions. The staff continues to request early-warning disclosures that alert investors to the underlying conditions and risks that a registrant faces before a material charge or decline in performance is reported. In addition, when issuing comments on the timing of impairments, the staff may use hindsight, after an impairment or charge is reported, to inquire why the registrant did not include any early-warning disclosures in prior periods leading up to the period in which the impairment was recorded. The staff expects registrants to clearly disclose emerging risks related to impairments and other macroeconomic events in all relevant sections of their SEC filings, including the risk factors section, MD&A, the business section, legal proceedings, DC&P, ICFR, and financial statements. It has recommended that registrants discuss how management and the board of directors manage these emerging risks. In MD&A, registrants should address material known trends, including the actual impact of these emerging risks as well as potential future impacts. The staff expects a registrant’s disclosure of these emerging risks and related trends to evolve and become more company-specific as more information becomes known to the registrant.

See Section 3.1 for additional information on early-warning disclosures.