Pub. 10 2021 Issue 4

Pub. 10 2021 Issue 4 17 encouraged banks to work with borrowers who have been negatively impacted by COVID-19. However, these guidelines also consistently reference “prudent” efforts to work with borrowers and modify loan terms and further state that examiners will not criticize “prudent” efforts to modify terms on existing loans. The basic focus of “prudent” efforts to modify loan terms implies that the bank is acting to enhance the collectability of modified loans and is doing what is in the bank’s best interests and not just what is in the borrower’s best interests, although hopefully in most cases these interests will be the same. And while there have been changes in the requirements for designating modified loans as “TDRs,” other important considerations have not changed. Banks must properly “Risk Rate” COVID-19 loan modifications and incorporate such risk ratings into their ALLL/ACL calculations. Loans modified under Section 4013 or the Interagency Guidance pertain ONLY to borrowers who have been impacted by the coronavirus. By definition, these borrowers have financial performance less robust than before COVID-19. In some cases, these borrowers may have serious cash flow problems driven by the coronavirus that impact their ability to service their debt. It is incumbent on banks to accurately “Risk Rate” these borrowers at the time of loan modification and on a regular basis going forward. FinPro has observed that some banks have internally “risk rated” their COVID-19 loan modifications to a “watch” category where more severe risk ratings may be warranted. In May 2020, the regulators issued “Interagency Guidance on Credit Risk Review Systems” which every bank should be familiar with. The argument that banks and examiners should not adversely classify loans because the borrower has been negatively impacted by COVID-19 will not prevail. As stated earlier, these new risk ratings must be incorporated into the ALLL/ACL calculations. One “best practice” observed for community banks across the country is to establish a “homogenous pool sub-tier” within the ALLL/ ACL methodology to break out all such loan modifications within each homogenous pool. Noteworthy, this approach is Continued on page 18