Getting Your Financial Institution in Shape for Loan Workouts Amid the Coronavirus Pandemic

Kylee Wooten
April 30, 2020
Read Time: min

The federal government, agencies, and financial institutions (FIs) have been working diligently to mitigate the impact of the coronavirus on businesses and individuals. Last month, federal and state banking regulators eased coronavirus workout pressures, urging financial institutions to work with their borrowers and members affected by COVID-19, and agreeing that these FIs would not be required to categorize loan modifications made in good faith in response to COVID-19 as troubled debt restructurings (TDRs).

There has been an influx of calls from consumers who can no longer pay their loans, and this will quickly follow suit on the commercial lending side. Small businesses – even large corporations – are feeling the financial crunch from the coronavirus. While some borrowers will be able to catch up or refinance in market-available terms, others will need significant intervention from lenders, including the designation of loans as TDRs, when borrower hardship persists past the acute phase of the pandemic or energy shocks. So, what can a financial institution do with loans that have been impacted by the fallout from the coronavirus? What options do lenders have to work with borrowers, without causing additional regulatory scrutiny? Financial institutions across the country should establish effective plans for managing loan workouts.

Qualifying loan modifications

Loan modifications include, but aren’t limited to, a forbearance agreement, a new repayment plan, or interest rate modification. Financial institutions have the choice to account for loan modifications under the CARES Act section 4013, or the traditional ASC Subtopic 310-40. However, not all modifications may qualify under the CARES Act. For a loan modification to be eligible, the following must be true:

  • It must be related to COVID-19;
  • It must be executed on a loan that was not more than 30 days past due as of Dec. 31, 2019; and
  • It must be executed between Mar. 1, 2020, and the earlier of 60 days after the termination of the National Emergency, or Dec. 31, 2020

If a borrower meets the following criteria under ASC Subtopic 310-40, a TDR designation is not required:

  • The modification was in response to a National Emergency
  • The borrower was current on payments at the time the program was implemented
  • The modification was short-term (i.e., six months)

It’s important to note that a borrower might not meet the criteria above, but a loan modification may still be appropriate. Some borrowers, for example, that were between 15 and 60 days past due on Dec. 31, 2019, were already “near the edge.” Without intervention, these borrowers are likely to “fall off the cliff,” Rob Newberry, Senior Advisor at Abrigo, noted in a recent whitepaper, Coronavirus Survival Guide: Loans Under Pressure.

Under normal circumstances, Newberry explains, a modification would generally be considered a TDR when the new terms represent a concession – terms that are not market-available. Many loans will deteriorate due to the ripple effect following the pandemic, or due to other economic events, such as shocks to the energy sector. Understanding what terms are market-available or not will be paramount to developing an effective loan workout strategy.

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Creating a successful problem loan workout plan

The interagency guidance states that examiners will not criticize a financial institution’s attempt to help borrowers impacted by COVID-19 if the assistance is a part of a risk mitigation strategy intended to improve an existing loan that is beginning to display credit weakness. Fortunately, many loans requiring a workout over the next year will be credibly attributable to the pandemic, allowing more latitude when creating these plans. To develop a successful workout strategy, institutions should incorporate:

  • Specific legal expertise in crafting forbearance agreements. As these agreements override the original loan documentation, the lender can gain more flexibility to call the loan or require additional collateral based on the new terms and covenants of the workout agreement.
  • Methods to include and track additional review and due diligence on the borrower’s existing loan documents
  • Straightforward, measurable new terms and covenants for the borrower
  • Expectations outlined to ensure the borrower has the ability – and desire – to follow through
  • Borrower’s potential recovery of their equity position tied to the par recovery of the original loan profitability basis, at minimum. Present-value recovery for the financial institution can inform an argument that the new terms do not represent a concession.
  • Negotiation between impacted customers and personnel who have a direct interest in the health of the financial institution
  • Timely, authoritative, accurate information on the state of the borrower, with all participants on the lender side communicating the same message

This strategy is especially key for smaller, less complex lenders that may be worried about providing personal, prudent service in the face of the impending volume and pressure to scale, due to a lack of access to the resources of large financial institutions and public entities. These institutions would also benefit from automating loan workout and measuring lost revenue. Automated models enable institutions to better understand how much revenue a bank or credit union could lose based upon different scenarios. This can be achieved through the use of a discounted cash flow model that reflects missed, deferred, or interest-only payments, for example.

Successful, high-performing financial institutions will establish new processes and procedures for lenders to manage the influx of requests from borrowers that have been impacted by the pandemic or other shocks. Prioritizing these requests will be critical in successfully managing credit risk and maintaining profitability. To learn more about establishing consistent criteria for decision-making and developing integrated processes for secure, distributed decision-making, be sure to attend the upcoming webinar, Forbearance, Foreclosure, and Force Majeure: Managing Coronavirus Workouts at Your Institution on May 6.

About the Author

Kylee Wooten

Kylee Wooten is a content marketing manager at Abrigo.

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Abrigo is a leading technology provider of compliance, credit risk, and lending solutions that community financial institutions use to manage risk and drive growth. Our software automates key processes — from anti-money laundering to fraud detection to lending solutions — empowering our customers by addressing their Enterprise Risk Management needs.

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