US Banking Regulator Guidance on Loan Modifications in Response to COVID-19
On March 22, 2020, the US federal banking regulators1 (the “Regulators”), in consultation with the Financial Accounting Standards Board (“FASB”), issued an interagency statement (the “Statement”)2 concerning agency treatment of loan modifications made in response to COVID-19. The Statement is an expansion on statements made by the Regulators earlier in the same month and clarifies the unique treatment financial institutions can expect for short-term modifications to loans made in good faith in response to COVID-19 (“modified loans”).
Regulators had indicated on March 19, 2020 that a modified loan did not need to be reported as past due, but left unaddressed whether a modified loan was a troubled debt restructuring (“TDR”), in nonaccrual status, or subject to charge-off.3 The Statement expands on the earlier guidance by indicating that the Regulators will allow financial institutions to freeze the TDR status of borrowers, on an individual loan or loan program-wide basis irrespective of any loan modification that was made under the Statement. Further, the Statement indicates that modified loans generally would not need to be reported in nonaccrual status or charged-off, at least initially. The Statement, however, does not indicate if institutions must maintain an allowance account for estimated losses from such loans.
Background
As discussed in our earlier alert, Regulators are encouraging, and, in some instances, mandating, institutions to provide loan modifications to borrowers.4 Typically, however, loan modifications, may require a loan to be reported as past due, classified as a TDR, placed into nonaccrual status, charged-off, or subject to loss estimation/reserving. All of these actions have a negative effect on an institution’s balance sheet–and regulatory reporting.
The Regulators’ initial guidance on March 19, 2020 indicated the modified loans did not need to be reported as past due if the borrower was in compliance with the modified terms of the loan. This reflected the generally accepted position that a borrower is not delinquent if they comply with modified loan terms to which a lender has agreed.
The initial guidance, however, did not address status as a TDR, nonaccrual, or charge-off. The Statement addresses each of these issues.
TDR Status
The Regulators state that financial institutions will not be required to classify a modified loan as a TDR provided the following criteria is met:
- The borrower payments on the loan are current at the time of the modification;5 and
- The loan modification is short-term6 and made in good faith.
According to the Regulators, one-to-four family residential mortgages will not be considered modified or restructured under the applicable risk-based capital rules if, in addition to the guidelines outlined above, they are also:
- Prudently underwritten; and
- Not carried in nonaccrual status or past due.
Alternatively, if a financial institution has a loan (i) for which payments were already past due and (ii) that was subject to a payment deferral program prior to the COVID-19 crisis, the FDIC states that financial institutions may adjust the delinquency status of the borrower back to the status held immediately prior to the borrower becoming affected by COVID-19.7
While the Regulators do not provide an exhaustive list of loan modifications that may be used, the Statement recognizes that institutions may rely on a number of modification options, including extending loan maturity dates or, in the case of a balloon payment loan, making deferred payments due at maturity.8
Further, financial institutions are still required to maintain basic documentation for modified loans “that considers borrowers’ payment status prior to being affected by COVID-19, and borrowers’ payment performance according to the changes in terms provided by the payment accommodation”;9 such documentation could extend to include information on “borrowers’ recovery plans, sources of repayment, additional advances on existing or new loans, and value of the collateral.”10
Reporting
According to the Statement, financial institutions are not required to investigate whether a borrower is experiencing financial difficulties in determining TDR status: a borrower is presumptively financially stable if the loan payments are current at the time of modification. As noted above, past due reporting is to be determined in accordance with the loan terms, as modified.11
Nonaccrual and Charge-off Status
The Statement indicates that an institution should consult its internal accounting policies and regulatory reporting instructions to determine if a modified loan should be placed in nonaccrual status or charged-off. However, it appears that the Regulators take the position that a deferral due to short-term, COVID-19 factors does not per se indicate a borrower will not pay interest or repay principal. Therefore, the Statement provides that, in general, modified loans should not be reclassified as “nonaccrual” loans.12
If a financial institution receives information that indicates a specific loan will not be repaid, however, then the institution should recognize any credit losses in accordance with applicable charge-off policies and guidance,13 as soon as such loss can be reasonably estimated.
Takeaways
This Statement sends a clear message that the Regulators will support financial institutions in offering borrowers short-term, good faith loan modifications as a result of COVID-19 by mitigating some of the negative accounting consequences associated with such modifications. As summed up by the Regulators, “regardless of whether modifications result in loans that are considered TDRs or are adversely classified, agency examiners will not criticize prudent efforts to modify the terms on existing loans to affected customers.”
However, certain actions are beyond the control of Regulators. In this regard, the Statement does not address whether or when institutions are required to maintain an allowance or reserve for losses on modified loans. The FDIC has requested that FASB suspend certain of the accounting standards related to loss estimation and reserving, but it remains to be seen whether FASB will grant this request.14 Congress also is moving forward with temporary relief for TDRs and some aspects of loss estimation and reserving.15
1 The US federal banking regulators are the Board of Governors of the Federal Reserve System (“FRB”), Federal Deposit Insurance Corporation (“FDIC”), National Credit Union Administration (“NCUA”), Office of the Comptroller of the Currency (“OCC”), Consumer Financial Protection Bureau (“FDIC”), and State Banking Regulators (together, the “Regulators”).
2 FIL-22-2020 (Mar. 22, 2020), https://www.fdic.gov/news/news/financial/2020/fil20022.html.
3 FDIC, FIL-17-2020 (Mar. 13, 2020), https://www.fdic.gov/news/news/financial/2020/fil20017.html; FDIC, FIL-18-2020 (Mar. 19, 2020), https://www.fdic.gov/news/news/financial/2020/fil20018.html.
4 US Banking Regulators Issue Guidance on Customer Accommodation (Mar. 27, 2020), https://www.mayerbrown.com/en/perspectives-events/publications/2020/03/us-banking-regulators-issue-guidance-on-customer-accommodation Federal or state mandated modification and deferral programs related to COVID-19 are beyond the Statement’s scope.
5 If the loan payments are less than 30 days past due when the modification is made, the borrower is considered current. See the Statement.
6 These modifications may include “payment deferrals, fee waivers, extensions of repayment terms” or other “insignificant” payment delays. See the Statement. The Statement gives six months as an example of a short-term modification. However, the Statement also notes that, under generally accepted accounting principles, the modification must be insignificant. So, short-term should be determined proportionally, in light of “the frequency of payments due under the debt, the debt’s original contractual maturity, or the debt’s original expected duration.” See the Statement, fn 2.
7 See FAQ #2. Frequently Asked Questions for Financial Institutions Affected by the Coronavirus Disease 2019 (Referred to as COVID-19) (Mar. 18, 2020) https://www.fdic.gov/news/news/financial/2020/fil20018.html (“FAQ”). No further guidance is given in the FAQ on how to determine the date the borrower should be considered affected by COVID-19.
13 Id. Such guidance includes the instructions for the Consolidated Reports of Condition and Income and NCUA LCU 03-CU-01, as applicable. See the Statement and the Statement, fn 5.
14 FDIC, FDIC Chairman Urges FASB to Delay Certain Accounting Rules Amid Pandemic (Mar. 19, 2020), https://www.fdic.gov/news/news/press/2020/pr20036.html; ABA, Financial Groups Ask SEC to Exercise Authority with CECL Delay, ABA Banking Journal (Mar. 22, 2020); Steve Marlin, CECL working as intended amid Covid-19 crisis, says FASB, Risk.Net (Mar. 18, 2020).
15 H.R. 748 §§ 4013, 4014 (May 26, 2020), https://www.congress.gov/bill/116th-congress/house-bill/748/text; see also FRB, Agencies announce two actions to support lending to households and businesses (May 26, 2020), https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200327a.htm (addressing aspects of loss reserving).
