Loan Modifications and TDR’s – Initial Thoughts on Recent Interagency Guidance
As we at Brady Martz have been assisting our clients with COVID-19 related questions, many financial institutions have been working with their clients and finding ways to handle the economic stress resulting from COVID-19. On March 22, 2020 Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus, was released. The statement was released in an effort to understand the process, effects, and reporting of loan modifications impacted by COVID-19. While likely there will be additional guidance and clarification (as the regulatory world seems to have daily updates!), listed below is a summary and our initials thoughts of the guidance released.
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.
ASC 310-40-15-20 (Receivables – Troubled Debt Restructurings by Creditors) provides information and indicators that a financial institution should review in determining if a borrower is experiencing financial difficulties. If your financial institution is in the process of designing a COVID-19 loan modification program, consider if the customer is in good standing prior to the COVID-19 pandemic. In addition, 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.
Under current guidance from the regulators and Financial Accounting Standards Board (FASB), it is reasonable that a 6-month payment holiday would not constitute a concession as it is not a significant delay. In addition, current guidance in ASC 340-10-15-17 provides a wide range of factors that need to be considered in determining the significance of the delay in timing of the restructured payment period, in the current COVID-19 environment the financial institution also needs 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.
Distinguishing COVID-19 Modifications
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.
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.
Other Items to Consider
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. In addition, the financial institution should consider potential core system limitations to account and track these loan modifications.
For residential mortgage loans and risk weighted capital, the interagency statement provides relief 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 depends 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.
Management should also be aware of the allowance for loan loss calculation and the impact of COVID-19. Potentially more loans will be specifically evaluated and if they are collateral dependent, a lower total reserve may result (as a result of the general reserve going away on these loans). However, the institution should consider the qualitative factors in the calculation with the ever-changing environment.
Brady Martz is here to assist your institution and navigate through these uncertain times. Please contact us with further questions and stay safe!