Short-Term Loan Accommodations  

The agencies encourage financial institutions to work constructively with borrowers experiencing temporary financial stress through short-term accommodation. Such actions can mitigate long-term adverse effects and are often beneficial for both the institution and borrower. However, prudent risk management practices and appropriate internal controls should be employed for short-term accommodation. Weak or imprudent practices can increase credit, compliance, operational and other risks. They can also negatively impact capital adequacy if widespread at an institution. Prudent practices include having policies, procedures, risk rating frameworks, and tracking systems. Prudent controls include management approvals, comprehensive policies, ongoing credit risk reviews, and timely and accurate reporting and communication. 

 Loan Workout Programs  

When short-term accommodations are insufficient, institutions may proceed to more formal and complex loan workout arrangements with borrowers. These can involve renewals, extensions, additional credit, or restructurings with or without concessions. An institution’s risk management practices should align with the scope and complexity of its lending and workout activities. Key elements typically include a prudent workout policy, infrastructure to oversee volume and complexity, documentation standards, management information systems, internal controls, collection procedures, adherence to limits, collateral administration, and ongoing credit risk reviews. 

Long-Term Loan Workout Arrangements  

Long-term workout arrangements should improve prospects for repayment under reasonable modified terms, be consistent with sound banking practices, and comply with laws and regulations. Workout plans are typically considered after analyzing a borrower’s repayment ability, guarantor support, and collateral values. They should be based on updated financials, valuations, appropriate structures and terms, and proper legal agreements. Examiners will not criticize institutions solely for engaging in prudent loan workouts, even if classified adversely after restructuring. However, workouts may warrant close monitoring. Collateral values should be reviewed and updated as appropriate during workouts. For income-producing property, factors like net operating income, vacancy rates, and capitalization rates should be evaluated. Assumptions made by qualified parties should generally be given reasonable deference by examiners in assessing collateral values. 

 Classification of Loans  

Performing loans should not be adversely classified solely due to declines in collateral value. Renewals or restructurings of loans to creditworthy borrowers are also not automatically considered adverse. Classification should consider risk over the life of the loan rather than just payment history. Examiners will exercise judgment if loan modifications lack adequate analysis and documentation until supported by the institution. Partial charge-offs may be taken on restructured loans with well-defined weaknesses. The remaining balance after a partial charge-off is generally classified as no worse than “substandard.” For problem loans dependent on collateral sale, any portion that exceeds the collateral’s fair value less costs to sell is classified “loss.” The portion that is adequately secured is generally classified as no worse than “substandard.” Examiners can use “doubtful” classification infrequently when loss exposure is uncertain. 

Regulatory Reporting and Accounting Considerations  

Loan workouts can impact regulatory reporting such as interest accruals and loss estimates. Management is responsible for preparing accurate regulatory reports in accordance with GAAP and regulatory requirements. A governance and control structure should exist over regulatory reporting. Workout decisions should be appropriately communicated to accounting/reporting staff. Restructured loans may need to be placed in nonaccrual status based on a current credit assessment. Otherwise, interest income could be overstated. A restructured loan placed in nonaccrual status generally should not return to accrual status until the borrower demonstrates sustained repayment performance. While an appropriately designed workout should improve collectability, it does not relieve an institution from promptly charging off identified losses. 

Examiners need to understand differences between credit risk management and accounting or regulatory reporting concepts. While similar data may be used, outcomes may differ. For example, loss classifications may not equate to allowance measurements. Examiners are responsible for reviewing management’s processes related to accounting, allowances, accrual status, and regulatory reporting. However, examiners will not criticize institutions solely for engaging in prudent loan workouts, even if weaknesses result in adverse classification of modified loans. The goal is to avoid unnecessary constraints on lending while ensuring sound risk management and accurate reporting.