ChallengeswithTroubledDebtRestructuring: AccountingandReporting

JoanneWakim SeniorAccountingPolicyAnalyst FederalReserveBoard

Anycommentsorstatementsinthispresentationrepresenttheviewsoftheauthorsonlyandnotnecessarilythoseofthe FederalReserveBankofKansasCityortheFederalReserveSystem.

TroubledDebtRestructurings(TDR)Agenda
Guidance

TDRidentification Accrual, Accrual impairment impairment,andreporting

ConsiderationsinTDRaccountingandreporting

Trialmodifications Revenuerecognition accrual/nonaccrual A/Bnotesplits TDRreporting Identifyingwhetherarateisamarketrate Lossmeasurementmethods

Questionsandanswers

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TDRIdentificationandGAAPGuidance
Primarysource ofTDRGAAP guidance id

FASBAccountingStandardsCodification31040

ATDRis definedas:

AloanrestructuringormodificationoftermsisaTDR ifthecreditorforeconomicorlegalreasonsrelatedto thedebtorsfinancialdifficultiesgrantsaconcessionto thedebtorthatitwouldnototherwiseconsider. Aborrowerisexperiencingfinancialdifficultiesand Aninstitutionhasgrantedaconcessionthatitwould nothaveotherwiseconsideredifnotforthe borrowersfinancialdifficulties.

ATDR determination requires judgmentto assessif:

TDRIdentification
TwoStepProcess:
Step1: Determinewhethertheborroweris experiencingfinancialdifficulties. Indicatorsincludethefollowing: Currentorprobabledefaultinforeseeable futureonanydebt Headedtoward,orisin,bankruptcy Doubtaboutabilitytoremainagoing concern Unabletoservicedebtbasedoncurrent capabilitiesfortheforeseeablefuture Inabilitytoobtaintakeoutfinancing Debtspecificweakness(inabilityto maintaintenants,rents,orlossofkey leadership) Step2: Determinewhethermodificationisa concession. Examplesincludethefollowing: Forgivingprincipalorinterest Modifyinginterestratetoabelowmarket rate Deferringprincipalpayments(e.g.,interest only) Extendingthematuritydate

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TDRIdentification:NewGuidance
FASBIssuedAccountingStandardsUpdate201102inApril2011
Providesclarifyingguidanceintendedtonarrowdiversityinpracticeof TDRidentification DidnotchangetheTDRdefinition

KeyPoints
Anincreaseinaborrowersinterestratedoesnotprecludea restructuringfrombeingconsideredaTDR(increaseinratemight representaconcession) Inassessingfinancialdifficulty,considerwhetherborrowermight d f l in default i the h foreseeable f bl future f Aninsignificantdelayinpaymentisnotaconcession Addingcollateralorguaranteesinexchangeforamodificationmaybe aconcessionifnotadequatecompensation

TDRIdentification:InsignificantDelay
Modificationsorrestructuringsthatresultinaninsignificant delayinpaymentarenotconcessions
ConceptofinsignificantdelayinimpairmentguidanceaddedtoTDR guidance

Insignificantdelayconceptrequiresanassessmentofboththe amountandtimingofcashflows
Amountoftherestructuredpaymentssubjecttothedelayis insignificantrelativetotheunpaidprincipalbalanceorcollateral valueofthedebtandwillresultinaninsignificantshortfall yintiming goftherestructuredp payments y isinsignificant g Thedelay relativetoanyoneofthefollowing:
Frequencyofpaymentsdue, Debtsoriginalcontractualmaturity,or Debtsoriginalexpectedduration.

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ApplyingtheGuidance:Collateral/Guarantees
Abankmayrestructureadebtinexchangeforadditional collateralorguarantees.Inthatsituation,abankhas grantedaconcessionwhenthenatureandamountofthat additionalcollateralorguaranteesreceivedaspartofa restructuringdonotserveasadequatecompensationfor othertermsoftherestructuring.

Accrual,Impairment,andReporting
Implicationsfor InterestAccrual
Bankshouldnot materiallyoverstate income. Decisiontoreturna loantoaccrualstatus shouldbebasedona sustainedperiodof performanceatthe revisedterms(e.g.,six months) months). Allamountsdue(both principalandinterest) arereasonablyassured ofcollection.

AllowanceforLoanand LeaseLosses(ALLL)
Loansthatarereported asTDRsaredeemedto beimpairedandshould generallybeevaluated basedonthepresent valueofexpectedcash flows. However,iftheloanis collateraldependent, theimpairmentshould bemeasuredbased uponthefairvalueof thecollaterallesscosts tosell.

CallReport (ScheduleRCCPartI memorandaitem1b)

Restructuredloansare reportedas restructureduntilpaid infull.However,a restructuredloanthat isincompliancewith itsmodifiedtermsand yieldsamarketrate neednotcontinueto bereported epo tedasa troubleddebt restructuringafterthe yearinwhichthe restructuringtook place.

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ConsiderationsinTDRAccountingandReporting
Applyingtheguidancerequiresjudgment
Qualitativeandquantitative Nobrightlines

Policyelections
Insignificantdelayevaluations Sufficientlygranular(e.g.byproducttype) Consistentapplication

TDRassessmentprocessshouldbereasonable,documented, andwellsupported

ApplyingtheGuidance:TrialModifications
Theremaybediversityinpracticewithrespecttothe identificationofatrialmodificationasarestructuringthat wouldbewithinthescopeofTDRaccounting. TrialmodificationsarenotautomaticallyscopedoutofTDR accounting. Severallargebanksarecurrentlydiscussingthisissuewiththe SecuritiesandExchangeCommission(SEC).

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ApplyingtheGuidance:A/BNoteStructures
Aformalrestructuringmayinvolveamultiplenote structureinwhich,forexample,atroubledloanis restructuredintotwonotes.
Thefirst,or"A"note,representstheportionofthe originalloanprincipalamountthatisexpectedtobe fullycollectedalongwithcontractualinterest. Thesecond,or"B"note,representstheportionof theoriginalloanthathasbeenchargedoff.

ApplyingtheGuidance:A/BNoteStructures
The"A"notemaybereturnedtoaccrualstatusprovided theconditionsinthep preceding gsectiononreturning gTDRs toaccrualstatusaremetand:
Thereiseconomicsubstancetotherestructuring, Theportionoftheoriginalloanrepresentedbythe"Bnotehas beenchargedoffbeforeoratthetimeoftherestructuring,and The"A"noteisreasonablyassuredofrepayment.

TheA A notemustbereportedasaTDRfortheremainder ofthecalendaryearbutneednotbereportedasaTDRin subsequentyears.

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ApplyingtheGuidance:TDRReportingIssues
Generally,onceaTDR,alwaysaTDR

NarrowTDRreportingexception
ForaTDRwithaninterestrateatorgreaterthana marketrateofinterestforthatborroweratthetimeof themodificationandthatisperformingincompliance withtherestructuredterms
Theloanisnotrequiredtobereportedincalendaryears aftertherestructuringifbothconditionsarepresent

ApplyingtheGuidance:WhenMarketsContract
Ifaborrowerdoesnototherwisehaveaccesstofundsat amarketrateforloanswithsimilarriskcharacteristicsas therestructuredloanbecausenobankisofferingthat loanproductinthemarket,therestructuringwouldbe consideredtobeatabelowmarketrate,whichwould likelyindicatethatthebankhasgrantedaconcession.

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ApplyingtheGuidance: MarketRateofInterestEvaluation
CallReportSupplementalInstructionsindicatethatin determiningwhetheraloanhasbeenmodifiedatamarket interestrate, rate aninstitutionshould:
Analyzetheborrowerscurrentfinancialconditionand Comparetherateonthemodifiedloantoratestheinstitutionwould chargecustomerswithsimilarfinancialcharacteristicsonsimilartypes ofloans.

Thisdeterminationrequirestheuseofjudgmentandshould
includeananalysisofcredithistoryandscores,loantovalue ratiosorothercollateralprotection,theborrowersabilityto generatecashflowsufficienttomeettherepaymentterms, andotherfactorsnormallyconsideredwhenunderwriting andpricingloans.

ApplyingtheGuidance:LossMeasurement
AloanrestructuredinaTDRisanimpairedloan. AllTDRsmustbemeasuredforimpairmentinaccordancewith ASCSubtopic31010, 10 Receivables Overall(formerlyFAS114, 114 AccountingbyCreditorsforImpairmentofaLoan,as amended). TDRsthataremodificationsofterms,whererepaymentis expectedfromtheborrower,aregenerallymeasuredforloss baseduponthepresentvalueofcashflows,discountedatthe loans loan soriginaleffectiveinterestrate. rate

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ApplyingtheGuidance:LossMeasurement
RegulatoryreportinginstructionsrequirethatTDRsthatare collateraldependentbemeasuredforloss,basedonthefair valueofthecollateral, collateral lesscoststosell. sell
LoansthatarecollateraldependentaredefinedinASC31030asloans forwhichtherepaymentisexpectedtobeprovidedsolelybythe underlyingcollateral. Ifaloanisrepaidthroughoperationorsaleofthecollateral,thatloan iscollateraldependentandshouldbemeasuredforloss,basedupon thefairvalue(FV)ofthecollateral.

QuestionandAnswer
Isaconcessiongrantedifthebankrestructuresthe loanfromanamortizing gloantoaninterestonly y loan?
Unlessthedeferralofprincipalpaymentisconsidered aninsignificantdelay,yes,itisaconcession.

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QuestionandAnswer
Alenderrenewsacommercialrealestate(CRE)loan (landacquisitionanddevelopment)inamarketwhere nolendersareoriginatingthattypeofloan.Isthisa TDR?
Itdependsonfactsandcircumstances. Istheloanbeingrenewedbecausetheoriginalexit strategyhasfailedandtheborrowercannotpaytheloan? Howdooperationscomparetooriginalexpectations? Baseduponcurrentforecasts,willtheborrowerscash flowsbesufficienttoservicethedebt(bothinterestand principal)inaccordancewiththecontractualtermsofthe existingagreementfortheforeseeablefuture?

QuestionandAnswer
A5yearballoonloanwithpaymentsbasedupona20 yearamortizationwasrestructuredatmaturitytoa3 yearballoonloanwithpaymentsbasedupona20year amortizationanda75bpincreaseintheinterestrate. Isthenewinterestrateaconcession?
Todeterminewhetherthemodificationisaconcession, thebankshouldperformacreditreviewoftheborrower. Istherateamarketrateofinterest?
Isthenewratecommensuratewiththeriskprofileofthe borrower? Justbecausetheratewasincreaseddoesnotmeanitisnot aconcession.

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QuestionandAnswer
ShouldaloanberemovedfromTDRreportingifthe borrowerdefaultsunderthemodifiedterms?
Asnotedabove,theonlyexceptionforTDRreportingis whentheTDRhadamarketrateofinterestatthetimeof therestructuringandisperformingincompliancewiththe restructuredterms. ATDRindefaultwouldnotmeetthatexceptionandwould thereforecontinuetobereportedasaTDR.(PastdueTDRs should h ldb bereported donRCNMemoranda). d )

QuestionandAnswer
ACREloanisrenewedwithaninterestrateconcession.The borrowerperformsunderthenewtermsforayear.Themodified rateisnowamarketrateofinterest(marketrateshavedeclined). declined) Theloanisfullysecured,baseduponarecentappraisal.While thepropertydoesntservicethedebt,theborrowersand guarantorsglobalcashflowsprovide1.1xdebtservicecoverage. CanthisloanberemovedfromTDRstatusandreturnedto accrualstatus?
Theloandoesnt doesn tmeettheexceptionandcannotberemovedfrom TDRreportingbecauseitwasnotatamarketrateofinterestatthe timeofthemodification. Theloancanbereturnedtoaccrualstatusoncetheborrowerhas demonstratedsustainedpaymentperformance(generallyconsidered tobe6months).

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QuestionandAnswer
Aloanhasbeenrestructured(i.e.partialforgivenessofdebt, reducedinterestrate,extendedmaturity)withtheborrower pa ingtherecordedbalanceaccordingtothemodifiedterms paying terms, withnoindicationofinherentloss.Atwhattimewoulditbe reasonabletoconsiderupgradingtheloanclassification?
Needtoconsider:
Anyuncertaintysurroundingthecollectionoftheremainingbalance Expectationsoftheborrowersabilitytocontinuetomakecontractual payments(profitabilityanddebtservicecoverage) Lengthoftimeborrowerhascompliedwithmodifiedterms Compliancewithbanksunderwritingstandards(A/Bnotesplit)

Questions?

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