April 2020 OBA Legal Briefs

• Coronavirus and Assisting Customers
  • Modify Policies—COVID-19 addendums
  • Assisting borrowers
    • New loans
    • Loans past due or about to be
    • Limits on fee, penalties and interest
    • Regulatory reporting
    • Credit bureau reporting

Coronavirus and Assisting Customers

By Andy Zavoina (with Pauli Loeffler)

There is a risk balance that banks must follow so that in six months or at your next exam, you will say, “we helped” rather than “we were damned if we did, and damned if we didn’t.” I’ve heard one property manager say she received text messages from renters verifying that because of the coronavirus there is no rent owed for the next month. The press is advertising that evictions and foreclosures have been stopped and small business loans are available (even before the House passed the CARES Act). People do not grasp that a stoppage because courts are closed and collection actions are delayed to avoid “kicking someone who is down,” will at a time resume and the obligations to pay as agreed will mean past due payments must be paid. Enter regulatory notices that encourage lenders to work with customers. The New York Times had an article on March 22, 2020, that began:

U.S. federal and state financial regulators are encouraging lenders to help borrowers affected by the coronavirus, and will not penalize them for doing so…

The regulators said they will not criticize banks for ‘safe and sound’ loan modifications or direct the lenders to categorize them as ‘troubled debt restructurings’ —something that could affect their financial wellness.

That sounds helpful, but nowhere does it say a borrower will not be responsible to make a payment. It does say a bank must act in a safe and sound manner. If a bank does not, it will be held accountable. Historically, after some form of government bailout or immediate reaction to a crisis such as with the recent $2 trillion stimulus package, enforcement actions increase. Fraud happens. Sometimes it is intentional and sometimes it is not, but it is looked for. What can a bank do to assist its customers in these very strange times of massive business closings with so many customers without cash reserves and without a paycheck? This landscape is changing fast and information is being updated daily. Stay on top of your daily regulatory updates.

A few weeks ago I was asked about extending mortgage loans for borrowers for 90 days. My first thought was “we never extend mortgages due to all the paperwork and costs.” But my, oh my! White flags began flying and the government recognized that consumers were deep in critical times. Shelter in place orders have been extended and schools are staying closed. Workers are being laid off literally by the tens of thousands. This begs the question, is 90 days of relief enough? Banks are getting in a mode of “ready, fire, aim” as they try to meet the needs of borrowers and the CARES Act. You’ll read more on this below. The Act will give many mortgage borrowers nearly a year of forbearance. Ninety days just isn’t enough for many.

What can banks do to assist borrowers but do so in a safe and sound manner? We may have to assume “safe and sound manner” is a subjective term. It certainly has a different meaning based on the condition of the bank and its region during a COVID-19 economy than it did last December when borrowers simply wanted loan extensions for holiday bills. Times are different now, but what will be said about a bank’s reaction a year after the pandemic is over?

Modify Policies—COVID-19 Addendums

In June 2000 the FFIEC established policy standards under the Uniform Retail Credit Classification and Account Management Policy imposing controls that are still followed today. This policy:

1) Required banks to establish explicit standards that control the use of extensions, deferrals, renewals, and rewrites for closed-end loans
2) Allowed an additional re-age of open-end credits in formal workout or debt management programs that meet all other re-aging requirements; and
3) Extended the charge-off time frame for open-end and closed-end retail loans secured by one- to four-family residential real estate to 180 days past due.

The Federal Register (65 FR 36903, June 12, 2000, at https://www.federalregister.gov/d/00-14704) defined standards on re-aging accounts. The term “re-age” is defined as “returning a delinquent, open-end account to current status without collecting the total amount of principal, interest, and fees that are contractually due.” The context of this policy is addressing troubled debts. But regulators began asking banks to have a policy addressing extending or deferring loan payments. I will use the term “extension” here to mean allowing a borrower to extend the loan by making an agreement with the lender to defer one or more periodic payments to the end of the contract. The amount of interest owed, or a specific fee is charged for this or may be waived under some circumstances. In the case of loans past due, what examiners did not want to see was a poor payment history and multiple extensions applied to a loan to bring it current without a plan for future payments. This was hiding past due accounts and was both misleading and an unsafe and unsound practice. Open-end loans were limited to one extension in a 12-month period and twice in five years. The June 2000 policy did not state that same limit for closed-end loans, but I have heard of examiners interpreting it to mean closed-end loans as well. In any case, a bank should have a policy or internal guidance on when extensions are allowed, why, how many may be applied at one time, how many are allowed in a year, over the life of the loan, and who can approve extensions as well as who can approve any exception to these internal requirements.

Criteria for extensions other than those offered during the holidays includes answering various questions similar to the underwriting process:

1) Why is the extension needed?
2) Will interest owed be paid at the time of the extension?
3) What is the recent payment history?
4) What is the plan for future payments, and how have financial conditions improved?
5) Is there loan collateral?
6) And particular to mortgages, is this in a flood zone (requiring signed disclosures), are mortgage documents necessary to be filed with the county, are we escrowing, and what happens to the accruals for those expenses?

Another issue deserving attention is an underwriting policy. A business loan may require several years of tax returns and other financials. In today’s CARES Act economy the policy needs to address new underwriting requirements. The lender’s highlights for the Paycheck Protection Program defines only four criteria to make a 100 percent Small Business Administration guaranteed loan:

1) verify that a borrower was in operation on February 15, 2020
2) verify that a borrower had employees and paid salaries and payroll taxes
3) verify the dollar amount of average monthly payroll costs
4) follow BSA requirements.

Obviously, there is more needed behind the scenes such as verifications of how many employees there are, etc. The SBA is getting pushback on some of these issues from big banks and is considering revising the guidance to increase acceptance by lenders. The loan programs are still developing as well as are compliance rules. It does make it difficult to follow this path when parts are being made up as we go. It’s important you keep abreast of the changes.

Your bank may have one or more policies addressing Troubled Debt Restructuring (TDR), extensions, and other workout issues. These may need an emergency addendum as it is unlikely any were created for the recent massive and critical changes in our economy.

Assisting Borrowers

What can your bank do today to assist borrowers? The information above leads us to this. In general, new loans can be made, HELOCs and other lines may be increased, and existing loans can be renewed, modified, or extended to assist your borrowers. While the demands are to react at a moment’s notice, the bank must act deliberately. Coordinate what is being done internally. It may not be necessary to have an amended policy board-approved prior to implementation for emergency purposes. Let management use its authority to react as needed and have the staff such as Compliance, Audit and lenders amend policies and procedures for appropriate approvals. Inform the bank’s CRA officer of the concessions being made to address customers affected by COVID-19 and keep examiners informed as to what the bank is doing on both the Lending and Operations sides of the bank.

New Loans

Section 1102 of the CARES Act addresses the Paycheck Protection Program. This is a commercial loan designed to provide a direct incentive for businesses to keep their workers on the payroll. These workers are your consumer and mortgage borrowers. The SBA will forgive loans if all the employees are kept on the payroll for eight weeks after the loan is made and the money is used for payroll, rent, mortgage interest, or utilities. The PPP will be available April 3 – June 30, 2020.

All federally insured banks can make PPP loans with a fast SBA approval. Banks can have lenders apply with the SBA online and we are hearing that in 36 to 48 hours lenders who are not yet SBA-approved can be approved. The bank can be paid a processing fee based on the loan balance for making these loans, based on tiers. Loans of $350K and less pay 5 percent to the lender, $350K to $2 million pay 3 percent and those greater than that pay 2 percent (check current information for any changes). The four underwriting criteria are outlined above.

You may also want to pay attention to bullet 1 in that underwriting list as to a date recognized as the beginning of the COVID-19 period. And if the bank is interested these PPP loans may be sold in the secondary market.

Banks can promote special loan products or the same products that were being offered a year ago. Rate considerations may be offered or deferred first payment dates. There are still qualified borrowers out there, but fewer. Some employees are more secure than ever and are creditworthy.

Loans Past Due or About to Be

Be proactive and communicate with your borrowers before they are past due. On March 22, 2020 the Fed, FDIC, NCUA, OCC and CFPB published an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus.” This statement encourages banks to work with borrowers. It also provides encouragement to work with borrowers who “are or may be unable to meet their contractual payment obligations because of the effects of COVID-19.” Add emphasis to “are or may be” and consider seeking out borrowers in advance of a payment difficulty. The bank may offer a lot of relief when payments may be deferred, and the contract extended. It provides goodwill and avoids a bump in past due loans. The statement goes on to say the “agencies will not criticize institutions for working with borrowers and will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as troubled debt restructurings (TDRs)” but it also points out that any modifications and actions taken must be consistent with safe and sound practices. The bank does not want to assist borrowers through special programs only to have those loans classified later as TDRs. Banks are still encouraged to work with classified and “special mention” loans as well.

The Statement went on to say “The agencies have confirmed with staff of the Financial Accounting Standards Board (FASB) that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not TDRs.” From the FDIC’s FIL-50-2013, “A TDR designation means a modified loan is impaired for accounting purposes, but it does not automatically result in an adverse classification. A TDR designation also does not mean that the modified loan should remain adversely classified for its remaining life if it already was or becomes adversely classified at the time of the modification.” So, a TDR doesn’t immediately require a classified loan status, but it is not far away. The bank may assume that borrowers who are current on payments are not experiencing financial difficulties at the time of the modification for purposes of determining a TDR status. When this is the case, no further TDR analysis is required for the loan.

Loan modifications and loan extensions may be a banks preferred options to address existing loans and avoiding past dues and the costs associated with them both in collection activity and additional ALLL reserves. Issues to keep in mind include training and applying the bank’s policy addendum and procedures consistently.

As to extensions of payments, consumer loan payments may be deferred either before or after default, but the agreement must be in writing. The bank can charge an extension fee, but it cannot charge both an extension fee and a late fee. The advantage— particularly if the borrower is more than 30 days late—is it will not be reported negatively to the credit bureau. The bank can contract for several extensions at once to advance the due date by several months, and then revisit the circumstances when payments are due to resume. The loans principal does not increase but interest continues to accrue.

Some issues to consider in your written extension agreements include requiring or reminding the borrower that insurance on collateral such as a vehicle must be maintained during this period. If your bank issues credit life or disability insurance, double check the policy and notify your borrower of any issues there. Some policies track only the originally scheduled amortization and do not extend coverage when there is a payment extension. A borrower extending a loan several times over the life of a loan may have no insurance for the last unscheduled payment periods which resulted from the extensions.

It is recommended that you accurately document the loan status when the extensions are granted, was it a 30 or 60 day or worse status, was the arrearage caused directly or indirectly by COVID-19 (document that briefly), and what are the prospects that once the extension period is over the borrower will be able to resume payments?

When on the loan desk my bank looked at the period the borrower was employed at their job. We often worked with borrowers in lower income positions who were employable at many places. For example, a person who was a cook or waitstaff was employable at many types of restaurants and unemployment periods would be brief as they often went from job to job. That is not the case today and these are some of the most unemployed folks during the current crisis. Documenting facts such as this may justify allowing multiple loan extensions at one time. If the coronavirus curve flattens in two months and the economy returns to a near normal state, positions for this group of workers will fill quickly. But at that time, those who have been unemployed may have rent and mortgage payments stacked up along with utilities, and most borrowers pay those bills before a signature loan at your bank. For this reason, a buffer month or two is recommended. This may be one of the reasons the CARES Act is providing such an extended period for mortgage extensions of up to a year.

How many deferrals/extensions should be granted? That can be up to the bank and the policy in effect. In 2019 that may have been two payment extensions in a year. In 2020 it may be three or six. It is recommended that management decide, based on its market, what is reasonable and reduce that to a policy.

Because we have limited guidance as to what an examiner may feel is acceptable, the Compliance Officer or a member of senior management, or both, may want to have a call with the bank’s examiner in charge and say, “this is what we are implementing” and explain why, and how many extensions will be allowed based on what circumstances. Then, what happens if the quarantine period is extended? Will more extensions be allowed? Don’t ask the examiner to approve your policy as they do not manage the bank, just ask what their impressions would be. This may provide the bank with an opportunity to avoid criticism later or hear that an even more flexible policy would be considered safe and sound. The intent here is not to hide any past due loans, but to work with good borrowers and help protect their credit ratings during these difficult times.

Keep in mind that most real estate secured loans are only subject to disclosure and remedy provisions of the U3C, but Reg Z does at least talk about “skip-a-payment” extensions and that neither late fees nor extension fees are considered finance charges. The written extension agreement would supersede application of payment provisions which usually state that payments are applied first to interest, then principal, and finally late fees. Extension agreements can be used with real estate secured loans and these can be done in the same manner as for U3C covered loans, and address escrows. Check with your forms vendor or counsel on the use of forms.
In the case of mortgages, the bank is extending the loan. That is a MIRE (Make, Increase, Renew or Extend) event and under the flood rules the bank may need to check the flood status of the property and if it is in a Special Flood Hazard Area, disclose that and have an acknowledgment from your borrower signed.

The bank needs to address escrows if there are any. Ask whether they must be paid, or may they go unpaid as well? I understand there are different approaches to this question. Some banks will not collect any part of the mortgage payments at this time and will adjust the final payment of the loan to include the extension fees, but I also hear about banks that are requiring the escrow portions to be paid and are staying in a 90- to 120- day range for extensions. While some banks are planning to capitalize interest, not all are. In any discussion with your EIC it may be wise to inquire about this, because the agencies don’t seem to be handling the nuances of the CARES Act, TDR and Generally Accepted Accounting Principles uniformly.

Section 4022 of the CARES Act will allow government-supported loan borrowers such as those with loans from Freddie, Fannie and the VA, to request a forbearance for 180 days if they were impacted by COVID-19, and at the end of that period another 180-day forbearance period can be requested. There are new rules to provide these extensions (modifications) and to show the loans as current, and not past due. More on that below.

Section 4022 is targeted at 1-4 family dwellings meeting certain qualifications. It must be a federally backed mortgaged meaning it is:

a) insured by the Federal Housing Administration
b) insured under section 255 of the National Housing Act
c) guaranteed under section 184 or 184A of the Housing and Community Development Act of 1992
d) guaranteed or insured by the Department of Veterans Affairs
e) guaranteed or insured by the Department of Agriculture
f) made by the Department of Agriculture; or
g) purchased or securitized by the Federal Home Loan Mortgage Corporation or the Federal National Mortgage Association.

Many of the loans your bank is servicing in-house may not qualify for such a lengthy extension period as the government programs backing the covered loans adds to the safety and soundness of the loan, meaning there is less risk to the lender. Instead of six months, the bank may adopt a standard three or four payment limit or may factor the current loan to value ratio into the decision and base the period deferred in part on that. Like the extensions discussed above, I recommend documenting what happened and what is projected to happen.
For the loan qualified under Section 4022, during the covered period, a borrower experiencing a financial hardship due, directly or indirectly, to the COVID–19 emergency may request forbearance by:

a) submitting a request to the borrower’s servicer; and
b) affirming they are experiencing a financial hardship during the COVID–19 emergency

That’s all the CARES Act calls for. It does not allow for the any forms or questions, but this applies only to the government backed mortgages.

Limits on fee, penalties and interest

Section 4022 goes on to describe the servicer’s requirements. “Upon receiving a request for forbearance from a borrower…the servicer shall with no additional documentation required other than the borrower’s attestation to a financial hardship caused by the COVID–19 emergency and with no fees, penalties, or interest (beyond the amounts scheduled or calculated as if the borrower made all contractual payments on time and in full under the terms of the mortgage contract) charged to the borrower in connection with the forbearance, provide the forbearance for up to 180 days, which may be extended for an additional period of up to 180 days at the request of the borrower, provided that, the borrower’s request for an extension is made during the covered period, and, at the borrower’s request, either the initial or extended period of forbearance may be shortened.” Specifically mentioned are “fees, penalties, or interest” but escrow payments are not referenced. We hope there will be clear guidance on this, so banks will know whether escrow payments may or may not be suspended or postponed. Absent this, banks may need to run an analysis of what the cost of paying taxes and insurance will be to avoid surprises later. There will be more impact based on the number of extensions, amounts of escrow payments and the timing of the escrow funds paid out. The escrow analysis may indicate the bank will be making a large amount of interest free loans as borrowers repay the deficiencies and shortages slowly.

Apart from the CARES Act, if an Oklahoma mortgage states a maturity date or the maturity date is ascertainable (you or counsel needs to review your documents), Sec. 301 of Title 46 requires foreclosure to be commenced within six years of that date, so it is relatively safe to not file notice of extension for a short extension. An extension for a year would not be a short term. On the other hand, if the mortgage neither states a maturity date nor is it ascertainable from the mortgage, the mortgagee must file a notice of maturity within 30 years of the date of the mortgage. So, if it is a 30-year mortgage with no maturity date, a short extension in such case could impede the bank in a worst-case scenario. If the bank is unsure which applies, the best action is to file.

Whether the loan is a mortgage or consumer loan, a modification may the solution to a problem. The June 2016 Legal Briefs has an excellent article explaining the differences between a modification and a renewal/refinance. A new loan created by the latter would require all the Reg Z and TRID disclosures applicable to the loan. A modification does not, and this why it is the easier and less costly process. Payment extensions may be the simplest solutions, especially for consumer installments. Some banks are being proactive and contacting consumers to offer no cost, three payment extensions.

Regulatory reporting

There is more confusion based on guidance documents and, in this case, I’m referring to credit reporting. The document is the FDIC’s March 27, 2020 FAQs addressing working with borrowers (at https://www.fdic.gov/coronavirus/faq-fi.pdf). In question 2, the FAQ discusses the credit reporting of loans which have had payment extensions. The first paragraph says, “Past due reporting status in regulatory reports should be determined in accordance with the contractual terms of a loan, as its terms have been revised under a payment accommodation or similar program provided to an individual customer or across-the-board to all affected customers. Accordingly, if all payments are current in accordance with the revised terms of the loan, the loan would not be reported as past due.” This makes sense because a loan that receives an extension advances the due date and is not contractually delinquent. The loan system would show it as current on regulatory reports and to the credit bureaus.

The second paragraph in questions 2 states, “For loans subject to a payment deferral program on which payments were past due prior to the borrower being affected by COVID-19, it is the FDIC’s position that the delinquency status of the loan may be adjusted back to the status that existed at the date of the borrower became affected, essentially being frozen for the duration of the payment deferral period For example, if a consumer loan subject to a payment deferral program was 60 days past due on the date of the borrower became affected by COVID-19, an institution would continue to report the loan in its regulatory reports as 60 days past due during the deferral period (unless the loan is reported in nonaccrual status or charged off).” This then indicates that if a borrower was, for example, one payment past due, and then lost his job due to a government-mandated closure and could not make his next two payments, the bank could extend only the two payments owed after the closure or at least would report it as a month past due. I do not see a bank handling one past due loan in two ways. The bank would collect what it can for three extensions in total. Systems will typically not advance a due date, but still report a loan as still delinquent. Note, though, that the reporting described in the FDIC’s FAQ is regulatory reporting, not reporting to credit bureaus.

Credit bureau reporting

The CFPB on April 1 provided credit bureau reporting guidance in its “Statement on Supervisory and Enforcement Practices Regarding the Fair Credit Reporting Act and Regulation V in Light of the CARES Act” and stated, “As lenders continue to offer struggling borrowers payment accommodations, Congress last week passed the CARES Act. The Act requires lenders to report to credit bureaus that consumers are current on their loans if consumers have sought relief from their lenders due to the pandemic. The Bureau’s statement informs lenders they must comply with the CARES Act. The Bureau’s statement also encourages lenders to continue to voluntarily provide payment relief to consumers and to report accurate information to credit bureaus relating to this relief.” This indicates that when a loan date is advanced due to an extension, COVID-19 or not, that is the correct way to report the loan. The CFPB does have authority over Reg V.

The CFPB also recognizes that loan departments are strained due to COVID-19 personnel shortages. It notes that if there are FCRA dispute investigations that are not handled in a timely manner the CFPB does not intend to cite this in an exam nor bring any enforcement actions because of it. Hopefully the other agencies will follow suit.