Does Capital Market Scrutiny Discourage Banks from Accommodating Distressed Borrowers?

To encourage banks to accommodate distressed borrowers during the COVID-19 pandemic, regulators redacted loan modification activity from each bank’s public regulatory filings so that banks could modify loans free from capital market scrutiny. Congress also superseded U.S. GAAP by allowing banks to modify loans without disclosing them as “troubled debt restructurings” (TDRs). This study examines whether capital market scrutiny does in fact discourage banks from making loan modifications, as posited by bank regulators. To test this question we exploit the fact that the SEC still required public banks to disclose the modifications, meaning that the type of bank that faces the most capital market scrutiny (public banks) had to disclose loan modifications, while the type of bank that faces the least capital market scrutiny (private banks) faced even less scrutiny of loan modifications due to lack of disclosure. Using a measure of the extent to which banks delay collection of loan payments, which we find to be highly correlated with actual modification activity disclosed by public banks, we do not find significant differences in loan modification activity between public and private banks during the pandemic. Prior to the pandemic we also do not find a difference in modification activity between these two groups, as measured by TDRs. Additional analysis reveals that during this time period disclosed TDRs are informative for estimating future chargeoffs. Overall, the results are not consistent with the idea that suppressing information about loan modifications encourages additional modification activity