Credit and the Coronavirus

(March 23, 2020)
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As the unprecedented governmental response to the COVID-19 pandemic continues to develop, it is important that banks and their customers are up to date on the latest governmental assistance and regulatory relief that is available to them.  This client alert briefly describes some of the latest developments.

SBA Economic Injury Disaster Loans

The Small Business Administration (“SBA”) has quickly added to its list of states with businesses eligible for economic injury disaster loans.  Over the weekend of March 21, the SBA added several states, such that almost all small businesses in the country are eligible to apply for the loans.

For small businesses and private non-profit organizations economically impacted by the pandemic, Economic Injury Disaster Loans (“EIDLs”) may be available through the SBA.  EIDLs are intended to serve as working capital loans to assist businesses with meeting their ordinary business obligations, including the servicing of existing debt.  For COVID-19-related loans, the rate for for-profit businesses will be 3.75% (2.75% for non-profits), with terms varying up to 30 years based upon ability to repay.  Collateral is required for loans over $25,000, but the type of collateral is flexible.  Qualifying businesses may apply for an EIDL either on the SBA’s website (disasterloan.sba.gov) or by completing a paper application.  The latest information from discussion with affected businesses suggests that these loans will be priced at 3.75% and have terms of five to seven years.

FDIC Guidance on Payment Accommodations

Considerations in Making Payment Accommodations

On March 19, the FDIC published an FAQ for state non-member banks regarding, among other things, working with borrowers impacted by the COVID-19 pandemic.  The guidance encourages banks to provide borrowers affected by the pandemic with payment accommodations to help borrowers deal with the short-term impacts of the pandemic.  Banks that make payment accommodations will need to consider how to address any skipped or deferred payments, which may require extending the original maturity date or having skipped or deferred payments be payable in a balloon payment upon maturity.  Any payment accommodations will need to be properly documented, and appropriate lending and consumer disclosures must be made.  The documentation and disclosures required for different types of loan modifications can vary significantly depending on the specific circumstances of the modification.  For residential mortgage loans, most deferrals and payment schedule modifications will not constitute a “refinancing.”  This characterization is important because refinancing triggers a requirement to provide all new disclosures.  However, the terms of modifications should be disclosed in a manner that is clear and that will not result in consumer confusion.  Some extensions may also trigger the need for new flood hazard determinations.  The FDIC suggests reaching out to your FDIC regional office with any questions.

The guidance issued by the FDIC should be interpreted as a strong signal of regulatory support for banks to work with their borrowers in this economic emergency for small businesses.  We are aware, however, of the reasonable skepticism of banks—many expressing concern that examiners may not be as forgiving as initial signals from the regulatory agencies have suggested.  We believe that the current leadership of the regulatory agencies can be trusted to ensure that guidance is implemented at the exam level; however, bankers should take the best measures available to guard against future regulatory criticism, particularly if there is any change in leadership at the agencies.  For most situations, that means ensuring to the extent possible that credit decisions are well-documented at the board and/or executive levels, even if there is not time to obtain the documentation ordinarily required in loan modifications.  Bank boards may also want to consider updating their loan policies to more formally permit and provide for these types of emergency loan modifications and any related exceptions to normal documentation and underwriting requirements.

Reporting and Accounting Considerations

The federal banking regulators have also focused on the accounting and other reporting consequences of working with borrowers addressing COVID-19 concerns.  The FDIC guidance states that loans for which borrowers receive payment accommodations should generally be reported for regulatory purposes as they were prior to the pandemic (assuming compliance with the revised loan terms).  For example, an account that was current prior to the outbreak should still be considered current even if payments are skipped or deferred under a payment accommodation, and an account that is 60 days past due should still be considered 60 days past due even if no payments are made for a longer period because of a payment accommodation.  However, if a loan is reported in nonaccrual status or charged off, the foregoing would not apply.

From an accounting standpoint, the industry has been grappling with whether COVID-19 related loan modifications should be classified as Troubled Debt Restructurings (“TDRs”) under applicable standards of the Financial Accounting Standards Board (the “FASB”).  Banks of course want to avoid TDR classification given that those amounts are typically included in their non-performing asset ratios and, more importantly, are considered impaired from an accounting standpoint.

The FDIC began the effort of addressing loan modifications from an accounting standpoint by requesting that FASB exclude COVID-19 related restructurings from the definition of TDRs.  The banking industry received significant clarity on this issue on March 22, 2020, when banking regulators, including the FDIC, the Federal Reserve Board, and the OCC, issued an Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (the “Interagency Statement”).  The Interagency Statement again encourages banks to work with their borrowers amid the current circumstances but goes further than the previous FDIC guidance in attempting to provide comfort that loan modifications extended to borrowers dealing with the impact of the virus will not automatically be considered TDRs. 

The Interagency Statement confirms that modifications made on a good faith basis with borrowers who were current prior to such relief are not TDRs.  The litany of modifications contemplated by the Interagency Statement includes short-term payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant (a term of art in the accounting literature).  The Interagency Statement uses six months as an example of what is meant by “short-term,” which is longer than the modifications that most of our clients are considering.  The Interagency Statement also confirms that state-mandated forbearance is not within the scope of the accounting guidance used to determine if a modification constitutes a TDR, which would be important as more foreclosure moratoriums are under consideration across the country.

Within two hours of the release of the Interagency Statement, FASB issued its own statement, confirming its agreement with the guidance of the banking regulators in the Interagency Statement.  This common message from FASB and the bank regulatory agencies eases a great deal of prior concern that banks’ auditors might be forced take a different, and less flexible, approach to TDR classification. 

This relief with regard to TDRs is extremely significant to the industry given the strain on bank capital that a tremendous number of TDRs could create.  However, bankers should use caution and understand the ASC 310-40 language that governs TDRs as they consider restructurings.  As described above, the Interagency Statement can be read to limit the TDR exclusion to delays in payment that are “insignificant.”  Insignificant is a term of art within the accounting guidance for determining whether a concession has been provided, and bankers should be able to position payment accommodations to ensure that they fit within a determination of insignificance.  Audit committees and bank management may want to be proactive about consulting with their accounting firms on these issues.

Finally, on a related note, the FDIC has formally requested that FASB also allow the postponement of CECL implementation for banks already subject to it and further delay the phase-in for banks that are not subject to it.  FASB is examining this issue.

Consumer Disclosure Obligations

Even with the apparent forbearance of the regulators as it relates to reporting of past due loans and TDRs, there is no suggestion that there will be any level of forbearance as it relates to matters of consumer compliance.  In fact, experience tells us that now is when consumer compliance matters most.  As a result, we caution banks to ensure their disclosures and procedures are appropriate in the consumer context, particularly as they relate to modifications of home mortgage loans.  With respect to mortgage loan modifications or delinquencies, banks should consider the following questions, among others.

  • Will the proposed transaction be a modification or a refinance?
  • Are we extending the maturity of a loan such that a new flood hazard determination may be required?
  • Are the revised terms clearly disclosed in a manner that is unlikely to result in consumer confusion?
  • Is our bank a small servicer, or must we comply with all of the CFPB’s early intervention and loss mitigation rules?

In general, we believe that a bank’s compliance department should review and assess each consumer loan modification to ensure that it is appropriate under the particular circumstances.

We expect more guidance to be published in the coming week with regard to all of the above matters, and we encourage bankers to stay abreast of the latest developments.

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