Accommodating Loan Modifications
This blog was co-authored with my colleague, Brittany Stern, Financial Institutions Manager.
As we continue to navigate the impacts of the COVID-19 pandemic with our financial institution clients, the topic of loan modifications remains at the top of the list. As early as March 22, 2020, the regulators were issuing interagency guidance to provide insights to financial institutions, encouraging them to work with borrowers during these challenging times. The Coronavirus Aid, Relief, and Economic Security (CARES) Act came on the heels of this guidance and introduced new considerations under Section 4013. The regulatory agencies provided additional guidance and more recently, the Federal Financial Institutions Examination Council (FFIEC) addressed the next big question: what if my borrowers need additional modifications?
Current Guidance
One of the earlier concerns for financial institutions was the potential for a high volume of loan modifications resulting in troubled debt restructurings (TDRs). As evidenced in the interagency guidance prior to the passage of the CARES Act, short-term modifications (i.e. six months or less) would not be recognized as TDRs. Section 4013 of the CARES Act went a step further and provided a temporary suspension of GAAP, with regard to TDRs, based on the current loan status and reason for modification. These pieces of guidance gave financial institutions the opportunity to evaluate these loans under either Section 4013 or the revised interagency guidance. Furthermore, the FFIEC explored the need for additional accommodations for certain borrowers.
As we move into the seventh month of this pandemic, financial institutions are faced with additional modification requests from borrowers. It is crucial management teams actively analyze these portfolios and ensure they comply with the guidance as prescribed. Some key points to consider:
- If a loan was current (less than 30 days past due) at December 31, 2019, and the modification occurs between March 1, 2020 and December 31, 2020, the loan may be treated under Section 4013 of the CARES Act. Financial institutions have the flexibility to opt for Section 4013 even if a loan was originally treated as modified under the revised interagency guidance. If an institution anticipates additional modifications for a borrower, it should consider working with the borrower to modify this loan before the CARES act deadline of December 31, 2020.
- If a loan continues to be treated under the revised interagency guidance, financial institutions need to be prepared to perform a TDR review as borrowers approach the six-month modification window. As a reminder, borrower must be experiencing financial difficulty and the institution must be granting a concession to be considered a TDR.
- As noted in the revised interagency guidance, financial institutions are not required to report as TDRs any loans modified related to COVID-19 because of any government-mandated modification programs such as executive orders for required forbearances or halting foreclosure or repossession of assets.
Credit Risk Management
Financial institution’s decisions around loan modifications during this time should be sure to consider its credit risk management practices. In this period of economic uncertainty, management and lending teams should be looking at these loans objectively and executing internal policies for managing these loans and appropriately reporting the inherent risk.
Borrowers and Accrual Status
Lenders should be actively engaging with these borrowers and obtaining current and projected financial information to assess the viability of additional accommodations. While most of the guidance has suggested these loans would not be reported as nonaccrual loans, lenders should consider new information as it becomes available.
Additionally, as stressed by the FFIEC, documenting your decisions and ensuring clear and consistent communication to borrowers throughout this entire process is crucial to the adherence of applicable laws and regulations, which includes fair lending laws.
Credit Risk Ratings
Consider the current credit risk rating on each loan or loan pool. Although a loan modification may be treated under Section 4013 of the CARES Act, it is important to consider putting these loans on your watch list or considering a downgrade if a loan is displaying possible problem loan characteristics. This is critical especially if multiple modifications continue.
Tracking
We have posted numerous blogs throughout the pandemic and the need for appropriate documentation has remained present in almost every post. Financial institutions should be tracking all loan modifications made under Section 4013 of the CARES Act or the revised interagency guidance. Management teams should prepare a report that lists all loans modified with pertinent data such as loan type, date of modification, communications with the borrower, status of financial information, and modification program in place.
Furthermore, as stressed by the FFIEC, promote clear and consistent communication to borrowers throughout this entire process and adhere to applicable laws and regulations, which includes fair lending laws. Your ability to assess, document, and account for these risks and lead objectively is crucial.
Allowance for Loan and Lease Losses
Lastly, management’s evaluation of the credit risk ratings and financial status of these loans should also consider the impact to the allowance for loan and lease losses (ALLL). While the modifications granted to help borrowers are not considered TDRs, they do pose additional inherent risks to the institution’s loan portfolio. These risks, in addition to other qualitative COVID-19 risks and factors, should be assessed as part of a pandemic-specific qualitative factor. Institutions may benefit from tracking these COVID-19 ALLL factors or amounts separately.
How can we help?
CLA is here to know you and help you. The challenges of managing your loan modifications in the midst of the pandemic as well as unique borrower situations will remain as we close out 2020 and move into 2021. We have a team of financial institution professionals who are ready to help you evaluate your loan modifications and recommend best practices. Stayed tuned for an upcoming webinar on Tuesday December 8, 2020 at 2pm CST where you can hear our financial institution professionals answer your questions about loan modifications. Please contact your CLA representative anytime for more information.
Susan is a CPA with more than 20 years of combined experience in public accounting and the financial institution industry, including experience with Fortune 500 financial services companies. Susan serves as the managing principal of CLA’s financial services group. Her responsibilities include providing engagement oversight in the areas of assurance and internal audit. In addition, Susan provides board advisory and management consulting services in the areas of strategic planning and mergers and acquisitions. Susan has been involved in multiple mergers and acquisitions of sizes ranging from $150 million to $500 billion with engagement at all stages of the process.
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