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US regulators, politicians encourage loan modifications with TDR exemption


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According to Market Intelligence, April 2023

US regulators, politicians encourage loan modifications with TDR exemption

U.S. regulators and legislators are sending a strong signal that they want banks to accommodate borrowers affected by the pandemic without worrying about accounting impacts.

On March 27, regulators ensured that banks did not have to take capital hits due to a new accounting standard, the current expected credit loss. On March 22, regulators issued a statement that loan modifications for borrowers affected by the novel coronavirus would not require an accounting classification known as troubled debt restructurings, or TDRs. Both items were also included in the $2 trillion emergency relief act passed by Congress.

"This is a time for bankers to make the decisions. That's what we need as a global economy," said Robert Klingler, a partner with law firm Bryan Cave Leighton Paisner. "So we are lifting [those requirements] and not letting the accountants decide what the bank needs to do in the short term."

By avoiding a TDR classification for a loan modification, banks can continue to treat interest income from the assets as current interest. Rules for TDRs dictate that banks have to apply any income toward principal paydown, Klingler said. TDRs also require an increase in loan loss provisioning, so the change could ease the burden to build reserves for loans that might experience only a temporary pause in on-time payments.

While banks will not have to classify the loan modifications as TDRs, they might still feel pressure to disclose the number of COVID-19 modifications. During the 2008 financial crisis, banks were painted as villains. Now, banks are well capitalized and eager to show Main Street that they have the wherewithal and desire to help their customers survive the pandemic and thrive in its aftermath, said Joe Stieven, president of Stieven Capital Advisors, an investment firm focused on financial services.

"I think banks are going to disclose a lot because I think banks want to show the public and show the politicians how much they are working to help their customers," Stieven said in an interview.

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TDRs have been declining since reaching a post-2008 crisis peak of more than $180 billion in 2011. At 2019 year-end, Wells Fargo & Co. reported the most TDRs at $11.77 billion.

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Both the regulators' statement and the law's text suggest the TDR exemption should only apply to loans that were current prior to the pandemic. The law stipulates the loans must have been less than 30 days late as of Dec. 31, 2019, and that the impairment was a result of the pandemic. The regulatory guidance states the loans must have been current prior to the modification.

"The spirit of this is that a loan that is current today should not be deemed TDR if it gets a COVID-19 modification," said Reza van Roosmalen, a principal for KPMG.

Beyond the income statement benefits of avoiding TDR classifications, the change should also reduce banks' workload, van Roosmalen said. TDR accounting requires new cash flow projections, an onerous exercise considering the massive volume expected.

Perhaps the trickiest part of the TDR change will be identifying which loans suffered a COVID-19-related impairment.

"Some loans would have become troubled during the month of March or April even if coronavirus did not exist. That's just the life-cycle of individual businesses: Some make it, and some don't," Klingler said in an interview.

Klingler said the guidance and legislation suggest regulators are going to accept banks' initial conclusions on which modifications are temporary reprieves tied to the coronavirus as opposed to fundamental downturns. Craig Miller, a partner for the financial services practice at Manatt Phelps & Phillips LLP, also said regulators are making clear they want banks to show flexibility with borrowers in distress. He said regulators and politicians at the federal and state levels have made it plain to banks that they want financial institutions to operate with "extreme flexibility and extreme accommodation."

"I think banks are in the funny position now where if they don't make accommodations or are flexible, the reaction from the regulators is going to be more negative than if they did make the accommodation," Miller said in an interview. "They have to be safe and sound and prudent, but now is not the time to act in an aggressive manner."

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