It has been nearly 8 months since the COVID-19 pandemic swept the nation, bringing with it sweeping economic upheaval. With that came relief efforts from the federal government and guidance from regulatory agencies. Credit unions quickly answered the call, helping members who were adversely affected by the pandemic in the form of deferral programs.
Many of these deferral programs have since expired and many still have been extended again.
As borrowers move closer to the end of their deferral phase, decisions will need to be made to determine if the deferral will end or be extended. As we continue making these determinations, it would be wise to review the Joint Statement on Additional Loan Accommodations Related to COVID-19 issued on August 3rd.
Here are some highlights:
Agencies continue to view loan accommodations as positive actions which may mitigate adverse effects on borrowers. However, determining if an additional accommodation is required must be done prudently and based on the credit risk of the borrower.
They also recognize that determining credit risk in this environment may be challenging. Relief efforts from the federal government along with COVID-19 assistance programs offered from financial institutions can mask the financial situation of a borrower. We reflect on this specific notion in our last blog post, Credit Reporting During COVID-19.
The statement indicates that institutions should practice prudent risk management including;
- Identifying, measuring, and monitoring the credit risk of loans that receive accommodations.
- Allowing for the institution to identify any potential losses or exposure. Adequate allowance for loan loss reserves should exist regardless of your determination of whether or not the loan qualifies as a Troubled Debt Restructuring (TDR).
Well Structured and Sustainable Accommodations
So if a deferral or accommodation is extended, what does the financial institution need to do? You should assess the loan based on the ability to collect on the credit. This includes knowing the underlying collateral value of the loan. This seems especially critical given that the pandemic has affected different segments of the economy in unexpected ways
Real estate values have actually seen an increase in values during this economic downturn, different from the Great Recession where real estate values plummeted. This recession is marked by historic levels of unemployment, whereas the Great Recession was CAUSED by the subprime mortgage crisis and thus had a more substantial impact on real estate values. So there is no real blueprint as to how real estate values may be affected moving forward.
Auto values have also experienced unexpected improvement over the past 3 months. Because of a shortage of supply due to factories having to close during the lock down and demand increasing with government relief efforts putting more money in peoples pockets, used car prices are up a shockingly 15% over the prior year according to Cox Automotive.
The takeaway here is there is no way to predict how collateral values may change. The anecdote is to update collateral values on a regular basis to spot trends before they happen.
Accounting and Regulatory Reporting
The statement asserts that financial institutions must continue to comply with accounting and regulatory requirements for all modifications using GAAP reporting, including maintaining an appropriate allowance for loan loss. The big question is determining if it is a modification under the CARES Act which has specific criteria. Section 4013 of the CARES Act allows for additional loan modifications so long as it meets the criteria of the CARES Act. Specifically,
- Financial hardship is related to the COVID pandemic.
- Loan was not more than 30 days past due as of December 31, 2019.
- Modification is given between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the National Emergency has ended.
If a loan modification does not meet the requirements above it can still avoid being recorded as a TDR if it complies with the standards set by the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised).Specifically;
- Cumulative modifications are all related to COVID.
- Cumulative loan modifications are short term (less than 6 months).
- The loan is less than 30 days past due at the time of the modification.
Internal Control Systems
The guidance states that financial institutions should maintain prudent internal controls systems at the end of an accommodation and in determining if an additional accommodation is made. This will include;
- Appropriate approval is used to extend terms.
- Options are provided to borrower in a fair manner complying with Fair Lending Practices.
- Systems are set up to for the accommodations including consolidating balances, billing and calculating payments.
- Staff is trained and qualified.
- Communications are clear and accurate and comply with contractual terms, policy guidelines federal and state laws and regulatory agencies.
- Risk ratings assessments are timely and supported appropriately.
Providing an additional loan modification is an important way to continue to support members who have been adversely affected by the COVID-19 pandemic but must be done in a prudent manner. Data analytics can be instrumental in monitoring borrowers who have been given an accommodation. Specifically by identifying when a loan goes into deferral, when that deferral period is scheduled to end and most importantly what happens next.
- Is there a payment made?
- Does that loan become past due?
- Do they continue or extend the deferral period?
- If that deferral is extended has there been prudent assessment of the credit risk?
Additionally, understanding the collateral value securing the loan is essential to determining the loss exposure in the event of borrower default.
2020 Analytics provides the data analytics and collateral valuation to keep financial institutions compliant with the interagency statement. Contact us today to learn more.