The below article is the Special Focus section of the August 2020 Compliance Journal. The full issue may be viewed by clicking here.
The Board of Governors of the Federal Reserve System (FRB), Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC), and National Credit Union Administration (NCUA) (collectively, the agencies) recently issued a joint statement to provide prudent risk management and consumer protection principles for financial institutions to consider while working with borrowers as loans near the end of initial loan accommodation periods applicable during the Coronavirus Disease 2019 (COVID event). The principles are consistent with the agencies’ Interagency Guidelines Establishing Standards for Safety and Soundness and are generally applicable to both commercial and retail loan accommodations. The principles are intended to be tailored to a financial institution’s size, complexity, and loan portfolio risk profile, as well as the industry and business focus of its customers. The following is a summary of the release.
In the new guidance, the agencies recognize that while some borrowers will be able to resume contractual payments at the end of an accommodation, others may be unable to meet their obligations due to continuing financial challenges. The agencies also recognize that some financial institutions may face difficulties in assessing credit risk due to limited access to borrower financial data, COVID event-induced covenant breaches, and difficulty in analyzing the impact of COVID event-related government assistance programs.
The agencies provide several principles to illustrate prudent practices for financial institutions in working with borrowers as loans near the end of accommodation periods, including: prudent risk management practices, well-structured and sustainable accommodations, consumer protection, accounting and regulatory reporting, and internal control systems.
As outlined by the agencies, prudent risk management practices include identifying, measuring, and monitoring the credit risks of loans that receive accommodations. Sound credit risk management practices include applying appropriate loan risk ratings or grades and making appropriate accrual status determinations on loans affected by the COVID event. Further, the agencies believe effective management information systems and reporting helps to ensure that bank 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 in the portfolios.
When working with borrowers who continue to experience financial challenges after an initial accommodation, the agencies believe it may be prudent for a financial institution to consider additional accommodation options to mitigate losses for the borrower and the financial institution. The effectiveness of accommodations improves when they are based on a comprehensive review of how the hardship has affected the financial condition and current and future performance of the borrower.
When considering whether to offer additional accommodation options to a borrower, the agencies stated it is generally appropriate for the institution to assess each loan based upon the fundamental risk characteristics affecting the collectability of that particular credit. The new guidance further identifies what financial institutions should consider in its evaluation of the borrower’s financial condition and repayment capacity. The agencies also note that the COVID event may have a long-term adverse impact on a borrower’s future earnings and therefore bank management may need to rely more heavily on projected financial information for both commercial and retail borrowers when making underwriting decisions as supporting documentation may be limited, and cash flow projections may be uncertain.
The agencies also encourage financial institutions to provide consumers with available options for repaying any missed payments at the end of their accommodation to avoid delinquencies or other adverse consequences. The agencies also encourage institutions, where appropriate, to provide consumers with options for making prudent changes to the terms of the credit product to support sustainable and affordable payments for the long term. Eight examples of generally effective approaches to risk management in this context are included in the guidance.
The new guidance also includes a discussion regarding accounting and regulatory reporting that financial institutions need to consider for all loan modifications, including additional modifications for borrowers who may continue to experience financial hardship at the end of the initial accommodation period. Institutions are reminded to consider regulatory reporting instructions, section 4013 of the CARES Act regarding temporary relief from troubled debt restructuring, and the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised).
Lastly, the guidance sets forth the importance of internal control functions, commensurate with the size, complexity, and risk of a financial institution’s activities. The internal control functions typically include appropriate targeted testing of the process for managing each stage of the accommodation. Included in the new guidance are six examples of the type of activity the agencies believe can be confirmed through prudent testing by a financial institution’s internal control functions.
As financial institutions work to determine whether certain borrowers need additional accommodations due to the effects of the COVID event, and in preparation of federal and state examinations resuming, the new guidance provides examples of prudent risk management and consumer protection principles that each financial institution need weigh. Additionally, the new guidance provides factors to consider when working through accounting and regulatory reporting requirements as it relates to each particular credit. The new interagency statement may be viewed at: www.ffiec.gov/press/PDF/Statement_for_Loans_Nearing_the_End_of_Relief_Period.pdf