Our perspectives on 2020 interagency loan modification and TDR guidance

• March 25, 2020
• Scott Klitsch

In the current environment, many institutions are seeking ways to assist borrowers impacted by the economic distress resulting from the COVID-19 pandemic. On March 22, 2020, Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus, was released. We noted this interagency statement seeks to provide relief from matters institutions have struggled with when structuring modifications with borrowers impacted by COVID-19.

Here are our initial observations on this significant release:

Accounting for Loan Modifications
The interagency statement does not change Generally Accepted Accounting Principles (GAAP). Financial institutions still need to address and document (a) whether or not the borrower is experiencing financial difficulty and (b) whether or not the institution has granted a concession. However, the interagency statement does indicate it is reasonable that loan modifications linked to COVID-19 would differ from how you might answer the two questions above as compared to other drivers of modifications such as general recessions or natural disasters or the borrower was known to have prior financial difficulties.

Financial difficulty:

Current guidance (Receivables – Troubled Debt Restructurings by Creditors, ASC 310-40-15-20) provides various indicators an institution should consider in determining if a borrower is experiencing financial difficulties. When documenting those indicators, consider:

• A COVID-19 modification program should be designed to give customers in good standing more access to financial services and products during this difficult time compared to designing a traditional program for customers who have known financial difficulties. Therefore, it seems reasonable to establish simple and practical methods of documenting and analyzing borrowers to see if they have indicators of financial difficulty.
• The indicators of a troubled debt restructuring (TDR) are premised on there being a current identifiable payment concern. While it is reasonable to expect financial difficulties could arise at some point related to COVID-19, speculation around possible payment default, bankruptcy or debt service are not assumed to exist.
• The programs are being offered on a preemptive basis to assist customers as they work through the economic impact of COVID-19. There is no expectation that borrowers who are current will not be able to pay the contractual amounts due.
• While there are forecasts of short-term economic stress, there are no current explicit signs that the entire population of borrowers in good standing, are in financial distress.
• There is a continued expectation that the health impact of COVID-19 is a temporary disruption that will subside in the coming months.

Concession granted:

• It is reasonable that a 6-month payment holiday would not constitute a concession as it is not a significant delay. This is supported by the guidance from the regulators and Financial Accounting Standards Board (FASB).
• While current guidance (Receivables – Troubled Debt Restructurings by Creditors, ASC 340-10-15-17) provides factors to consider in assessing the significance in the delay in timing of the restructured payment period, in this scenario you also need to consider the impact of government actions, requests and/or restrictions imposed during this time that are directly linked to COVID-19. The 6-month payment holiday is designed to ensure that people will have a flexible solution through the temporary economic effects of actions related to COVID-19 such as shelter-in-place and social distancing. Because it is expected to be temporary, a 6-month time period should not be deemed significant.

Operational and Financial Reporting Considerations
The interagency statement relates specifically to COVID-19 modifications and not all modifications. Therefore, the institution will need to establish a method for identifying and tracking these separately from other loans and modified loans for purposes of financial reporting.

Financial Reporting Considerations:

Past due reporting

• Borrowers who were current (30 days or less pass due) prior to the loan modification as a result of the effects of COVID-19 generally would not be reported as past due.
• The status of the loan would be essentially frozen for the duration of any payment deferral that occurred as a result of a COVID-19 payment deferral.
• A loan with a COVID-19 payment deferral would continue to be reported as current in regulatory reports.

Nonaccrual reporting

• Similar to past due reporting above, a short-term payment deferral would not generally result in a nonaccrual loan.
• 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 institution should evaluate for impairment or potential charge-off.

Risk-weighted capital calculation

• The call report instructions specify that residential mortgage exposures that are restructured or modified are not eligible for 50 percent risk weighting. This requirement is irrespective of the payment status of the loan. The interagency statement provides relief from these instructions by stating that COVID-19 modified loans that are prudently underwritten and not past due or carried in nonaccrual status, will not result in the loans being considered restructured or modified for the purposes of their respective risk-based capital rules.
• For all other loan types, the call report instructions do not specifically address troubled debt restructurings. The risk weighting of these loans therefore depend on whether or not the loan is performing in accordance with its modified terms. Loans past due more than 90 days or on nonaccrual should generally be risk weighted at 150 percent. The interagency statement again provides relief from these instructions as it addresses past due and nonaccrual reporting for COVID-19 modified loans.

Operational Considerations:

• The institution will need to identify and resolve any system limitations that might impede its options for matters such as applying subsequent payments. The institution should consider the option to use flex fields in its core system for tracking these loans.
• It is also important that financial institutions maintain appropriate documentation that considers borrowers’ terms and payment status prior to a COVID-19 modification and borrowers’ payment performance according to the new terms of the loan.

Allowance for Loan and Lease Losses (ALLL)
The automatic TDR classification for COVID-19 modifications could result in ALLL results that contradict management’s expectations in the current environment. Generally, the industry improved underwriting standards as a result of the Great Recession. While TDRs are considered impaired loans for purposes of ALLL calculations, it wouldn’t be unusual for collateral dependent COVID-19 modified loans (if classified as a TDR) to result in a lower ALLL as the fair value of collateral dependent loans less costs to sell may result in a specific reserve that is less than the general reserve amount currently applied to the loan. Additionally, we encourage financial institutions to evaluate and adjust your March 31, 2020 qualitative and environmental factors, and consider the impacts to your loan portfolio from COVID-19.

CLA is here to help you work through the challenges as you modify loans for your borrowers.  Please contact us.

, Auditing/Accounting, Financial Services General, Lending | 1 Comment »