COVID-19 Related Loan Modifications
This blog is being posted on behalf of my colleagues, Susan Sabo and A.J. Eschle, principals in CLA’s financial institutions practice.
As we enter the middle of May, many financial institutions are facing their next set of challenges in the COVID-19 environment – loan modifications. Financial institutions are now documenting the various types of COVID-19 related loan modifications issued, as well as how to follow the current accounting, regulatory and government guidance.
Accounting Matters
This blog does not intend to discuss the accounting for troubled debt restructures (TDRs). As discussed in previous blogs and regulatory guidance, many of the COVID-19 related loan modifications will not be deemed TDRs. For any non-TDR COVID-19 related loan modifications, financial institutions should consider the following:
Accrual of Interest / Interest Income
Most loan modifications granted right now are short-term and may include a deferral of principal and/or interest. The FASB has provided two options for recording interest during payment deferment periods. Simply stated, financial institutions may either:
- Accrue interest receivable and recognize interest income during the payment deferment period and apply it prospectively for the remaining term; or
- Stop accruing interest receivable and not recognize interest income during the payment deferment period. The process of recognizing interest income would resume when the payment deferral period ends. Tax paying financial institutions should consult with their tax providers to understand the impact to their tax provision.
Additionally, regardless of the election to accrue interest or not, management may need to determine and apply a new effective interest rate to these loans as a result of the modification. Management should work with its core provider to understand the options available for accounting and reporting for its COVID-19 related loan modifications.
Past Due and Nonaccrual Reporting
Borrowers who were current (30 days or less pass due) prior to a COVID-19 related loan modification generally would not be reported as past due and a short-term payment deferral generally would not result in a nonaccrual loan. Management should consider the following:
- The status of the loan would be essentially frozen for the duration of any payment deferral.
- The loan would continue to be reported as current in regulatory reports.
- Financial institutions should continue to monitor their borrowers and if additional information becomes known during the payment deferral period that a loan might not be repaid, the financial institution should evaluate for impairment or potential charge-off.
Examples
A few of the more common COVID-19 related loan modification examples are discussed below. All of these examples assume a 6-month principal and interest payment deferment and management should fully explore the options available in their core system.
- Repayment of the deferred payments is expected in full at the end of the deferment period. Financial institutions should assess the borrower’s ability to repay in this scenario and if necessary, consider a repayment under one of the other examples. Borrowers may not be in a position to repay 6-months of payments immediately following the deferment period. Once the borrower repays the 6-months of deferred payments, the lender would simply apply the payment against the outstanding principal balance and the accrued interest receivable.
- Repayment of the deferred payments is spread over the remaining life of the loan. The core system is the primary challenge to this option and management should confirm if the core system can handle this option. Regardless of the financial institution’s election around interest income, this option may create reconciling differences in principal and accrued interest receivable that will need to be monitored.
- Repayment of the deferred payments is made by extending the original maturity date by 6 months. The response to this example is similar to example #2. In addition, financial institution should consider the regulatory compliance implications for extending the original maturity date.
- Repayment of the deferred payments is made through a small balloon payment at the original maturity date. The response to this example is similar to example #1. Like traditional balloon payments, the financial institution should assess the borrower’s ability to make a larger payment at the end of the loan term.
Allowance for Loan and Lease Losses (ALLL)
While an impairment analysis is not required, management should recognize an appropriate ALLL for those loans modified due to COVID-19. Additionally, management may want to consider pooling these loans and providing a separate Q&E factor
Financial Reporting
Financial institutions should consider financial reporting impacts for COVID-19 related loan modifications including the need to supplement existing loan and ALLL footnote disclosures and whether they were treated under Section 4013 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act or the interagency guidance.
Documentation and Monitoring
The regulators have continuously said they will not criticize financial institutions for working with their customers in a safe and sound manner. However, they have also indicated that financial institutions should maintain records of their COVID-19 related loan modifications during this time, especially those loans modified pursuant to Section 4013 CARES Act, for future supervisory purposes. In one of our earlier blogs , we discussed the concepts of communicating, documenting and monitoring. Some critical best practices include:
- Document the financial institution’s loan modification program including but not limited to the date it was established, any election to follow Section 4013 of the CARES Act and the different modification options offered.
- Communicate regularly with lending & operational teams; consider forming a task force.
- Establish consistent documentation for all modifications including how the borrower was impacted by COVID-19. Create a checklist for modifications as a best practice.
- Utilize flex data fields in your core system to track COVID-19 related loan modifications.
- Establish a report for monitoring all loan modifications to inform credit, risk and accounting teams.
How can we help?
CLA is here to know you and help you, and we can help you understand the accounting rules and craft best practices for the impact of COVID-19. Please contact your CLA representative anytime for more information. We are here to help you navigate through this.
Scott is the leader in CLA’s Financial Institutions group, and a member of the National Assurance Technical Group. He has 15 years of experience with audit and accounting services for financial institutions of all sizes.
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