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COVID-19 REGULATORY COMPLIANCE: When is a loan modification a troubled debt restructuring?

How financial institutions can avoid troubled debt restructuring accounting after the CARES Act provisions expire.

During the COVID-19 pandemic, the banking regulators issued guidance to help institutions avoid classifying loan modifications as troubled debt restructurings (TDRs).

Why was the regulatory guidance issued?

One reason was to comply with the CARES Act. Another reason was to reduce the TDR accounting and reporting burden so institutions could help borrowers whose businesses were impacted by mandatory closures through no fault of their own.

Has the regulator's position changed over time?

Banking regulators must continue to monitor the safety and soundness of the banking industry. Positive earnings growth since the Great Recession has helped institutions to accumulate capital beyond regulatory safety levels. So, assisting some businesses through forbearance and short-term loan modification programs may not compromise capital to where the regulators become concerned about safety and soundness. However, as the pandemic has progressed, there appears to be a limit to how much leeway the regulators will allow institutions before TDRs must be recorded.

The accounting profession waived the need to report certain loan modifications after the Great Recession.

Modifications of loan terms do not automatically result in troubled debt restructurings (TDRs). According to U.S. GAAP, a restructuring of a debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider.

When the CARES Act was passed, the banking agencies confirmed with the Financial Accounting Standards Board (FASB) staff that making short-term modifications on a good faith basis in response to COVID-19 to borrowers who were current before any relief are not TDRs. The accounting standard relief included short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are less than 30 days past due on their contractual payments when implementing a modification program.

Did the regulators and the FASB provide new relief from TDRs in response to the CARES Act? Not actually. The FASB issued this same short-term modification approach in 2011 after institutions were struggling with the Great Recession fallout. Therefore, working with borrowers that are current on existing loans, either individually or as part of a program for creditworthy borrowers who are experiencing short-term financial or operational problems resulting from COVID-19, generally would not be considered TDRs based on the accounting guidance issued in 2011.

Institutions can follow the 2011 accounting guidance during and after the pandemic

As more is learned about COVID-19 and CARES Act provisions expire, institutions can still help borrowers through short term forbearance and loan modification programs without reporting TDRs. The FASB's guidance in their Accounting Standards Update (ASU) No. 2011-02, issued in April 2011, updated the Accounting Standards Codification (ASC) Topic 310, Receivables. The title of this update is "A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring." The update was issued to help borrowers after the Great Recession so that institutions did not have to report the forbearance or short-term loan modification programs as TDRs.

Fast forward from 2011 to 2020

For modification programs designed to provide temporary relief for current borrowers affected by COVID-19, financial institutions may presume that borrowers that are current on payments are not experiencing financial difficulties at the time of the modification for purposes of determining TDR status. Thus no further TDR analysis is required for each loan modification in the program. Again, this approach complies with FASB's 2011 accounting guidance.

When will the regulators begin to enforce TDR accounting?

Currently, banking examiners indicate that they will exercise judgment in reviewing loan modifications, including those that would otherwise be reported as TDRs. They will not automatically adversely risk rate credits that are affected by COVID-19, including those considered TDRs. However, only time will tell what will happen when forbearance programs expire, and short-term modifications become concessions that no longer fit within the definitions found in the 2011 accounting guidance.

Without government support programs, regulators will have no choice but to enforce safety and soundness requirements, including ensuring that loan workout programs are recorded as TDRs when granting a concession to the debtor that the institution would not otherwise consider.

Although examiners will not criticize prudent efforts to modify the terms on existing loans to affected customers, institutions must focus on "prudent efforts." Be sure to document your loan modification decisions because TDR accounting will be required when institutions make concessions as part of workout programs that exceed the 2011 accounting guidance scope.

Want to learn more about when TDRs must be reported and when they do not? Click here.

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