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Pandemic Triggers Loan Modifications, New Accounting Dilemmas

March 20, 2020, 6:55 PM

When borrowers run into money trouble, they can appeal to their bankers to rework the terms of their loans or try to reduce their interest rates.

Banks expect many of these appeals as the new coronavirus spreads and economic uncertainty intensifies. But accounting for these so-called troubled debt restructurings under major new accounting rules could thwart banker attempts to work with borrowers.

Jelena McWilliams, chairman of the Federal Deposit Insurance Corporation, raised this concern to accounting rulemakers on Thursday as part of an appeal to accounting rulemakers to delay the current expected credit losses (CECL) accounting standard for some financial institutions.

McWilliams urged the Financial Accounting Standards Board to exclude coronavirus-related modifications from being considered a concession when determining whether to classify a loan change as a troubled debt restructuring.

“Institutions want to assist their customers, but are worried about a modification being classified as a TDR,” McWilliams wrote. “I believe a public statement by the FASB will help encourage banks to work with their customers through this period.”

FASB said it was examining the issue.

“Based on our initial review of the letter, we agree with the need for close coordination with the SEC and banking regulators to address issues associated with loan modifications,” a FASB spokesperson said. “We’re also continuing to work with financial institutions to understand their specific challenges in implementing the CECL standard.”

Even Bigger Losses

The CECL accounting standard, which large publicly traded banks had to start following in January, outlines what loan modifications should be considered troubled debt restructurings. Two criteria must be met: The borrower must be experiencing financial difficulty, and the bank must grant a concession like a principal or interest rate reduction it wouldn’t otherwise consider.

The accounting overhaul requires bankers to look to the future and consider potential losses the day they issue a loan. In a big change from outgoing practice, credit losses related to potential troubled debt restructurings also must be incorporated into this loan-loss estimate. As the pandemic spreads and the economy weakens, banks expect a lot of loan modifications that will qualify as troubled debt restructurings. That means recording even bigger expected losses and thus more pressure on balance sheets at a critical time.

“What that means is your forecast horizon typically stops at the contractual maturity of a loan, but if there’s an anticipated extension stemming from an anticipated TDR, you’ve got to consider that,” said Reza van Roosmalen, accounting change services lead at KPMG LLP. “There’s been a debate around that and how you operationalize it.”

There were debates before, but the fallout from the coronavirus pandemic intensifies those questions. Many banks won’t be able to handle the volume, said Paul Noring, managing partner at Berkeley Research Group.

“It is operationally impossible to do on this size and scale,” Noring said.

Bankers also are struggling with determining which concessions qualify as troubled debt restructurings, said Sydney Garmong, managing partner at Crowe LLP.

“The number of questions I’ve seen on, ‘is this a TDR?’ is just astronomical,” he said.

To contact the reporter on this story: Nicola M. White in Washington at nwhite@bloombergtax.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; David Jolly at djolly@bloombergtax.com

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