Loan modifications in the current economic downturn

Recent events have created much uncertainty in the world. Uncertainty leads to anxiety in the financial markets and, invariably, stress in financial institutions. One particular area of stress that financial institutions across the U.S. are feeling right now is borrower inability to make loan payments.

When a borrower is unable to make a required loan payment, the lender has three basic options.

One, do nothing and assume the borrower just forgot and will make a payment soon. This is never a good strategy.

Two, declare the loan to be in default and begin repossession or foreclosure on the collateral. This is generally appropriate when other avenues have been exhausted and the borrower is being uncooperative and/or the borrowing relationship is no longer salvageable.

The third option is for the lender to try and work with the borrower to develop a plan that is acceptable to both parties.

Working with a struggling borrower is most often the best course of action. Frequently, this involves loan modifications. Lenders often shy away from loan modifications for fear of creating troubled debt restructures (TDR). There is a stigma with TDRs because of additional accounting and reporting needed related to TDR loans. However, not every loan modification is a TDR.

By now, most lenders have had requests from struggling borrowers for cash flow relief. Many lenders are currently granting 90-day payment modifications for borrowers who request them. For borrowers who had been current and not struggling before the sudden downturn, this modification would not be considered a TDR. In fact, if at the end of 90 days the borrower is still struggling with cash flow issues and remains unable to make the required loan payments, the lender may grant an additional 90-day payment deferral. This, too, may not be considered a TDR. Although every situation is different, granting 90-day — even up to 180-day — payment deferral can be a very prudent option.

Many borrowers are struggling today, and lenders who are willing to work with borrowers are building stronger relationships with their customers and avoid, at least at this point, the time and cost of aggressively demanding payment and related collateral repossession. Again, this assumes the borrower was performing previously on the loan and not experiencing significant cash flow issues.

Whether granting a payment deferral or not, this could be an excellent time to get some updated financial information from the borrower, particularly for commercial and agricultural borrowers. If you are granting a payment deferral, consider adding some covenants to require the borrower to provide more frequent financial information. Remember, you are granting them something, and it is not wrong to get something in return.

For all other borrowers, take a look at the existing financial reporting and covenant requirements that have been spelled out in the credit agreement. Tax return filing dates have been extended, and undoubtedly financial statement audits and other financial statement reports will be extended as well. Lenders should be requiring internally prepared or compiled financial statements, both now and on a more frequent basis — monthly would be best if possible. In addition, consider requesting accounts receivable and payable aging reports. Depending on the type of business, a listing of contracts, a work-in-progress status report and inventory or equipment listings could be valuable as well. Without obtaining current financial information both now and on an ongoing basis, it is difficult to monitor the improvement or ongoing deterioration of the borrower’s financial situation.  

Lenders should be proactive and reach out to borrowers who may be struggling in this current economic downturn. Don’t let fear of creating TDR situations keep you from offering loan modifications to defer loan payments for 90 or even 180 days. Examiners have said they will be lenient in reviewing loans for TDR classification. That does not mean repeated payment deferrals will not trigger TDR classification at some point, but up to 180 days may not. Beyond 180 days gets a little murky and may be reviewed on a case-by-case basis. In addition, consider obtaining current financial information and including increased financial reporting as part of the loan modification process (or for any other renewals).

As we saw in the last financial crisis, proactive lenders were more successful in working through borrower difficulties than were delayed, reactive lenders. And remember, if you have questions navigating the economic turmoil, reach out to your Wipfli relationship executive for guidance.