NCUA Provides Guidance on Commercial Real Estate Loan Accommodations and Workouts
On June 29, 2023, NCUA, along with several other federal regulatory agencies, issued an interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts ("Statement") in a Letter to Credit Unions, 23-CU-05, which provided updated guidance and calls for financial institutions to work “prudently and constructively” with creditworthy borrowers during times of financial stress.
The Statement is substantially similar to a proposal issued last year except for the added guidance on short-term loan accommodations and accounting changes when estimating loan losses. The Statement will replace the 2009 guidance that was previously adopted. The Statement addresses supervisory expectations with respect to a financial institution's handling of loan accommodations and workouts including prudent risk management practices, the classification concepts for commercial real estate ("CRE") loans, accounting considerations and examples of a CRE workout.
The Statement reaffirms two critical principles: financial institutions that implement the CRE loan accommodation and workout arrangements won’t be criticized for engaging in these efforts. Second, modified loans to borrowers who can repay their debts according to reasonable terms will not be adversely classified due to the underlying collateral. However, it is important to note that the burden remains on credit unions to employ prudent and appropriate internal controls to manage the risks associated with accommodated loans.
Loan Accommodation versus a Workout Program
A loan accommodation is a short-term or temporary agreement which can defer one or more payments, allow for partial payment, forbearance of delinquent amounts, modify a loan or contract, or provide other assistance or relief to a borrower who is experiencing a financial challenge. However, when a loan accommodation isn’t sufficient or wasn’t successful, credit unions can provide a longer-term or more complex loan arrangement under a formal workout program which can include renewing or extending loan terms, granting additional credit to improve prospects for overall repayment, or restructuring the loan with or without concessions.
Short-Term Loan Accommodations
The Statement added a new topic for short-term loan accommodations. Specifically, a credit union should employ prudent risk management practices including developing and maintaining appropriate policies and procedures, updating and assessing financial and collateral information, maintaining an appropriate risk rating (or grading) framework, and ensuring proper tracking and accounting for loan accommodations. Further, prudent internal controls should be in place including comprehensive policies and practices, proper management approvals, an ongoing credit risk review function, and timely and accurate reporting obligations.
Long-Term Loan Workout Arrangements
For long-term workout programs a credit union should develop a more detailed prudent plan that supports risk management practices that are appropriate for the scope, complexity, and nature of the financial institution’s lending activity. The practices should be consistent with safety and soundness standards, and include effective practices such as:
- Analyzed the borrower’s global debt service coverage, including realistic projections of the borrower’s cash flow, as well as the availability, continuity, and accessibility of repayment sources;
- Analyzed the available cash flow of guarantors;
- Demonstrated the willingness and ability to monitor the ongoing performance of the borrower and guarantor under the terms of the workout arrangement;
- Maintained an internal risk rating or loan grading system that accurately and consistently reflects the risk in the workout arrangement; and
- Maintained an allowance methodology that calculates (or measures) an allowance, in accordance with U.S. generally accepted accounting principles (“GAAP”) for loans that have undergone a workout arrangement and recognizes loan losses in a timely manner through provision expense and recording appropriate charge-offs.
Classification of Loans
The Statement adds that loans made to sound borrowers which are modified in accordance with prudent underwriting standards should not be adversely classified by examiners unless well-defined weaknesses exist that jeopardize repayment. However, loans can be flagged for management’s attention or added to a “watch lists” of loans that management can monitor more closely. A credit union’s loan modifications should be supported by adequate analysis, documentation and support management’s conclusions and internal loan grades.
The Statement discusses managements processes related to accounting stating that “a loan that has been restructured so as to be reasonably assured of repayment and performance according to prudent modified terms need not be placed in nonaccrual status.” Therefore, for a loan to remain in accrual status, the restructurings and any charge-off taken on the loan must be supported by a current, well-documented credit assessment of the borrower’s financial condition and prospects for repayment under the revised terms.
The Statement also reflects changes in GAAP since 2009, including changes in relation to the current expected credit losses (CECL) methodology. In particular, the relevant accounting standards for TDRs will no longer be applicable after 2023. Appendix 5 of the final Statement addresses the relevant accounting and supervisory guidance on estimating loan losses for financial institutions that use the CECL methodology.
Examples of a CRE Workout
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