Forbearance

Forbearance is the practice by which a lender agrees to relax the terms of a loan, or to hold back from enforcing its rights, because the borrower is having or is about to have difficulty meeting its obligations. Typical measures are a temporary reduction or suspension of payments, an extension of the term, a lower interest rate or the adding of arrears to the balance. The aim is to give a viable borrower time to recover and to avoid the losses that default, repossession or insolvency would cause to both sides.

The word is used in consumer lending, especially for a mortgage or student loan, and in commercial lending, where a formal forbearance agreement follows a default or covenant breach. It also has a precise regulatory meaning for banks, which must identify and report forborne exposures. A separate usage, regulatory forbearance, describes supervisors choosing not to enforce rules against a weak institution.

• Payment holiday or deferral. Payments are paused or reduced for a set period; interest usually continues to accrue. See payment holiday.
• Interest-only period. The borrower pays interest but no principal for a time.
• Term extension. The maturity is lengthened to lower each instalment.
• Rate reduction. The interest rate is cut, temporarily or permanently.
• Capitalisation of arrears. Missed payments are added to the loan balance and repaid over the remaining term.
• Partial forgiveness. Part of the debt is written off, generally as a last resort.
• Standstill. In corporate lending, lenders agree for a defined period not to accelerate the debt or enforce security while a plan is negotiated.

Short-term measures suit a temporary problem such as illness or loss of a job. Where the difficulty is lasting, a permanent loan modification or a wider loan restructuring is needed. Forbearance differs from a loan covenant waiver: a waiver removes the breach, whereas under forbearance the default remains and the lender merely agrees not to act on it for a time.

In the European Union, the European Banking Authority defines forbearance measures as concessions made to a debtor that is experiencing or about to experience difficulties in meeting its financial commitments. A concession is either a change to the contract terms that would not have been granted had the borrower not been in difficulty, or a full or partial refinancing on the same basis. Both elements are needed: a commercial renegotiation with a healthy borrower is not forbearance.

Forborne exposures are reported separately and may be performing or non-performing. A forborne loan classed as a non-performing exposure can return to performing status only after a cure period of at least one year in which the borrower has paid as agreed and no concern remains about full repayment. It then stays flagged as forborne for a probation period of at least two years. If a second concession is granted or the loan falls more than thirty days past due during probation, it is reclassified as non-performing. These rules are designed to stop banks from disguising bad loans by repeatedly rescheduling them.

Under IFRS 9, granting forbearance is evidence that credit risk has risen. The loan will normally be treated as having had a significant increase in credit risk, moving it to Stage 2 with a lifetime expected credit loss allowance, or to Stage 3 if it is credit-impaired. When contractual cash flows are changed, the lender recalculates the carrying amount using the original effective interest rate and recognises a modification gain or loss; a substantial change leads to derecognition of the old loan and recognition of a new one.

In the United States, the long-standing category of troubled debt restructuring was removed from accounting standards for lenders that had adopted the current expected credit loss model, with effect from 2023, and replaced by disclosures about modifications made to borrowers in financial difficulty.

Many jurisdictions require lenders to consider forbearance before taking enforcement action. In the United Kingdom, regulators expect firms to treat customers in arrears fairly and to consider options suited to their circumstances. In the United States, the servicers of federally backed mortgages must offer loss mitigation, and during the pandemic the CARES Act of 2020 gave borrowers with such mortgages a right to request forbearance for up to 180 days, extendable for a further period, without proof of hardship. Payment moratoria on a similar model were introduced in many other countries. The practical handling of requests, documentation and reporting to credit bureaus falls to loan servicing teams.

Forbearance can preserve value, but it can also postpone the recognition of losses. Lenders may be tempted to extend failing loans in the hope of recovery, or simply to avoid booking provisions, a practice often described as extend and pretend. On a large scale this ties up capital in unproductive borrowers and was widely blamed for slow recoveries in Japan in the 1990s and in parts of Europe after 2010. Supervisors therefore require banks to assess whether the borrower is viable, to set clear limits on the number and length of concessions, and to move loans that cannot be cured to recovery or write-off in good time. For borrowers, deferral is not forgiveness: interest continues to build, the total cost usually rises, and a record of delinquency or forbearance may affect future access to credit.

• European Banking Authority
• Consumer Financial Protection Bureau