- The OCC, FDIC, NCUA and Fed have adopted a new Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts.
- The new policy statement updates, expands on and supersedes existing guidance from 2009, and reaffirms the message that prudent commercial real estate loan accommodations and workouts are often in the best interest of both financial institutions and borrowers. Most notably: (1) it adds a new discussion of short-term loan accommodations; (2) it expands guidance regarding the evaluation and assessment of guarantors, to also encompass loan sponsors; (3) it incorporates information about changes to accounting principles since 2009; and (4) it updates and expands the illustrative examples of commercial real estate loan workouts.
- The new policy statement provides important guidance to banks and other financial institutions, on matters of risk management, classification of loans, regulatory reporting, and accounting considerations, in the context of workouts and restructurings.
INTRODUCTION
On June 29, 2023, the Office of the Comptroller of the Currency (“OCC”), the Federal Deposit Insurance Corporation (“FDIC”), the National Credit Union Administration (“NCUA”), and the Board of Governors of the Federal Reserve System (“Fed”) adopted a new Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts (the “2023 Policy Statement”)1. The 2023 Policy Statement addresses a variety of risk management, regulatory and accounting considerations related to accommodations and workouts for loans secured by commercial real estate, whose borrowers may be experiencing financial difficulty, and is relevant to all financial institutions supervised by the OCC, FDIC, NCUA and Fed (collectively, the “Agencies”).
Background: The 2009 Statement
The 2023 Policy Statement updates, expands on, and supersedes an existing Policy Statement on Prudent Commercial Real Estate Loan Workouts (the “2009 Policy Statement”), which was adopted on October 30, 2009, by the Agencies along with the Federal Financial Institutions Examination Council (“FFIEC”) State Liaison Committee and the former Office of Thrift Supervision. The 2023 Policy Statement reaffirms the 2009 Policy Statement’s guidance on the importance of working constructively with creditworthy borrowers in times of financial stress, expands on existing interagency guidance on workouts and restructurings, and adds a discussion of short-term loan accommodations. Additionally, the new policy statement addresses various accounting changes since 2009, and both updates and adds to the loan workout and restructuring scenarios provided as examples in the 2009 Policy Statement.
As discussed below, the 2023 Policy Statement describes a broad set of principles relevant to commercial real estate loan accommodations and workouts in all business cycles, including challenging economic environments. It also provides useful guidance to banks and other financial institutions, by addressing supervisory expectations with respect to risk management and underwriting, classification of loans, regulatory reporting requirements and accounting considerations, in connection with loan accommodations, workouts and restructurings.
On October 30, 2009, in the aftermath of the Great Recession and the corresponding shakeout in commercial real estate, the Agencies, together with the FFIEC State Liaison Committee and the former Office of Thrift Supervision, adopted the 2009 Policy Statement as a resource for supervised financial institutions and agency staff. It was predicated on the understanding that prudent workout arrangements and restructurings were often in the best interest of both the financial institution and the borrower, and it was intended to encourage and assist efforts by financial institutions to work with borrowers who were unable to meet their commercial real estate loans’ current contractual payment obligations or were unable to repay such loans in full at maturity. As such, the 2009 Policy Statement sought to clarify the federal regulators’ positions on risk management, regulatory reporting and accounting practices for commercial real estate loan workouts, with the aim of promoting supervisory consistency among bank examiners.
To that end, the 2009 Policy Statement affirmed that examiners would not criticize a financial institution for its efforts to implement prudent and appropriate loan workout arrangements, following a comprehensive review of a borrower’s financial condition, even if the restructured loan had weaknesses that resulted in an adverse credit classification. Additionally, the statement confirmed that examiners would not adversely classify renewed or restructured loans to borrowers with the ability to repay their debts in accordance with reasonable modified terms solely because the value of the collateral securing the loan had declined below the loan balance.
The 2009 Policy Statement provided guidance on various forms of loan workouts, including renewals or extensions of a loan’s term, the extension of additional credit or the restructuring of a loan (with or without concessions), and it addressed supervisory expectations for prudent risk management elements in a financial institution’s loan workout program. Additionally, it discussed assessments of collateral values, and the evaluation of appraisals for loans involved in a workout.
The 2009 Policy Statement also provided guidance with respect to the classification of loans, including the classification of renewals and restructurings of maturing loans and of loans dependent on the sale of collateral for repayment. In that context, examiners were instructed not to adversely classify renewed or restructured loans to sound borrowers unless well-defined weaknesses existed that jeopardized repayment, and not to adversely classify loans solely because a borrower was associated with a particular industry that was experiencing financial difficulty. Additionally, the statement provided guidance on compliance, regulatory reporting and accounting requirements and considerations.
Finally, the 2009 Policy Statement included an appendix consisting of a series of examples of commercial real estate loan workouts, for illustrative purposes, which were intended to demonstrate the analysis employed by bank examiners to arrive at an appropriate credit classification for renewed or restructured loans, and to assess accounting and reporting treatment.
Highlights from the 2023 Policy Statement
The 2023 Policy Statement builds on (and supersedes) the 2009 Policy Statement. It reiterates and reaffirms the key principles from the 2009 Policy Statement and reinforces the message that financial institutions should work prudently and constructively with creditworthy borrowers who may be experiencing financial difficulties (while also clarifying that this message applies in all economic cycles).
The new policy statement, like the 2009 Policy Statement, is intended to promote supervisory consistency among bank examiners, and to enhance the transparency of commercial real estate loan accommodation and workout arrangements. It is important to note, however, that the policy statement does not affect the existing regulatory reporting requirements or guidance provided in relevant interagency statements issued by the Agencies, or the accounting requirements under U.S. generally accepted accounting principles (“GAAP”).
The 2023 Policy Statement also updates and expands on the 2009 Policy Statement in a number of ways. Most notably: (1) it adds a new discussion of short-term loan accommodations; (2) it expands guidance regarding the evaluation and assessment of guarantors, to also encompass loan sponsors; (3) it incorporates information about changes to accounting principles since 2009; and (4) it updates and expands the illustrative examples of commercial real estate loan workouts.
SHORT-TERM LOAN ACCOMMODATIONS:
One of the key changes included in the 2023 Policy Statement is the addition of a discussion of short-term or temporary loan accommodations. The statement distinguishes such short-term arrangements from long-term, more complex workouts and restructurings.
While the distinction is not a bright line rule, the statement identifies agreements to defer payments, make partial payments, forbear on delinquent amounts, temporarily modify a loan or contract or provide other short-term assistance or relief to a borrower experiencing a financial challenge, as examples of short-term loan accommodations. By contrast, the statement identifies renewals or extensions of a loan’s term, granting additional credit to improve prospects for overall repayment, and restructurings (with or without concessions) involving formal, legally enforceable modifications to a loan’s terms as examples of long-term workout arrangements.
The statement encourages financial institutions to work prudently with borrowers undergoing financial stress by entering into appropriate short-term loan accommodations before a loan reaches a workout scenario. It specifically notes that such a course of action may mitigate long-term adverse effects on borrowers and can often be in the best interest of financial institutions in addition to their borrowers. The statement then goes on to provide additional guidance with respect to prudent risk management practices and appropriate internal controls in the context of short-term loan accommodations.
EVALUATION AND ASSESSMENT OF GUARANTORS AND SPONSORS:
While the 2009 Policy Statement specifically identified the support provided by guaranties from financially sound guarantors as a factor that bank examiners consider in determining credit classifications for workouts, the 2023 Policy Statement goes a step further to extend that analysis to the sponsorship of a commercial real estate borrower. The new policy statement notes that examiners will review the finances and incentives of sponsors that support a loan, even though those sponsors may not be legally obligated to repay the debt and acknowledges that such sponsors may be similar to a guarantor in terms of their capacity, willingness and incentives to pay debt service, to make principal curtailments, or to otherwise support a loan.
UPDATES TO ACCOUNTING STANDARDS:
The 2023 Policy Statement also addresses and discusses accounting changes and updates to GAAP since 2009, including changes relevant to estimating loan losses. Those changes include adding new accounting and regulatory guidance related to Current Expected Credit Losses (“CECL”) methodology (in light of the addition of the CECL methodology to GAAP, in accounting standards issued by the Financial Accounting Standards Board (“FASB”) in 2016), while removing all discussion of troubled debt restructuring (“TDR”) accounting (as a result of the FASB’s decision to eliminate the reporting of TDRs completely, as of year-end 2023).
REVISIONS AND ADDITIONS TO LOAN WORKOUT EXAMPLES:
Finally, the 2023 Policy Statement updates and adds to the 2009 Policy Statement’s appendix of illustrative examples of workout scenarios for commercial real estate loans, and the classification and accounting considerations applicable to those example arrangements.
Among the entirely new examples are: (i) several workout scenarios in the context of a loan secured by an income-producing hotel property; (ii) several workout scenarios in the context of a loan for acquisition, development and construction of residential properties; and (iii) several workout scenarios in the context of a loan secured by multifamily residential real estate (including seemingly pandemic-inspired scenarios involving moratoriums on residential evictions). Additionally, the 2023 Policy Statement makes various updates to the existing examples and scenarios, to reflect the current guidance and updates made elsewhere in the statement, as well as to reflect some recent broader trends affecting commercial real estate. For instance, the 2023 Policy Statement adds references to greater consumer reliance on e-commerce in the workout scenarios for a shopping mall loan, and references to hybrid work-from-home arrangements in the office property workout examples.
However, it is worth noting that despite having added an entirely new discussion of short-term loan accommodations to the policy statement itself, the 2023 Policy Statement does not add any illustrative examples of such shorter-term, temporary arrangements to its appendix of examples.
Conclusion
On its face, the 2023 Policy Statement does not appear to be an attempt by regulators to sound alarm bells over some impending crisis or to reign in commercial real estate lending by supervised financial institutions. It does, however, come as a timely reminder to those financial institutions to evaluate whether they have prudent risk management policies and practices, sound internal controls and appropriate regulatory reporting practices in place with respect to loan accommodations, workouts and restructurings.
Likewise, while nothing in the 2023 Policy Statement is particularly ground-breaking or revolutionary, the statement should help to increase supervisory flexibility and transparency. It also provides an important reaffirmation of the 2009 Policy Statement’s overall message on the importance of financial institutions working prudently with commercial real estate borrowers through all economic cycles. It is a message particularly relevant in the current uncertain climate of rising interest rates, inflationary pressures and continued supply chain and labor disruptions, all of which are likely to have an impact on the financial condition and repayment capacity of at least some commercial real estate borrowers.
1. Office of the Comptroller of the Currency: Docket ID OCC-2022-0017.
Federal Deposit Insurance Corporation: RIN 3064-ZA33.
National Credit Union Administration: Docket No. 2022-0123.
Federal Reserve System: Docket ID OP-1779.
