FFIEC Issues Statement on Additional Pandemic-Related Loan Accommodations

Since the onset of the COVID-19 pandemic in early 2020, financial institutions, both on their own initiative and with the encouragement of their federal and state regulators, have allowed their commercial and retail loan customers to defer payments, make partial payments, modify loan terms, or obtain other relief while experiencing financial challenges.

Most of these accommodations were short-term because they were designed to permit borrowers to escape the worst effects of the early part of the pandemic. As a result, such accommodations were not subject to adverse regulatory or accounting treatment. However, financial institutions are now faced with decisions on whether and how to extend expiring accommodations.

To help FDIC-supervised financial institutions with under $1 billion in total assets perform such analysis, the Federal Financial Institutions Examination Council (FFIEC), on behalf of its member agencies, issued a statement on August 3, 2020 that provides principles to consider while working with borrowers as loans near the end of their initial accommodation periods. Financial institutions are encouraged to consider prudent accommodation options that can ease cash flow pressures on affected borrowers, improve their capacity to service debt, and facilitate a financial institution’s ability to collect on its loans. The FFIEC statement addresses the following:

  • prudent risk management practices;
  • well-structured and sustainable accommodations;
  • consumer protection considerations;
  • accounting and regulatory reporting treatment; and
  • internal control systems.

Prudent Risk Management Practices

Prudent risk management practices include identifying, measuring, and monitoring the credit risks of loans for which accommodations are made. The FFIEC statement recommends ongoing monitoring and assessment of loan accommodations, to help financial institutions recognize any deterioration, including potential loss exposure, in a timely manner.

Sound credit risk management includes applying appropriate loan risk ratings or grades and making appropriate accrual status decisions on loans affected by the pandemic. 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).

In executing an accommodation, financial institutions are encouraged to provide clear, accurate, and timely information to borrowers and guarantors regarding the accommodation. This includes information on how to contact the lender or servicer to discuss options that might best fit an individual borrower’s needs.

Well-structured and Sustainable Accommodations

If a borrower continues to experience financial challenges after an initial accommodation, the financial institution may consider additional accommodations to mitigate losses for the borrower and the financial institution. The institution should review how the hardship has affected the financial condition and current and future performance of the borrower, and the FFIEC statement suggests that it is generally appropriate for the financial institution to assess each loan based upon the fundamental risk characteristics affecting collectability. For both commercial and retail loans, this typically includes evaluating the borrower’s financial condition and repayment capacity and assessing whether current conditions have affected collateral values or the strength of guarantees, if applicable. For a commercial loan, this would also include evaluating both actual and projected cash flows of the borrower’s business. Because the pandemic may adversely affect a borrower’s future earnings, management making underwriting decisions might need to rely more heavily on projected financial information for both commercial and retail borrowers, as supporting documentation may be limited and cash flow projections may be uncertain.

Consumer Protection Considerations

The FFIEC statement encourages financial institutions to provide consumers with options for repaying any missed payments at the end of the accommodation. This might involve the following:

  • providing affordable and sustainable accommodation options to borrowers;
  • providing clear, conspicuous, and accurate communications and disclosures to inform the borrowers of the available options;
  • providing the communications and disclosures before the end of the accommodation period, to allow adequate time for the borrower and financial institution to consider next steps, such as payment deferral, loan modification, or loan extension;
  • basing eligibility and payment terms on consistent analyses of borrowers’ (and, if applicable, guarantors’) financial condition and reasonable capacity to repay;
  • ensuring that policies and procedures reflect accommodation options offered by the financial institution and are consistent with applicable laws and regulations, including fair lending laws;
  • providing appropriate training to employees and other persons responsible for compliance and operational procedures;
  • ensuring that risk monitoring, audit, and consumer compliance systems are adequate to evaluate compliance with applicable laws, regulations, policies, and procedures; and
  • providing complete and accurate information to borrowers and servicers during loan transfers and ensuring that post-transfer servicing is consistent with the agreement with the borrower and the borrower’s status at the time of transfer.

Accounting and Regulatory Reporting Treatment

The FFIEC statement reminds financial institutions of the applicable accounting and regulatory requirements for all loan modifications, including maintenance of appropriate allowances for loan and lease losses (ALLL) and allowances for credit losses (ACL), as applicable. Appropriate ALLL or ACL methodologies consider all relevant and available information when assessing the collectability of cash flows, including changes in borrower financial condition, collateral values, lending practices, and economic conditions as a result of the pandemic.

Recognizing that financial institutions might need more time to determine the pandemic’s effect on some borrowers’ ability to repay, the FFIEC statement suggests that management should consider the effect of the pandemic in its ALLL or ACL estimation processes in accordance with GAAP and regulatory reporting instructions. Management should consider whether the resulting changes in estimated credit losses are in accordance with GAAP and regulatory reporting requirements as additional information becomes available.

The FFIEC statement also refers financial institutions to the regulatory reporting instructions of Section 4103 of the CARES Act (discussed in this alert) and the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised) (discussed in this alert). According to GAAP, loans are to be segmented into a separate portfolio when they share similar risk characteristics for the purposes of estimating credit losses, unless they are evaluated individually.

Internal Control Systems

The FFIEC statement emphasizes that internal control procedures and risk management practices be implemented at the end of initial accommodation periods and in connection with additional accommodations. Such internal control functions typically confirm that

  • accommodation terms are extended with appropriate approval;
  • additional accommodation options offered to borrowers are presented and processed in a fair and consistent manner and comply with applicable laws and regulations, including fair lending laws;
  • servicing systems accurately consolidate balances, calculate required payments, and process billing statements for the full range of potential repayment terms that exist once the accommodation periods end;
  • staff, including problem loan and collections personnel, are qualified and can efficiently handle expected workloads;
  • borrower and guarantor communications, and legal documentation, are clear, accurate, and timely and are in accordance with contractual terms, policy guidelines, and federal and state laws and regulatory requirements; and
  • risk rating assessments are timely and appropriately supported.

In response to the COVID-19 pandemic, Lewis Rice has formed a COVID-19 Task Force, which brings together subject matter experts from various practice areas within the Firm. If you need assistance with compliance, please contact one of the authors of this alert or another member of the Task Force.