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Loan Modifications and COVID-19
by Jordan Jhamb, Financial Analysis Associate, Federal Reserve Bank of New York, Alex Kobulsky, Senior Financial Institution and Policy Analyst II, Board of Governors of the Federal Reserve System, and Jonathan Trunfio, Senior Financial Institution and Policy Analyst I, Board of Governors of the Federal Reserve System

In response to the COVID-19 crisis, the Federal Reserve, in collaboration with other agencies, has issued a number of statements to encourage banks to work with customers affected by the pandemic. This article summarizes the discussion from the April 24, 2020, Ask the Regulators session,¹ which highlighted the April 7, 2020, “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus”² and clarified the interaction between existing accounting rules and Section 4013 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (section 4013).³

Interagency Statement

On April 7, 2020, the Federal Reserve, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the Consumer Financial Protection Bureau, in consultation with state financial regulators, issued an interagency statement on loan modifications and reporting. The first section of the interagency statement encourages banks to work prudently and constructively with borrowers affected by COVID-19. The agencies view loan modification programs as positive actions that can mitigate adverse effects on borrowers due to COVID-19, and prudent modifications done in a safe and sound manner will not be criticized. Proactive adjustments may serve to mitigate adverse effects on borrowers, reduce risk, improve loan performance, and ultimately serve the long-term interests of our communities. The interagency statement also clarifies the interaction between existing accounting rules and the temporary relief within section 4013; supervisory considerations on regulatory reporting; capital implications; and the agencies' views on consumer protection considerations.

Accounting for Loan Modifications

As provided for under the CARES Act, a bank may account for an eligible loan modification either under section 4013 or in accordance with Accounting Standards Codification Subtopic 310–40.⁴ If a loan modification is not eligible under section 4013, or if the bank elects not to account for the loan modification under section 4013, the bank should evaluate whether the modified loan is a troubled debt restructuring (TDR).

Accounting for Loan Modifications Under Section 4013

Section 4013 provides relief for banks from categorizing certain loan modifications as TDRs. A modification is eligible to be accounted for under section 4013 if the modification:

1. was in response to the COVID-19 pandemic;

2. occurred between March 1, 2020, and the earlier of December 31, 2020, or 60 days after the end of termination of the national emergency; and

3. was not more than 30 days past due as of December 31, 2019.

A modification that is accounted for in accordance with section 4013 is not treated as a TDR for accounting or regulatory reporting purposes for the remaining life of the modified section 4013 loan. Moreover, banks need not determine impairment associated with certain loan concessions that would otherwise have been required for TDRs, such as interest rate reductions, payment deferrals, and loan extensions.

Accounting for Loan Modifications Under ASC Subtopic 310–40

Banks should follow existing accounting guidance in ASC Subtopic 310–40 to determine whether the modification is a TDR, provided a loan modification is not eligible for or accounted for under section 4013. According to ASC Subtopic 310–40, a restructuring of a debt is 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. However, the interagency statement notes that a bank may conclude that the modification is not a TDR without further analysis if the modification is:

1. short term (e.g., six months or less), which includes payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant;

2. made in response to the COVID-19 pandemic on a good-faith basis; and

3. current (that is, the borrower is less than 30 days past due on the contractual payments) at the time the modification program is implemented.

If a modification does not meet the criteria under section 4013 or the interagency statement, the bank should follow its existing accounting policies to determine whether the modification should be accounted for as a TDR.

Nonaccrual and the Allowance

Banks and regulators alike are concerned about nonaccrual status and allowance implications from loan modifications made in response to COVID-19. Short-term modifications that meet the criteria for eligibility under section 4013 or the interagency statement would generally not be required to be on nonaccrual status. However, each bank should refer to the applicable regulatory reporting instructions, as well as its internal accounting policies, to determine whether these loans should be placed on nonaccrual status and reported as such in regulatory reports. Banks should continue to maintain an appropriate allowance for loan and lease losses or allowance for credit losses, as applicable, for modified loans that are not accounted for as TDRs based on the criteria in section 4013 or the interagency statement.

Regulatory Risk Ratings and Risk Management

While related, a modified loan’s regulatory credit risk rating and its TDR analysis are separate and distinct decisions. Bankers and examiners alike should exercise judgment in reviewing modifications, including TDRs and section 4013 loans, to determine the appropriate risk grade for these credits. Examiners will not criticize banks for working with borrowers in a safe and sound manner.

Additionally, management should maintain records of the number of section 4013 loans outstanding and the outstanding balance of section 4013 loans, as these data will be collected on regulatory reports starting in the second quarter of 2020.