Statutory, Regulatory Actions on TDRs: Short-Term Alleviation, Long-Term Aggravation?

By Josh Stein

Responding to concerns that accounting rules for troubled debt restructurings, or TDRs, could hamper banks’ ability to assist borrowers during the anticipated COVID-related economic downturn, the federal banking agencies and Congress quickly moved earlier this year to alleviate the operational and capital-related challenges related to such loan modifications.

The March 22, 2020, interagency guidance on TDRs was significant, affecting not only the accounting processes, but the reporting for nonaccrual and past due loans, as well as qualifications to be considered collateral under the Federal Reserve Discount Window. The guidance concentrated on deferrals and payment extensions and insignificant deferrals. In an unprecedented action then taken by Congress to effectively establish new U.S. GAAP, the CARES Act went a further step on the accounting, providing a temporary and optional suspension of TDR accounting for virtually all loans that are related to COVID-19.

Compared to the interagency guidance, ABA believes that the CARES Act expanded the related time period and the kinds of modifications that would automatically bypass TDR accounting consideration. For example, subject to safety and soundness principles, the CARES Act allows virtually all modifications to bypass TDR accounting consideration, rather than providing short-term extensions. With this in mind, the banking agencies offered further guidance on April 7 to clarify that either the CARES Act or the interagency guidance could be applied by banks.

These actions are significant and show the concern around proactive engagement with borrowers. Amid the rush of modifications without a requirement to consider impairment under TDR accounting, however, agency personnel emphasize that sound evaluation of credit risk is critical, no matter the TDR designation. Bankers must be vigilant in understanding and assessing the actual risk in their portfolios, and they must do this with a significant disruption in traditional credit metrics.

Delinquencies may be artificially low due to forbearance and business cash flows will likely be supported through government programs like the Payment Protection Program. This may often leave bankers guessing at how many of their loans will ultimately perform. This all begs further questions: Will one modification be enough? How long until the bank can safely begin collecting payments again? What will the business look like on the other side of this health crisis? Will there be additional government stimulus? What form will this take?

Ultimately, whether institutions are using CECL or not, assessing risk and modeling cash flows are less certain than at any time in most bankers’ and examiners’ careers. So while the TDR relief is a necessary step to create a short-term bridge to economic recovery, it is also accompanied by the longer-term need for more robust monitoring and real time assessment of the portfolio to ensure the overall safety and soundness of the nation’s banks.

Josh Stein is VP for accounting and financial management at ABA.