What the CARES Act is Missing

Rethinking CARES Act Incentives: Unleashing the Power of Out-of-Court Workouts in a Post-Pandemic Landscape

The COVID-19 pandemic has inflicted unique hardship on businesses, regardless of their financial health or innovation. This unprecedented crisis demands a novel approach to loan restructuring, one that prioritizes out-of-court workouts for maximum value preservation. While the CARES Act offers valuable regulatory relief to banks engaging in such workouts, it falls short in providing the crucial financial incentives to truly drive widespread adoption.

The Imperative for Out-of-Court Workouts:

In traditional bankruptcy proceedings, secured loans and their underlying collateral often suffer significant devaluation, leading to heightened net losses for banks. Out-of-court workouts, however, offer a more promising path. By collaboratively restructuring loans outside of the courtroom, all stakeholders – borrowers, lenders, and investors – can experience greater value preservation. This benefit stems from avoiding costly legal fees, preserving business continuity, and minimizing collateral erosion.

CARES Act: A Stepping Stone, Not the Destination:

The CARES Act recognizes the importance of out-of-court workouts by providing temporary regulatory relief for banks engaging in loan modifications related to COVID-19. For instance, Section 4013 suspends Troubled Debt Restructuring (TDR) accounting requirements for certain modifications, while Section 4014 grants reprieve from the CECL methodology for estimating credit losses. These measures aim to reduce regulatory burdens and encourage banks to engage with borrowers.

The Missing Link: Financial Incentives, the Key to Unlocking Workouts:

While the CARES Act paves the way for more flexible loan modifications, it fails to address the critical factor holding back widespread adoption: a lack of tangible financial incentives for banks. The current regulatory relief, though helpful, does not directly impact a bank's income statement, which remains subject to GAAP accounting. This can be a major deterrent for bank executives concerned about explaining potentially inflated loan losses to shareholders.

Tax Breaks: The Catalyst for Increased Workouts:

To truly unlock the power of out-of-court workouts, the CARES Act needs to be amended to incorporate financial incentives for banks. One effective approach would be to offer reduced taxes on income derived from loans successfully restructured or worked out as a result of COVID-19. This direct financial benefit would significantly increase the appeal of out-of-court solutions for banks, leading to a more active and efficient loan restructuring landscape.

Conclusion:

In the post-pandemic era, with its unique economic challenges, out-of-court workouts present a critical tool for safeguarding the interests of both borrowers and lenders. While the CARES Act provides a valuable starting point, its effectiveness can be significantly enhanced by introducing tax incentives for banks. By bridging the financial incentive gap, we can unleash the full potential of out-of-court workouts, allowing businesses to recover, rebuild, and contribute to a stronger, more resilient economy.

This revised version maintains the conciseness of the previous draft while providing more context and justification for the proposed solution. I hope this meets your expectations!