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Federal Agencies Offer Guidance on Loan Modifications Due to COVID-19

Client Alert

Authors: Deborah J. Enea and Loren A. Flath

3/25/2020
Federal Agencies Offer Guidance on Loan Modifications Due to COVID-19

The Board of Governors of the Federal Reserve System (FRB) and certain other federal agencies issued an interagency statement on loan modifications and past-due loan policies in the wake of the economic disruption caused by the COVID-19 outbreak. The statement provides guidance regarding existing policies that is helpful to commercial lenders and corporate borrowers. It also encourages financial institutions, regardless of asset size, to work with borrowers who cannot make contractual payments. The statement highlights three policy interpretations:

  • Financial institutions will not be directed to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings (TDRs).

  • Short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.

  • Financial institutions are not expected to classify loans as past due when deferrals are granted because of COVID-19.

The statement was issued by FRB, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, the Consumer Financial Protection Bureau, and the State Banking Regulators to guide lenders as they address impending defaults under existing loan facilities.

Analysis

Encouraging Lending Institutions to Work With Borrowers

The agencies are urging lenders to work prudently with borrowers who cannot meet contractual payments under their loan facilities due to financial disruption caused by COVID-19. Loan modification programs are categorized as positive actions when used to mitigate the effects from these interruptions. In their statement, the agencies confirm they will not criticize institutions for working with borrowers to mitigate credit risk by taking proactive steps. Institutions will not be told to automatically categorize all COVID-19 related loan modifications as TDRs.

Accounting for COVID-19 Loan Modifications

Under U.S. GAAP, a debt restructuring is classified as a TDR if the creditor grants a concession that it otherwise would not consider due to the debtor’s financial difficulties. The Financial Accounting Standards Board (FASB) staff has confirmed that short-term modifications made on a good faith basis in response to COVID-19 related difficulties to borrowers who were current prior to any relief should not be categorized as TDRs. Short-term modifications, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant, will not trigger the TDR categorization. Borrowers are considered current if they are less than 30 days past due on contractual payments when the modification program is implemented. Therefore, it is important for lenders and borrowers to work together promptly if a modification is likely to be needed. For modification programs designed to provide this type of short-term relief, agencies will presume that borrowers who are current on payments are not experiencing financial difficulties, thereby avoiding TDR status and further analysis. Of note, modifications or deferral programs that are mandated by the state or federal government are outside the scope of this guidance.

Even when modifications are deemed to be TDRs or are adversely classified, so long as the lenders attempted to work with the borrowers using prudent efforts to modify the loan, they will not be criticized by the agencies.

Past-Due Reporting and Nonaccrual Status

Lenders are not expected to classify loans as past due when deferrals are granted because of COVID-19. Whether there was, in fact, a deferral will be dependent on the specified payment dates in the loan agreement. If a payment deferral results in no regularly scheduled payments being past due, the loans may not be considered past due during the deferral period. Lenders should therefore be cognizant of payment dates when negotiating modification programs.

Generally, when there are short-term modifications made to a loan, the underlying loans should also not be reported as nonaccrual. If additional information leads the lenders to believe a specific loan will not be repaid, lenders should then refer to the charge-off guidance in the instructions for the Consolidated Reports of Condition and Income.

Takeaways for Commercial Lenders

Lenders are being encouraged to work prudently with borrowers to address the economic slowdown arising from COVID-19. Lenders have an opportunity to partner with borrowers without audit repercussions. Lenders should actively develop loan modification protocols and be prepared for an uptick in requests for skip payments, deferral payments and other loan modifications.

Takeaways for Corporate Borrowers

In the past, corporate borrowers may have been hesitant to proactively reach out to their lenders when liquidity challenges arose. Now, there are incentives in place to do so if the borrowers did not need this type of assistance before the COVID-19 crisis (i.e., were not more than 30 days overdue on payments). Borrowers facing financial difficulties as a result of the COVID-19 crisis should promptly reach out to their lenders before multiple payments are missed.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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