On June 30, 2023, the Federal Reserve Board, Treasury Department, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency and National Credit Union Administration (the agencies) published a final joint policy statement on “Prudent Commercial Real Estate Loan Accommodations and Workouts.” The 2023 policy updates and supersedes a policy statement on the same topic adopted on Oct. 30, 2009.
Adopted in the aftermath of the 2008 financial crisis, the 2009 policy provided guidance to financial institutions supervised by the agencies to navigate the uptick in commercial real estate (CRE) borrowers experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial real estate.
To that end, the 2009 policy was grounded in the principle that prudent CRE loan accommodations and workouts often are in the best interest of financial institutions and borrowers and, as a consequence: (1) examiners will not criticize financial institutions that implement prudent accommodation arrangements, even if modified loans result in adverse classification; and (2) modified loans to borrowers that have the ability to pay their debts will not be adversely classified solely because of a decline in the value of the underlying collateral.
The 2023 policy explicitly reaffirms this principle and offers expanded guidance in several key areas. Notably, it offers guidance specific to short-term loan accommodations, provides for assessment of loan sponsors in addition to guarantors, and incorporates information about changes to accounting principles since 2009. The 2023 policy also reflects certain changes and explanations resulting from 22 unique comments from banking organizations, credit unions and others and provides three new examples of CRE loan workout arrangements.
As the commercial real estate market faces new challenges analogous to those that arose in 2009, this updated and expanded guidance will be beneficial in determining what an examiner will consider when analyzing the adequacy of a financial institution’s workout of a troubled CRE loan. The 2023 policy notes, however, that the guidance set forth is designed to apply in all stages of the economic cycle.
Short-Term Accommodations vs. Long-Term Workouts
A significant change in the provided guidance is the 2023 policy’s distinction between short-term loan accommodations and long-term modifications, workouts and restructurings. The agencies recognized that certain circumstances may call for short-term loan accommodations as a tool to mitigate adverse effects on borrowers during periods of financial stress. While commenters requested more specific guidance on the definition of a short-term accommodation, the agencies declined, finding the 2023 policy sufficiently differentiates between short-term accommodations and long-term workouts while maintaining flexibility for financial institutions.
The 2023 policy, without drawing a bright line, does provide more detailed guidance for short-term, informal arrangements, including the deferral of payments, the making of partial payments, forbearances with respect to delinquent amounts, temporary modifications of loans or contracts, and the provision of other short-term assistance or relief to a borrower experiencing a financial challenge. If such short-term accommodations are not successful, the 2023 policy provides guidance for more complex, formal workouts, including renewals or extensions of loan terms, granting additional credit or restructuring the loan.
In implementing the guidance for short-term accommodations, the 2023 policy repeats the recommendation that financial institutions adopt prudent internal controls, including comprehensive policies and practices, necessary management approvals, an ongoing credit risk review function, and timely and accurate reporting obligations. For long-term workouts, the 2023 policy recommends more detailed, forward-looking analysis of service coverage, including realistic projections of the borrower’s cash flow, as well as the availability, continuity and accessibility of repayment sources.
Guarantors and Sponsors
The 2009 policy contemplated the evaluation of guarantors when assessing the quality of a loan. The 2023 policy extends that analysis to the sponsors of the real estate borrower. The updated guidance notes that examiners will review the finances and incentives of sponsors that support a loan, even if those sponsors are not legally obligated to repay the loan.
Loan Accounting Standards
The 2023 policy changes include adding new accounting and regulatory guidance related to the current expected credit losses methodology issued by the Financial Accounting Standards Board (FASB) in 2016. Notably, the 2023 policy removes any discussion of troubled debt restructuring accounting, consistent with the FASB’s recent guidance on that subject.
Clarification of Examiner’s Role
In response to questions from commenters regarding the scope of an examiner’s review, the agencies affirmed that the role of an examiner is to review and evaluate the information provided by financial institution management to support its valuation and not to perform a separate, independent valuation. An examiner may adjust an estimated value of collateral for credit analysis and classification purposes when the examiner can establish that underlying facts or assumptions presented by the financial institution are irrelevant or inappropriate.
The 2023 policy also clarified that examiners should focus on existing local and state market conditions versus the referenced “general market conditions” to further align with real estate lending standards and requirements.
Although the 2023 policy adheres to the principles enacted following the 2008 financial crisis, financial institutions should be cognizant of the updated and more detailed guidance. This guidance should be helpful in navigating market uncertainties related to rising interest rates, inflation, and ongoing labor and supply-chain disruptions. The expanded examples in Appendix 1 to the 2023 policy also provide real-world circumstances to guide institutions when deciding the arrangements in a CRE loan workout.