Troubled Debt Restructuring from the Lender Perspective
The clock is ticking: Lenders, have your CARES Act or banking Interagency Statement loan modifications become a TDR (Troubled Debt Restructuring)?
Why Does it Matter?
The CARES Act included a provision applicable only to financial institutions for TDR relief on loan modifications related to the COVID-19 pandemic. The banking Interagency Statement also provided some TDR relief, but only for short-term modifications of six months or less, arguing that a borrower is not considered to be in financial difficulty (and not considered a TDR) if:
- The modification is in response to COVID-19;
- Is less than six months; and
- The borrower was current at the modification date.
Application of the CARES Act is narrow and limited to financial institutions only (i.e., excludes mortgage real estate investment trusts [REITs]), but per the banking Interagency Statement guidance, the TDR relief available is permissible to any entity applying U.S. Generally Accepted Accounting Principles (GAAP).
Section 4013 of the CARES Act, which provides for TDR relief, does not have the same six-month modification term limitation included in the banking Interagency Statement, so there is less of a concern that a second round of modifications or extension of existing modifications would result in a TDR, provided these changes are COVID-19 related and meet all other criteria.
For most entities, initial loan modifications kicked off with the April loan payments. September has arrived, along with the six-month modification time limit. Based on the Interagency Statement described above, initial loan modifications were frequently not considered TDRs, but as these loans hit the term limit, any further modifications or continuations of existing modifications pushes them beyond the short-term window for relief eligibility.
Lenders should review their loan modifications that began in April 2020 to determine whether they should now be classified as a TDR; this requires additional disclosures such as qualitative and quantitative information on how the loan was modified, the financial effects of the modification, and impacts on the allowance for credit losses. Loans with multiple modifications made in the last 12 months, whether they were eligible for TDR relief under the Interagency Statement or not, would be considered in the TDR analysis, not just the most recent modification.
A mortgage REIT allowed a borrower to suspend mortgage payments of principal and interest for five months whereby these suspended payments would be added to and extend the term of the loan. Such loan modifications are likely ineligible for TDR relief under the CARES Act, but the same loan modification may be eligible for TDR relief provided that the modification is for six months or less and meets the above Interagency Statement criteria.
Now, assume that the borrower is four months into the loan modification and realizes that they will not be able to resume mortgage payments next month under the modified contractual terms, and requests an additional three-month payment suspension. If the lender agrees to the proposed modification for an eight-month term, exceeding the Interagency Statement maximum term of six months, then this loan modification will need to be reassessed to determine if it is in fact a TDR because of the extension. The lender must then also collectively consider the original, the new, and any previous loan modifications in the TDR determination within the past 12 months and the subsequent loan accounting.
Many banks are experiencing additional requests for a second round of loan modifications from borrowers that may extend the term of the loan modifications and render them ineligible for TDR relief under the Interagency Statement. Loan modifications that were not TDRs a month or two ago may need to be re-evaluated if they are extended beyond a maximum term of six months to determine if they meet the definition of a TDR. The accounting and required disclosures for a TDR are more expansive than for a loan modification and need to be considered before quarter end.
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