On August 3, 2020, bank regulators provided prudent risk management and consumer protection principles for financial institutions to consider while working with borrowers as loans near the end of initial loan accommodation periods applicable during the coronavirus disease event (COVID event), when they issued the Joint Statement on Additional Loan Accommodations Related to COVID-19.
The regulatory agencies recognize that some financial institutions may face difficulties in assessing credit risk, due to limited access to borrower financial data, COVID event-induced covenant breaches, and difficulty in analyzing the impact of COVID event-related government assistance programs. Summarized below are key takeaways from the interagency statement.
Troubled Debt Restructuring (TDR) Determination
Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides financial institutions the option to temporarily suspend certain requirements under U.S. generally accepted accounting principles related to TDR for a limited period of time to account for the effects of the COVID event.
- If a financial institution elects to account for a loan modification under Section 4013, an additional loan modification could also be eligible under Section 4013. To be eligible, each loan modification must be:
- Related to the COVID event;
- Executed on a loan that was not more than 30 days past due as of December 31, 2019; and
- Executed between March 1, 2020, and the earlier of (a) 60 days after the date of termination of the national emergency or (b) December 31, 2020.
- If a financial institution does not elect to account for a loan modification under Section 4013 or a loan modification is not eligible under Section 4013, additional modifications should be viewed cumulatively in determining whether the additional modification is a TDR.
- For example, if the cumulative modifications for a loan are all COVID event related, in total represent short-term modifications (e.g., six months or less combined), and the borrower is contractually current (i.e., less than 30 days past due on all contractual payments) at the time of the subsequent modification, management may continue to presume the borrower is not experiencing financial difficulties at the time of the modification for purposes of determining TDR.
Credit Risk Grade or Classification
- Sound credit risk management includes applying appropriate loan risk ratings or grades and making appropriate accrual status decisions on loans affected by the COVID event. Generally, following an accommodation, a financial institution reassesses risk ratings for each loan based on a borrower’s current debt level, current financial condition, repayment ability, and collateral.
- Effective management information systems and reporting help to ensure that management understands the scope of loans that received an accommodation, the types of initial and any additional accommodations provided, when the accommodation periods end, and the credit risk of potential higher-risk segments of the portfolio(s).
Past Due Status
- A loan’s payment date is governed by the due date stipulated in the loan agreement.
- The past due status reported in regulatory reports should, therefore, be determined in accordance with the revised contractual terms of a loan.
Accrual of Interest
- Financial institutions should continue to refer to the applicable regulatory reporting instructions, as well as internal accounting policies, to determine if the loan should be reported as a nonaccrual asset.
- Current Call Report instructions provide that an asset should be reported as nonaccrual if:
- It is maintained on a cash basis because of deterioration in the financial condition of the borrower
- Payment in full of principal or interest is not expected
- Principal or interest has been in default for a period of 90 days or more, unless the asset is both well secured and in the process of collection
Internal Control Systems
- Sound risk management practices should be maintained after the end of the initial accommodation and through the additional accommodation period. Financial institutions should establish appropriate internal controls over the following areas related to additional accommodations to ensure that:
- Approval is documented and in accordance with loan policy
- Service systems accurately reflect balances, payments, etc.
- No violations of laws or regulations occurred through the underwriting process
- Staff levels are appropriate
- Risk rating assessments and the determination of accrual status are timely and appropriately documented
Due to the potential for a high volume of loan accommodations, and work-from-home mandates, many financial institutions have changed the way they operate, which include changing which employees are responsible for certain internal controls or how a particular control is performed. Financial institutions should reevaluate their segregation of duties over the above areas to ensure they are appropriate based on the size and complexity of the institution.
Below is the link to the joint statement:
Joint Statement on Additional Loan Accommodations Related to COVID-19