As banks work to determine appropriate and effective loan modification options for borrowers, key questions arise around how to account for and report on these modifications. There is new guidance from Congress in the form of the CARES Act, new guidance from the regulators and new guidance from the FASB and the SEC. Much of the guidance is aimed at making operations simpler.
While this may be helpful, there are still open questions on how to track and report on loan modifications and how to determine interest income. The following steps guide institutions through the analysis of appropriate treatment:
- Step 1: Institutions will need to determine if they will adopt Section 4013 of the CARES Act and suspend TDR accounting for qualified loans. For those institutions that choose to elect Section 4013, these loans will need to be tracked separately for regulatory and investor reporting. Both the FDIC and SEC have noted the need for transparency around the volume and type of loans/modifications that would normally be considered TDRs but are not due to Section 4013. Internal management will also want to know the volume of loans modified, regardless of the modification structure and accounting treatment. The SEC has additionally stressed the importance of outlining elections and policies in detail.
- Step 2: Institutions will need to determine how to treat non-TDR loan modifications. While in most cases, a short-term payment suspension will be considered a minor modification, formal testing is challenging as servicing systems are often not equipped to perform the tests required by GAAP to classify a modification. Will banks adopt simplifying assumptions around classification? Will the sheer volume of these transactions overwhelm an institution’s existing technology?
- Step 3: Banks will need to determine how to account for interest income for these modifications. The FASB noted there are two acceptable ways to deal with interest income during a forbearance period:
- Interest income will be recognized at a new effective yield, taking into account the revised terms, or
- Interest income will be recognized in accordance with the contractual terms (i.e., no interest income during the forbearance period).
The FASB also noted that, because of the diversity of practice in accounting for TDRs and interest income during this period, additional disclosures would be expected. This would include reporting on interest income recognized on the modified loans, the volume and dollar amount of loans modified, the delinquency information on these loans at the time that the modification was granted, etc.
The FASB’s broad guidance on interest income masks the operational complexity required to comply. These accounting policy elections are often difficult for servicing systems to consume, calculate accurately and report on. The typical approach, historically, has been to perform manual overlays. In the best of circumstances, these overlays are a burden and a control risk. In today’s unprecedented situation, the burden and risk are intensified—the sheer volume of the modifications may overwhelm a manual ability to perform the calculations, especially with the remote work arrangements that many institutions are facing.
The updated guidance will, in some ways, help institutions in accounting for loan modifications but, in other ways, increase the burden around tracking and reporting. Institutions should consider how to deal with the added burden in a way that is controlled and viable, given the volume of expected modifications and the associated materiality. For other important considerations around the loan modification process, refer to COVID-19 loan modifications: Near-term and longer-term considerations.
And for more information about how SS&C Primatics can help you navigate and address these challenging decisions, please contact us at email@example.com.