A recent statement by federal and state regulators of financial institutions paves the way for businesses and their employees to seek temporary debt relief during the nation’s COVID-19 response.
On Sunday, federal and state regulators issued an Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Interagency Statement). The Interagency Statement relaxes the requirements for financial institutions that provide loan modifications to assist struggling businesses and consumers to report those modified loans as troubled debt restructurings (TDRs).
What are TDRs and Why are they a Problem for Lenders?
TDR accounting rules were implemented after the last financial crisis and restrict a lender’s options in terms of the modifications that the lender can make to a loan without causing adverse financial consequences to the lender. A TDR is a restructuring of a loan if the lender, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the terms of the loan that it would not otherwise consider. Examples of concessions are converting loan payments to interest-only payments, deferring payments, reducing the interest rate payable on the loan or extending the maturity date of the loan.
If a loan is considered a TDR because of a modification, the financial institution has to report it separately on its financial statements as a potentially troubled loan, test the loan for impairment and possibly accrue a reserve for a loss on the loan. Once a loan as classified as a TDR, it is always a TDR regardless of whether the borrower’s financial condition improves. These actions adversely affect the financial results of the financial institution and make it difficult for financial institutions to make short-term loan modifications to respond to current but temporary circumstances like COVID-19.
How does the Interagency Statement Promote Loan Modifications?
The Interagency Statement encourages all financial institutions to work with borrowers affected by the COVID-19 response and provide loan modifications. Financial institutions that make loan modifications for borrowers experiencing short-term financial or operational problems do not have to report the modified loans as TDRs if two primary requirements are satisfied. These requirements are: (1) the loan modification must be short-term (e.g., six months); and (2) the borrower must be current or less than 30 days past due on contractual loan payments at the time the modification is implemented. Because financial institutions do not have to report such modifications as TDRs, the Interagency Statement provides enormous incentive for financial institutions to work with businesses and consumers experiencing financial difficulties due to the COVID-19 response before the loan becomes a problem.
What should Businesses and Employees do to take Advantage of Loan Relief?
For a modification to qualify for the special treatment permitted by the Interagency Statement, the borrower must be current or less than 30 days past due on contractual loan payments when the modification is made. Therefore, do not wait if you anticipate potential financial difficulties due to the COVID-19 response. Call your lender now if your business is temporarily closed or restricted in operations to discuss options available for debt relief for your business loans. Call your lender now if you are laid off or furloughed from a business that is closed or restricted in operations due to COVID-19 and discuss options available for debt relief for your mortgage and auto loan payments. If you wait until the loan is significantly past due or in default, or until you are already in financial crisis, your lender will have far fewer options to work with you to get you through the temporary financial difficulties many are experiencing due to the COVID-19 response.