Financial Institutions Should Be Proactive in Accommodating Borrowers Impacted by COVID-19

March 27, 2020

The extent to which COVID-19 will cause financial distress, or even financial ruin, to businesses throughout the State of Wisconsin is yet to be determined.  We do know, however, that there will be many businesses that struggle to maintain sufficient cash to survive the mandatory shutdowns and the loss of revenue resulting from the pandemic.

Significant numbers of businesses are likely to seek reprieve in the form of accommodations from the financial institutions that serve as their primary lenders.  In providing this much needed relief in those situations where it is warranted, financial institutions should be proactive, and should be comfortable that obliging borrower requests will not be criticized later by federal banking regulators.  Financial institutions should also not have to fear that working with borrowers will have a negative effect on their financial statements.

On March 22, 2020, the Board of Governors of the Federal Reserve System, along with five other federal banking regulators (the “Agencies”) collectively issued an Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (the “Interagency Statement”), which is attached here.  In the Interagency Statement, the Agencies encourage financial institutions to work with borrowers who are or may be unable to meet their payment obligations because of effects of COVID-19.  The Agencies seek to provide comfort to financial institutions who choose to work with troubled borrowers by noting that they will not criticize financial institutions for doing so.  Furthermore, the Agencies clarify that COVID-19 related loan modifications will not be automatically categorized as troubled debt restructurings (“TDRs”) for financial reporting purposes.

The Interagency Statement provides, in relevant part:

Modifications of loan terms do not automatically result in TDRs.  According to U.S. GAAP, a restructuring of a debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider.  The agencies have confirmed with staff of the Financial Accounting Standards Board (FASB) that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not TDRs.  This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.  Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented.

Working with borrowers that are current on existing loans, either individually or as part of a program for creditworthy borrowers who are experiencing short-term financial or operational problems as a result of COVID-19, generally would not be considered TDRs.  For modification programs designed to provide temporary relief for current borrowers affected by COVID-19, financial institutions may presume that borrowers that are current on payments are not experiencing financial difficulties at the time of the modification for purposes of determining TDR status, and thus no further TDR analysis is required for each loan modification in the program.

Emphasis added.

The Interagency Statement should help to persuade financial institutions to be proactive about considering loan modifications for borrowers affected by COVID-19.  It allows financial institutions to work with borrowers early, before cash flow has evaporated and businesses are forced to shut down.

Financial institutions will also want to be sure to properly document their agreements with borrowers.  In addition to the provisions typically included in loan modification documents, financial institutions that grant loan modifications to borrowers affected by COVID-19 should consider incorporating certain non-standard provisions, such as provisions to address or include:

  1. Reference to the fact that the modification is being made in response to the COVID-19 pandemic.
  2. Restrictions on payments to insiders and related parties, including shareholder distributions, executive compensation, and payments on loans from related parties.
  3. Enhanced financial reporting from borrower and guarantors.
  4. Relief from financial covenants.
  5. Borrower’s potential receipt of financial assistance from government programs.
  6. Potential increase in balloon payments due to accommodations.

The fact that government agencies have signaled to financial institutions that they will not be penalized for working with borrowers should encourage financial institutions to be proactive with borrowers who may face financial difficulties in the coming months as a result of COVID-19.  With this knowledge in hand, financial institutions should be communicating with their borrowers and, where appropriate, entering into loan modification agreements to alleviate the financial pain of the pandemic.

The Banking & Financial Institutions Focus Team at Ruder Ware is prepared to support financial institutions as they navigate the implications of the COVID-19 pandemic, including assisting you with the documentation of loan modifications.

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