COVID-19 Loan Modification & What that means for Reporting on Troubled Debt Restructuring (TDR)

By: Omar Nabulsi, Edited by Malia Roberto

Just as you can see in the recovery years of the 2008 U.S. Housing Crisis, the COVID-19 pandemic has resurfaced the prudent conversations and questions surrounding loan modifications and what that means from a financial reporting standpoint. 

Using data from the Federal Reserve Economic Data (FRED), we are able to see that nonfinancial corporate debt securities and loans have reached a record high of 56.34% of US Gross Domestic Product (GDP) as of Q2’20, equating to roughly $11 trillion. In March, The Economist reported that approximately two-thirds of the U.S.’s nonfinancial corporate bonds are rated as “junk” or slightly better “BBB” bonds. 

In building this concoction of (1) America’s continuously rising addiction to debt; (2) the country’s high level of non-investment grade bonds; and (3) a pandemic that has caused unprecedented disruption to the global economy, the pressure for mutual agreements amongst lenders and borrowers for loan modifications becomes inevitable. And as a result, the conversation for identification and subsequent treatment for troubled debt restructurings (TDRs) becomes front and center. 

Although the Financial Accounting Standards Board (FASB) has not issued new guidance surrounding the treatment of loan modifications and the determination of a TDR, the Trump Administration’s Coronavirus Aid, Relief, and Economic Security Act (CARES Act) alongside the later issued Interagency Statement (Revised), has provided a safety net for lenders currently working with troubled borrowers. 

As a result of the Trump Administration’s CARES Act signed into law March 27th, Section 4013, “Temporary Relief From Troubled Debt Restructurings,” provides relief for financial institutions in scope by allowing the temporary suspension of certain requirements relating to the traditional GAAP treatment of troubled debt restructurings. But is it enough? 

“When debts are designated as troubled, they are categorized as a loss on balance sheets and a lender must adhere to strict reporting, tracking, and accounting requirements that are administratively costly.”

Terms & Conditions

In order to bypass the traditional application of ASC Subtopic 310-40 in determining a TDR, loan modifications must meet the following criteria under the CARES Act: 

1. The loan modification is directly related to COVID-19.

2. The modification was executed on a loan that was not more than 30 days past due as of December 31, 2019; and

3. The loan modification was executed between March 1, 2020, and the earlier of: (A) 60 days after the date of termination of the National Emergency or (B) December 31, 2020.

Using the CARES Act as a foundation, the Interagency Statement (Revised) issued by a coalition of banking agencies can be leveraged by all lenders applying U.S. GAAP; however, under the caveat that the COVID-19 related payment deferrals are short-term (i.e. six months). For loan modifications under Section 4013 of the CARES Act, there is no limit on the duration of payment deferrals. 

For modifications that do not fall under the criteria of the CARES Act or the revisionary interagency statement issued on April 7th, lenders must follow ASC Subtopic 310-40 to determine whether loan modifications in questions are considered troubled debt restructurings, and therefore, impairment losses on their balance sheets. 

The Aftermath… Risk Management!

It is critical that from a reporting standpoint, we consider what happens once the temporary relief suspending traditional treatment of TDRs wears off. 

For example, we can look to loans not covered by the CARES Act but within scope of the Interagency Statement. As mentioned above, these loan modifications have a short-term timeline of only six months. This pegs the question of what happens when the timer runs out and clients are still experiencing difficulties regarding cash flow management and declining income? 

Without the added pressure for extended relief, we may start to see a misrepresentation of risk begin to hit the financial statement of lenders as new loan modifications are now up for impairment testing, potentially resulting in reduced asset value on lender balance sheets and impairment losses on the income statement. 

In the coming months it will be critical that entities in question practice adequate risk management to ensure proper consideration of the issues and risks surrounding TDRs. Lenders should take it upon themselves to include supplemental disclosures for loan modifications that are not accounted for as TDRs while simultaneously pushing for stronger internal controls related to internal loan review and internal audit.

Enhanced functionality surrounding loan review will allow for effective reporting on compliance with current policies in place while assisting in the proper identification of TDRs. This will then convert to Internal Audit’s increased ability to verify appropriateness and accuracy of reporting procedures while ensuring that any prospective TDRs are properly reflected in the Company’s financial reporting.