TDRs: Determining TDR Status and Valuation Methodologies · TDR Agenda • Current landscape and...

TDRs: Determining TDR Statusand Valuation Methodologies

Tuesday, June 18, 2013 3:30 PM – 4:45 PM

Presented by:Tal ScheerSenior ManagerCrowe Horwath LLP354 Eisenhower Parkway, Suite 2050Livingston, New Jersey 07039P: (973) 422-4557E: [email protected]

www.fmsinc.org | 800-ASK-4FMS

Tal ScheerSenior ManagerCrowe Horwath LLP354 Eisenhower Parkway, Suite 2050Livingston, New Jersey 07039P: (973) 422-4557E: [email protected]

TDR Agenda• Current landscape and guidance• Measuring Impairment• Managing the complexity in the allowance

computation• Getting out of TDR status• After the accounting• Examples• Forthcoming regulatory guidance


• Current landscape and guidance• Measuring Impairment• Managing the complexity in the allowance

computation• Getting out of TDR status• After the accounting• Examples• Forthcoming regulatory guidance

slide 2

Landscape• Continued increase in loans identified as TDRs

– Driven by:• Stress in the environment and responding to it• Regulator attention and focus• Auditor focus

• Increased complexity in the allowance calculation todeal with TDRs

• Need for new/improved TDR policies• Need for tools and tracking systems to monitor

decisions and success


• Continued increase in loans identified as TDRs– Driven by:

• Stress in the environment and responding to it• Regulator attention and focus• Auditor focus

• Increased complexity in the allowance calculation todeal with TDRs

• Need for new/improved TDR policies• Need for tools and tracking systems to monitor

decisions and success

slide 3

Key TDR Accounting Guidance

• Codification Topic 310-40 (Receivables/TroubledDebt Restructurings by Creditors);

• CAQ Whitepaper, Application of SFAS 114 toModifications of Residential Mortgage Loans thatQualify as Troubled Debt Restructurings, issued Dec.23, 2008

• http://thecaq.org/newsroom/pdfs/FAS114_LoanModifications.pdf


• Codification Topic 310-40 (Receivables/TroubledDebt Restructurings by Creditors);

• CAQ Whitepaper, Application of SFAS 114 toModifications of Residential Mortgage Loans thatQualify as Troubled Debt Restructurings, issued Dec.23, 2008

• http://thecaq.org/newsroom/pdfs/FAS114_LoanModifications.pdf

slide 4

Other Sources• Regulatory

– OCC Bank Accounting Advisory Series (BAAS), Topic 2A,updated Oct. 2010

• http://www.occ.gov/static/publications/BAAS.pdf

– OTS Thrift Bulletin 85, Regulatory and Accounting IssuesRelated to 1-4 Family Residential Mortgage Loans, issuedAug. 28, 2009

• OTS CEO Memo 315 – rescinded although does notchange the applicability of the conveyed document

• http://files.ots.treas.gov/84303.pdf

– OCC - TDR Supervisory Guidance on Accounting andReporting Requirements – April 5, 2012

• http://www.occ.gov/news-issuances/bulletins/2012/bulletin-2012-10.html


• Regulatory– OCC Bank Accounting Advisory Series (BAAS), Topic 2A,

updated Oct. 2010• http://www.occ.gov/static/publications/BAAS.pdf

– OTS Thrift Bulletin 85, Regulatory and Accounting IssuesRelated to 1-4 Family Residential Mortgage Loans, issuedAug. 28, 2009

• OTS CEO Memo 315 – rescinded although does notchange the applicability of the conveyed document

• http://files.ots.treas.gov/84303.pdf

– OCC - TDR Supervisory Guidance on Accounting andReporting Requirements – April 5, 2012

• http://www.occ.gov/news-issuances/bulletins/2012/bulletin-2012-10.html

slide 5

TDR Prerequisites• A loan modification is a TDR when two conditions are

present:– Borrower is experiencing financial difficulty– Creditor grants a concession it would not otherwise consider

but for the borrower’s financial difficulties

“A restructuring of a debt constitutes atroubled debt restructuring for purposes ofthis Subtopic if the creditor for economic or

legal reasons related to the debtor'sfinancial difficulties grants a concession to

the debtor that it would not otherwise.”ASC 310-40-15-5


“A restructuring of a debt constitutes atroubled debt restructuring for purposes ofthis Subtopic if the creditor for economic or

legal reasons related to the debtor'sfinancial difficulties grants a concession to

the debtor that it would not otherwise.”ASC 310-40-15-5

slide 6

Financial Difficultly?a) Currently in default on any debt (creditor must evaluate

probability that the debtor would be in payment default on anyof its debt in the foreseeable future without the modification)

b) Declared or in process of declaring bankruptcyc) Substantial doubt about borrower as a going concernd) Delisted, or in process of being delisted (e.g., stock exchange)e) Unable to service debt in accordance with the contractual

terms in the foreseeable futuref) Borrower unable to secure financing from other lenders at a

market rate


a) Currently in default on any debt (creditor must evaluateprobability that the debtor would be in payment default on anyof its debt in the foreseeable future without the modification)

b) Declared or in process of declaring bankruptcyc) Substantial doubt about borrower as a going concernd) Delisted, or in process of being delisted (e.g., stock exchange)e) Unable to service debt in accordance with the contractual

terms in the foreseeable futuref) Borrower unable to secure financing from other lenders at a

market rate

slide 7

Financial Difficultly?• Required judgments about future prospects of

a borrower:– For purposes of determining whether a borrower is

experiencing financial difficulty, creditors shouldconsider whether default is “probable in theforeseeable future.”


• Required judgments about future prospects ofa borrower:– For purposes of determining whether a borrower is

experiencing financial difficulty, creditors shouldconsider whether default is “probable in theforeseeable future.”

slide 8

Concession Granted?• Considering the Value of the Underlying Collateral

– If the payment of principal at original maturity is primarilydependent on the value of collateral, consider the currentvalue of that collateral in determining whether the principalwill be paid.

• Evaluating Additional Collateral or Guarantees– Concession granted when the nature and amount of the

additional collateral or guarantees received as part of arestructuring do not serve as adequate compensation

– Must evaluate both a guarantor’s ability & willingness to pay


• Considering the Value of the Underlying Collateral– If the payment of principal at original maturity is primarily

dependent on the value of collateral, consider the currentvalue of that collateral in determining whether the principalwill be paid.

• Evaluating Additional Collateral or Guarantees– Concession granted when the nature and amount of the

additional collateral or guarantees received as part of arestructuring do not serve as adequate compensation

– Must evaluate both a guarantor’s ability & willingness to pay

slide 9

Concession Granted?• Considering Debtor’s Access to Market Rates

– If a debtor does not otherwise have access to funds at amarket rate for debt with similar risk characteristics as therestructured debt, the restructuring would be considered tobe at a below-market rate, which may indicate that thecreditor has granted a concession

• Considering Interest Rate Increases– A temporary or permanent increase in the contractual

interest rate does not preclude the restructuring from beingconsidered a concession because the new contractualinterest rate on the restructured debt could still be belowmarket interest rates for new debt with similar riskcharacteristics.


• Considering Debtor’s Access to Market Rates– If a debtor does not otherwise have access to funds at a

market rate for debt with similar risk characteristics as therestructured debt, the restructuring would be considered tobe at a below-market rate, which may indicate that thecreditor has granted a concession

• Considering Interest Rate Increases– A temporary or permanent increase in the contractual

interest rate does not preclude the restructuring from beingconsidered a concession because the new contractualinterest rate on the restructured debt could still be belowmarket interest rates for new debt with similar riskcharacteristics.

slide 10

Concession Granted?• Evaluating a Delay in Payment

–A restructuring that results in only a delay in payment that isinsignificant is not a concession. Consider whether:

• a. The amount of the restructured payments subject to the delay isinsignificant relative to the unpaid principal or collateral value of thedebt and will result in an insignificant shortfall in the contractual amountdue.

• b. The delay in timing of the restructured payment period is insignificantrelative to any one of the following:

– 1. The frequency of payments due under the debt– 2. The debt’s original contractual maturity– 3. The debt’s original expected duration

– If previously restructured, consider the cumulative effects


• Evaluating a Delay in Payment–A restructuring that results in only a delay in payment that isinsignificant is not a concession. Consider whether:

• a. The amount of the restructured payments subject to the delay isinsignificant relative to the unpaid principal or collateral value of thedebt and will result in an insignificant shortfall in the contractual amountdue.

• b. The delay in timing of the restructured payment period is insignificantrelative to any one of the following:

– 1. The frequency of payments due under the debt– 2. The debt’s original contractual maturity– 3. The debt’s original expected duration

– If previously restructured, consider the cumulative effects

slide 11

Tracking• Develop systems to track and monitor TDRs• Manual processes appear to be more

prevalent• Communication between lending and finance


• Develop systems to track and monitor TDRs• Manual processes appear to be more

prevalent• Communication between lending and finance

slide 12

TDR DisclosuresLevel Disclosure Requirement

Class of FinancingReceivable

For TDRs that occurred during the period, disclose: How the financing receivables were modified; and The financial effects of the modifications.(ASC 310-10-50-33, item a)

Portfolio SegmentQualitative information about how TDRs that occurred during the periodwere factored into the determination of the allowance for credit losses.(ASC 310-10-50-33, item b)For TDRs that were restructured within the previous 12 months and forwhich there was a payment default in the current period, disclose: The types of financing receivables that defaulted; and The amount of financing receivables that defaulted.(ASC 310-10-50-34, item a)


Class of FinancingReceivable

For TDRs that were restructured within the previous 12 months and forwhich there was a payment default in the current period, disclose: The types of financing receivables that defaulted; and The amount of financing receivables that defaulted.(ASC 310-10-50-34, item a)

Portfolio Segment

Qualitative information about how TDRs that were restructured within theprevious 12 months and defaulted on their restructured terms during theperiod were factored into the determination of the allowance for creditlosses.(ASC 310-10-50-34, item b)

slide 13

Observations• There is a rebuttable presumption that loan

modifications are TDRs– Shore up documentation of the TDR process, including

the decision making– Visibility in the loan files– Internal controls– Updated underwriting documentation must be prepared

to assess whether the modified loan terms are “atmarket” and other borrowers (with comparable creditrisk) would have qualified for these terms


• There is a rebuttable presumption that loanmodifications are TDRs– Shore up documentation of the TDR process, including

the decision making– Visibility in the loan files– Internal controls– Updated underwriting documentation must be prepared

to assess whether the modified loan terms are “atmarket” and other borrowers (with comparable creditrisk) would have qualified for these terms

slide 14

Observations• Renewing identified problem loans likely also triggers

TDR designation– Why? - Not at a market rate– Consider a policy decision (e.g., 7’s are, 6’s are not)– Impact? – TDRs are “impaired” and loans may move

from “pool” reserves to discrete impairment analysis,depending upon status and approach, pre-modification

• Should required allowance decline as a result of amodification that is a TDR?


• Renewing identified problem loans likely also triggersTDR designation– Why? - Not at a market rate– Consider a policy decision (e.g., 7’s are, 6’s are not)– Impact? – TDRs are “impaired” and loans may move

from “pool” reserves to discrete impairment analysis,depending upon status and approach, pre-modification

• Should required allowance decline as a result of amodification that is a TDR?

slide 15

Measuring Impairment• Measure impairment and allowance needed (ASC

310)– Based on the present value of expected future cash

flows discounted at the original loan’s effective interestrate

– Except that as a practical expedient, a creditor maymeasure impairment based on:

• The observable market price of the loan, or• The fair value of the collateral if the loan is collateral

dependent (or in liquidation)


• Measure impairment and allowance needed (ASC310)– Based on the present value of expected future cash

flows discounted at the original loan’s effective interestrate

– Except that as a practical expedient, a creditor maymeasure impairment based on:

• The observable market price of the loan, or• The fair value of the collateral if the loan is collateral

dependent (or in liquidation)

slide 16

Measuring Impairment• Present value calculation should be completed using

the effective yield (original terms).• Effective yield includes adjustments resulting from

deferred fees and costs as well as other adjustments,such as purchase premiums and discounts.

• Analysis should use the best estimate of expectedcash flows. This includes prepayment or defaultassumptions after being modified.

• Inappropriate to use a “teaser rate” percent as theeffective interest rate on estimated cash flows.


• Present value calculation should be completed usingthe effective yield (original terms).

• Effective yield includes adjustments resulting fromdeferred fees and costs as well as other adjustments,such as purchase premiums and discounts.

• Analysis should use the best estimate of expectedcash flows. This includes prepayment or defaultassumptions after being modified.

• Inappropriate to use a “teaser rate” percent as theeffective interest rate on estimated cash flows.

slide 17

Collateral Dependent• A loan is considered collateral dependent if

repayment of the loan is expected to beprovided solely by the underlying collateral– If a loan is impaired and considered collateral dependent,

fair value of the collateral is required for measuringimpairment.

– Many loans are considered collateral dependent, despite amodification of terms.

– Measure of impairment is fair value of the collateral -update appraisals

– Deduct costs to sell if expected to reduce cash flowsavailable


• A loan is considered collateral dependent ifrepayment of the loan is expected to beprovided solely by the underlying collateral– If a loan is impaired and considered collateral dependent,

fair value of the collateral is required for measuringimpairment.

– Many loans are considered collateral dependent, despite amodification of terms.

– Measure of impairment is fair value of the collateral -update appraisals

– Deduct costs to sell if expected to reduce cash flowsavailable

slide 18

CAUTION• A TDR does not make a collateral dependent

loan “good” again• Cannot “Extend and Pretend” – regulators

are watching, so are your auditors


slide 19

Non-Accrual Status?• GAAP does not provide specific guidance but, in

general, should not recognize income unless it isrealizable and earned

• Regulators have provided guidance related towhether impaired loans (which includes modifiedloans that are TDRs) should be considered accrual ornon-accrual loans:– Generally requires that interest should only be

recorded on a restructured loan when there has been asustained period of repayment performance andcollection under the revised terms is assessed asreasonably assured.


• GAAP does not provide specific guidance but, ingeneral, should not recognize income unless it isrealizable and earned

• Regulators have provided guidance related towhether impaired loans (which includes modifiedloans that are TDRs) should be considered accrual ornon-accrual loans:– Generally requires that interest should only be

recorded on a restructured loan when there has been asustained period of repayment performance andcollection under the revised terms is assessed asreasonably assured.

slide 20

Non-Accrual Status?

• FDIC Guidance– Restructured loan, reasonably assured of

repayment and of performance according toprudent modified terms need not be in nonaccrualstatus, must be supported by a current, well-documented credit assessment of the borrower’sfinancial condition and prospects for repayment underthe revised terms.

– Must include repayment performance for a reasonableperiod, six months (payments received prior to therestructure date may be taken into account), prior tothe date of return to accrual status.


• FDIC Guidance– Restructured loan, reasonably assured of

repayment and of performance according toprudent modified terms need not be in nonaccrualstatus, must be supported by a current, well-documented credit assessment of the borrower’sfinancial condition and prospects for repayment underthe revised terms.

– Must include repayment performance for a reasonableperiod, six months (payments received prior to therestructure date may be taken into account), prior tothe date of return to accrual status.

slide 21

AFLL Impact• TDRs are impaired loans, regardless

of size or type of loan– No safe harbor for homogeneous loans

(ASC 310-10-35-13a overridden by TDRstatus)


• TDRs are impaired loans, regardlessof size or type of loan– No safe harbor for homogeneous loans

(ASC 310-10-35-13a overridden by TDRstatus)

slide 22

AFLL Impact• Allowance measurement based on:

– Cash Flows – Excess of recordedinvestment over PV of projected cash flowsdiscounted at rate implicit in the loan (pre-modification)

– Collateral – reserve 100% of computedcollateral shortfall


• Allowance measurement based on:– Cash Flows – Excess of recorded

investment over PV of projected cash flowsdiscounted at rate implicit in the loan (pre-modification)

– Collateral – reserve 100% of computedcollateral shortfall

slide 23

AFLL Impact• Observations in dealing with increased

volume of impairment computations:– Increases time required to complete AFLL

calculation Increases risk of computation errors– Requires enhanced internal controls over the

computation - should build in monitoring andtracking into process

– More labor intensive judgments, like projectedcash flows


• Observations in dealing with increasedvolume of impairment computations:– Increases time required to complete AFLL

calculation Increases risk of computation errors– Requires enhanced internal controls over the

computation - should build in monitoring andtracking into process

– More labor intensive judgments, like projectedcash flows

slide 24

AFLL Impact• Tips:

– Standardize forms and templates used forcomputations

– Develop checklists and tools to help toconsistently determine and documentimpairment method, cash flow projections,discount rates

– Automate


• Tips:– Standardize forms and templates used for

computations– Develop checklists and tools to help to

consistently determine and documentimpairment method, cash flow projections,discount rates

– Automate

slide 25

AFLL Impact• Pooled impairment measurement is

allowed (ASC 310-10-35-21) and canhelp deal with volume– Some impaired loans may have risk characteristics in

common with other impaired loans. A creditor mayaggregate those loans and may use historical statistics, suchas average recovery period and average amount recovered,along with a composite effective interest rate as a means ofmeasuring impairment of those loans.


• Pooled impairment measurement isallowed (ASC 310-10-35-21) and canhelp deal with volume– Some impaired loans may have risk characteristics in

common with other impaired loans. A creditor mayaggregate those loans and may use historical statistics, suchas average recovery period and average amount recovered,along with a composite effective interest rate as a means ofmeasuring impairment of those loans.

slide 26

AFLL Impact• Projecting cash flows:

– Probable, not contractual, thus amountsand timing not necessarily tied to noteterms and maturities

– Projection may include eventual liquidationof collateral

– Projection may include cash flows fromguarantors or other sources

• Documentation is critical!


• Projecting cash flows:– Probable, not contractual, thus amounts

and timing not necessarily tied to noteterms and maturities

– Projection may include eventual liquidationof collateral

– Projection may include cash flows fromguarantors or other sources

• Documentation is critical!slide 27

AFLL Impact• Projecting Defaults:

– Appropriate to assume defaults (cash flowreduction/cessation) in your projections

– Track TDR specific default/loss experienceto provide support for assumptions

– Given lack of data, estimates might be onlyeducated judgments at this point

• Remember - Cash beyond collateralliquidation reduces computed reserve


• Projecting Defaults:– Appropriate to assume defaults (cash flow

reduction/cessation) in your projections– Track TDR specific default/loss experience

to provide support for assumptions– Given lack of data, estimates might be only

educated judgments at this point• Remember - Cash beyond collateral

liquidation reduces computed reserveslide 28

FAQQ: If a loan is considered a TDR but the specificimpairment measurement results in no loss,should the loan be classified as impaired withno allowance, or should the loan be evaluatedfor potential losses within a pool of other similarloans?A: If the impairment measurement shows noloss, the TDR should not be pooled orotherwise reserved for but should be shown asimpaired with no allocation of the AFLL


Q: If a loan is considered a TDR but the specificimpairment measurement results in no loss,should the loan be classified as impaired withno allowance, or should the loan be evaluatedfor potential losses within a pool of other similarloans?A: If the impairment measurement shows noloss, the TDR should not be pooled orotherwise reserved for but should be shown asimpaired with no allocation of the AFLL

slide 29

Once a TDR…• Generally, always a TDR. Accordingly,

– These loans remain impaired– These loans must be measured and

monitored for impairment and reportingpurposes

• Exceptions are changes thatpermanently “fix” a problem and carrya market rate – see next slides


• Generally, always a TDR. Accordingly,– These loans remain impaired– These loans must be measured and

monitored for impairment and reportingpurposes

• Exceptions are changes thatpermanently “fix” a problem and carrya market rate – see next slides

slide 30

FAQQ: Once a loan modification is designated as a TDR, itis always deemed to be a TDR?A: Once a loan has undergone a TDR, it must continueto be reported as a TDR until loan is paid in full, sold, orcharged-off.

– Exception: A TDR that is in compliance with its modifiedterms and bears a market yield at the time of therestructuring need not continue to be reported as a TDR inyears after the year in which the restructuring took place.

– Examples which may meet the exception are:• Principal forgiveness• Structured Note A / B scenarios


Q: Once a loan modification is designated as a TDR, itis always deemed to be a TDR?A: Once a loan has undergone a TDR, it must continueto be reported as a TDR until loan is paid in full, sold, orcharged-off.

– Exception: A TDR that is in compliance with its modifiedterms and bears a market yield at the time of therestructuring need not continue to be reported as a TDR inyears after the year in which the restructuring took place.

– Examples which may meet the exception are:• Principal forgiveness• Structured Note A / B scenarios

slide 31

FAQ• What if I have a PCI loan?

– TDR is an exit to PCI accounting, howeverif PCIs are aggregated in pools, there is noexit

– May consider the purchased basis in theloan for determining whether a concessionwas granted


• What if I have a PCI loan?– TDR is an exit to PCI accounting, however

if PCIs are aggregated in pools, there is noexit

– May consider the purchased basis in theloan for determining whether a concessionwas granted

slide 32

TDRs – FDIC Guidance• “Once a TDR, always a TDR” – GAAP• Call Reporting

– If (1) the TDR is in compliance with its modified terms and(2) the loan yields a market rate, then the TDR need notcontinue to be reported as a TDR in the Call Report incalendar years after the year in which the restructuring tookplace.

– TDRs by loan category in Schedule RC-C, Part I, Memoitems 1.a. and 1.b.

– TDRs by loan category in Schedule RC-N, Memo item 1


• “Once a TDR, always a TDR” – GAAP• Call Reporting

– If (1) the TDR is in compliance with its modified terms and(2) the loan yields a market rate, then the TDR need notcontinue to be reported as a TDR in the Call Report incalendar years after the year in which the restructuring tookplace.

– TDRs by loan category in Schedule RC-C, Part I, Memoitems 1.a. and 1.b.

– TDRs by loan category in Schedule RC-N, Memo item 1

slide 33

Market Rate• The hurdles of market rate and terms at

point of modification (to not be a TDR)are where the challenge lies

• Critical to document your analysis if thisis the objective you are trying to achieve


• The hurdles of market rate and terms atpoint of modification (to not be a TDR)are where the challenge lies

• Critical to document your analysis if thisis the objective you are trying to achieve

slide 34

Exit Strategies?• Keep TDRs and maturities shorter term

to provide a regular opportunity to revisitthe loan– Provides potential exit point for TDR

designation such as re-underwrite tomarket terms, push for repayment or applya permanent “fix”

– Adds leverage to the lending relationship


• Keep TDRs and maturities shorter termto provide a regular opportunity to revisitthe loan– Provides potential exit point for TDR

designation such as re-underwrite tomarket terms, push for repayment or applya permanent “fix”

– Adds leverage to the lending relationship

slide 35

Regulatory Focus• Renewals of problem loans as TDRs

based on rate/terms not being “market”• Debtor not being able to refinance

elsewhere at comparable terms createsa presumption of TDR– Creates substantially more TDRs– Adds substantial complexity to the AFLL

computation


• Renewals of problem loans as TDRsbased on rate/terms not being “market”

• Debtor not being able to refinanceelsewhere at comparable terms createsa presumption of TDR– Creates substantially more TDRs– Adds substantial complexity to the AFLL

computation

slide 36

Regulatory Focus• AFLL setting for TDRs

– Absent a rate (or balance) concession, noimpairment measured without assuming adefault in cash flows at some point

– Creates potentially lower allowance levelsthan held prior to the modification

– Does not pass the “reasonableness” test• Push towards collateral dependent

conclusion


• AFLL setting for TDRs– Absent a rate (or balance) concession, no

impairment measured without assuming adefault in cash flows at some point

– Creates potentially lower allowance levelsthan held prior to the modification

– Does not pass the “reasonableness” test• Push towards collateral dependent

conclusionslide 37

Regulatory Focus• Non-Accrual Decisions

– Expectation is non-accrual status untilability to comply with modified termsdemonstrated

– May create more loans with a non accrualperiod being caught up


• Non-Accrual Decisions– Expectation is non-accrual status until

ability to comply with modified termsdemonstrated

– May create more loans with a non accrualperiod being caught up

slide 38

After the Accounting• Given the environment, the expectation

is that TDRs will continue to increase• Institution controls and procedures need

to be reviewed and updated:– Education– Policy Development and Update– Support Systems– Reporting


• Given the environment, the expectationis that TDRs will continue to increase

• Institution controls and procedures needto be reviewed and updated:– Education– Policy Development and Update– Support Systems– Reporting

slide 39

After the Accounting• Education

– Lenders and workout teams need to understandTDR rules and implications

– Good processes for identification – start at thelending level

– Develop tools to document evaluation process andconclusions

– Determination that a modification is NOT a TDR isas critical a conclusion as otherwise


• Education– Lenders and workout teams need to understand

TDR rules and implications– Good processes for identification – start at the

lending level– Develop tools to document evaluation process and

conclusions– Determination that a modification is NOT a TDR is

as critical a conclusion as otherwise

slide 40

After the Accounting• Policy Development and Update

– Policies need to be established to addressrestructure decisions and development ofprograms targeted towards dealing with borrowerdifficulties

• Systems– Develop controls over decisions to restructure and

documentation of decisions– Determine accounting systems needs related to

tracking, income recognition, allowancecomputation, etc.


• Policy Development and Update– Policies need to be established to address

restructure decisions and development ofprograms targeted towards dealing with borrowerdifficulties

• Systems– Develop controls over decisions to restructure and

documentation of decisions– Determine accounting systems needs related to

tracking, income recognition, allowancecomputation, etc.

slide 41

After the Accounting• Reporting

– Board/Senior level review of volume and terms ofrestructuring decisions and programs

– Ongoing review of “success” of such decisionsincluding impact on realized loan losses andportfolio yield


• Reporting– Board/Senior level review of volume and terms of

restructuring decisions and programs– Ongoing review of “success” of such decisions

including impact on realized loan losses andportfolio yield

slide 42

After the Accounting• Documentation – consider a checklist

approach– Decision making tree – TDR y/n– Internal controls – sign off by process leaders– Current financial information– Current collateral valuation– Current business conditions– Outlook for the future– Why & when will this loan get better again?


• Documentation – consider a checklistapproach– Decision making tree – TDR y/n– Internal controls – sign off by process leaders– Current financial information– Current collateral valuation– Current business conditions– Outlook for the future– Why & when will this loan get better again?

slide 43

Credit Unions• Supervisory letter - Section 741.3(b)(2) - addresses the

following requirements, which become effective on October 1,2012 (with the exception of the modified regulatory reporting):– Requires a written policy for loan workouts.– Specifies management and internal controls for loan

workouts.– Modifies regulatory reporting of workout loans, including

TDRs altering how delinquent loans are reported on the CallReport (5300), and focusing future data collection on loansmeeting the definition of TDR under GAAP.

– Standardizes loan nonaccrual requirements and return toaccrual requirements, including the treatment of memberbusiness loan (MBL) workouts.


• Supervisory letter - Section 741.3(b)(2) - addresses thefollowing requirements, which become effective on October 1,2012 (with the exception of the modified regulatory reporting):– Requires a written policy for loan workouts.– Specifies management and internal controls for loan

workouts.– Modifies regulatory reporting of workout loans, including

TDRs altering how delinquent loans are reported on the CallReport (5300), and focusing future data collection on loansmeeting the definition of TDR under GAAP.

– Standardizes loan nonaccrual requirements and return toaccrual requirements, including the treatment of memberbusiness loan (MBL) workouts.

slide 44

Credit Unions• The Supervisory Letter is not intended to provide

detailed accounting guidance on loan workoutarrangements.

• NCUA does not intend through the IRPS or thisSupervisory Letter to change the FASB’s definition ofTDR in any way. This supervisory letter does notsupersede or replace GAAP.

• As always when questions arise regarding properGAAP accounting, examiners should encouragecredit unions to consult with a trained independentaccountant.


• The Supervisory Letter is not intended to providedetailed accounting guidance on loan workoutarrangements.

• NCUA does not intend through the IRPS or thisSupervisory Letter to change the FASB’s definition ofTDR in any way. This supervisory letter does notsupersede or replace GAAP.

• As always when questions arise regarding properGAAP accounting, examiners should encouragecredit unions to consult with a trained independentaccountant.

slide 45

Examples


slide 46

Owner Occupied SingleFamily Residential

Loan Summary• Mr. and Mrs. Smith acquired a home for $324,000 in May 2006.• The bank advanced 85% of the purchase price and booked the

resulting $275,000 loan.• The terms called for a 30 year amortization at 6.5% with a seven

year maturity to balloon in 2013. The monthly P&I payment is$1,738.

• The cost of taxes and insurance on the home are $235 permonth. Combined with the mortgage payment the total monthlyhousing expense is $1,973 per month.

• Mr. and Mrs. Smith have a combined income of $6,600 permonth. Total monthly housing expense is absorbing 30% oftheir gross income.


Loan Summary• Mr. and Mrs. Smith acquired a home for $324,000 in May 2006.• The bank advanced 85% of the purchase price and booked the

resulting $275,000 loan.• The terms called for a 30 year amortization at 6.5% with a seven

year maturity to balloon in 2013. The monthly P&I payment is$1,738.

• The cost of taxes and insurance on the home are $235 permonth. Combined with the mortgage payment the total monthlyhousing expense is $1,973 per month.

• Mr. and Mrs. Smith have a combined income of $6,600 permonth. Total monthly housing expense is absorbing 30% oftheir gross income.

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Owner Occupied SingleFamily Residential (cont)

Bumps in the Road• Mr. and Mrs. Smith have experienced a decline in income due to

various circumstances and their total income is now $3,200 permonth. Total monthly housing expense is now 62% of theSmith’s monthly income.

• The home is located in an area with a high number offoreclosures and the home now appraises for 70% of theoriginal price. The $226,800 current appraised value is lessthan the current $266,339 loan balance.

• The Smiths are four months behind on their payment resulting inpast due interest and escrow amounts totaling $4,971.


Bumps in the Road• Mr. and Mrs. Smith have experienced a decline in income due to

various circumstances and their total income is now $3,200 permonth. Total monthly housing expense is now 62% of theSmith’s monthly income.

• The home is located in an area with a high number offoreclosures and the home now appraises for 70% of theoriginal price. The $226,800 current appraised value is lessthan the current $266,339 loan balance.

• The Smiths are four months behind on their payment resulting inpast due interest and escrow amounts totaling $4,971.

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Debt Restructure• After backing out monthly escrow contributions a mortgage

payment of $981 will lower their MHE/Income ratio to 38%• To achieve this payment on a $271,710 loan balance:

– The interest rate was lowered to 3%.– That was not sufficient, so the amortization period was increased to

417 months.– Lastly $17,839 of loan is placed under a permanent forbearance.

As a result payment on mortgage is computed using a $253,870balance. The forbearance amount will be collected when the houseeventually sells.

– The maturity of loan is extended to 10 years from its originationdate – May 2016.



Debt Restructure• After backing out monthly escrow contributions a mortgage

payment of $981 will lower their MHE/Income ratio to 38%• To achieve this payment on a $271,710 loan balance:

– The interest rate was lowered to 3%.– That was not sufficient, so the amortization period was increased to

417 months.– Lastly $17,839 of loan is placed under a permanent forbearance.

As a result payment on mortgage is computed using a $253,870balance. The forbearance amount will be collected when the houseeventually sells.

– The maturity of loan is extended to 10 years from its originationdate – May 2016.

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• Financial difficulty – couldn’t meet original payment• Permanent Forbearance• Amortization period of 417 months

TDR?

YES



• Financial difficulty – couldn’t meet original payment• Permanent Forbearance• Amortization period of 417 months

TDR?

YES

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Commercial RetailCenter

Loan Summary• $1,980,000 mortgage loan on a 20-year amortization to finance

acquisition of a 15,000 sq. ft. shopping center.• At time of origination in August 2007, annual debt service was

projected to be $166,815 and stabilized NOI was $212,897.The actual NOI was $172,133. The center was 77% occupiedat an annual rent rate of 15.57 sq. ft.

• The center was approximately two years old and had nodeferred maintenance or capital expenditure issues.

• The guarantor had six other strip centers financed by variousbanks in individual LLCs with same general profile.


Loan Summary• $1,980,000 mortgage loan on a 20-year amortization to finance

acquisition of a 15,000 sq. ft. shopping center.• At time of origination in August 2007, annual debt service was

projected to be $166,815 and stabilized NOI was $212,897.The actual NOI was $172,133. The center was 77% occupiedat an annual rent rate of 15.57 sq. ft.

• The center was approximately two years old and had nodeferred maintenance or capital expenditure issues.

• The guarantor had six other strip centers financed by variousbanks in individual LLCs with same general profile.

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Commercial RetailCenter (cont)

Bumps in the Road• Guarantor was not the only individual that thought the market

could support an infinite number of strip shopping centers andlease rates started to fall.

• The center was in a predominantly Hispanic market. Thefeeding rooftops were occupied by a high percentage of mobilepeople who were dependent on the construction industry.

• In February 2009, the business occupying the center neededrent concessions to stay in business and several failed as theircustomers moved away. Actual NOI was $94,000 and thecenter appraised for $1,690,000.

• The owner found out that triple net leases can be problematicwith marginal tenants.


Bumps in the Road• Guarantor was not the only individual that thought the market

could support an infinite number of strip shopping centers andlease rates started to fall.

• The center was in a predominantly Hispanic market. Thefeeding rooftops were occupied by a high percentage of mobilepeople who were dependent on the construction industry.

• In February 2009, the business occupying the center neededrent concessions to stay in business and several failed as theircustomers moved away. Actual NOI was $94,000 and thecenter appraised for $1,690,000.

• The owner found out that triple net leases can be problematicwith marginal tenants.

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• A restructure to allow owner time to get center stabilized has a netpresent value that is equal to foreclosure scenario and allows lenderto possibly minimize or avoid a loss. Two new notes are createdtotaling balance of old mortgage.

• The amount of the first note (Note A) is derived by determiningamount of debt the property can support as its current $94,000 NOI.The present value of the note, assuming payoff of the full balance atits July 2014 maturity date is $1,323,029.

• The second (Note B) is composed of the remainder of unpaidprincipal balance at the time of the default.

• It requires no payments unless some excess cash flow hurdle is met.If that note also has a July 2014 maturity date and is paid in full atmaturity the net present value total of these two notes is $1,608,230.This number exceeds the NPV of foreclosure by $155,298.


• A restructure to allow owner time to get center stabilized has a netpresent value that is equal to foreclosure scenario and allows lenderto possibly minimize or avoid a loss. Two new notes are createdtotaling balance of old mortgage.

• The amount of the first note (Note A) is derived by determiningamount of debt the property can support as its current $94,000 NOI.The present value of the note, assuming payoff of the full balance atits July 2014 maturity date is $1,323,029.

• The second (Note B) is composed of the remainder of unpaidprincipal balance at the time of the default.

• It requires no payments unless some excess cash flow hurdle is met.If that note also has a July 2014 maturity date and is paid in full atmaturity the net present value total of these two notes is $1,608,230.This number exceeds the NPV of foreclosure by $155,298.

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Is this a Troubled Debt Restructuring?• Financial Distress?

– Four months behind on payments.– Low per square foot rental.– Vacancies.

• Concessions?– Second note is interest free with no required principal payments.– Unusually long amortization.

TDR?

YES



– Four months behind on payments.– Low per square foot rental.– Vacancies.

• Concessions?– Second note is interest free with no required principal payments.– Unusually long amortization.

TDR?

YESslide 54

Residential DeveloperCompany

Loan Summary• In early 2006, the bank loaned Mr. Dirtmover $750,000 to

acquire approximately 70 acres of land at a cost of $1,000,000.• In late 2006, the bank advanced another $150,000 to Dirtmover

based on a new appraisal so that he could complete re-zoningand permitting for a 150 lot subdivision. At this point he wasable to service interest from cash reserves and excess cashflow from other projects.


Loan Summary• In early 2006, the bank loaned Mr. Dirtmover $750,000 to

acquire approximately 70 acres of land at a cost of $1,000,000.• In late 2006, the bank advanced another $150,000 to Dirtmover

based on a new appraisal so that he could complete re-zoningand permitting for a 150 lot subdivision. At this point he wasable to service interest from cash reserves and excess cashflow from other projects.

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Residential DeveloperCompany (cont)

• In 2007, based on a $70,000 per lot, 70 lot contract fromMegabuilder, Inc. (NYSE) the bank committed to a developmentloan on Phase 1 which would utilize 35 acres and includeamenities. The loan in the amount of $3,356,000 wascomposed of the following components.– $500,000 land advance applied to initial loan. There was now a

development loan and a residual land loan in the amount of$450,000.

– $2,310,000 for development.– $400,000 for amenities.– $146,000 in interest reserves to carry project 18 months.

• Megabuilder’s contract was for $4,900,000 and had $250,000hard earnest money.


• In 2007, based on a $70,000 per lot, 70 lot contract fromMegabuilder, Inc. (NYSE) the bank committed to a developmentloan on Phase 1 which would utilize 35 acres and includeamenities. The loan in the amount of $3,356,000 wascomposed of the following components.– $500,000 land advance applied to initial loan. There was now a

development loan and a residual land loan in the amount of$450,000.

– $2,310,000 for development.– $400,000 for amenities.– $146,000 in interest reserves to carry project 18 months.

• Megabuilder’s contract was for $4,900,000 and had $250,000hard earnest money.

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Bumps in the Road• The subdivision’s name, Stone Summit, turned out to be more

than apropos and development costs were 15% higher thananticipated.

• In part due to unanticipated granite, development took longer tocomplete and interest reserve was drained.

• Megabuilder got cold feet and decided the delay was a default inthe contact and pulled out.


Bumps in the Road• The subdivision’s name, Stone Summit, turned out to be more

than apropos and development costs were 15% higher thananticipated.

• In part due to unanticipated granite, development took longer tocomplete and interest reserve was drained.

• Megabuilder got cold feet and decided the delay was a default inthe contact and pulled out.

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Debt Restructure• Dirtmover enters into contract with Tracthouse, Corp to take down

the 70 lots in a staged contract. The contract requires 20 lots in 12months at $40,000 per lot, 20 lots in year two at $42,500 per lot,and remainder at $45,000 in year three. $3,000,000 total.

• The bank agrees to a $3,000,000 loan, with $2,800,000 applied tooriginal development loan and $200,000 held in reserve for taxesand interest. Interest rate on loan is at market terms.

• The bank moved the $556,000 deficiency to the excess land as azero interest hope note with a second behind its own $450,000first. Dirtmover agrees he can service interest on the first lien at4% in exchange for avoiding litigation. He places $54,000 in apledged account to service interest at 4% for 3 years.


Debt Restructure• Dirtmover enters into contract with Tracthouse, Corp to take down

the 70 lots in a staged contract. The contract requires 20 lots in 12months at $40,000 per lot, 20 lots in year two at $42,500 per lot,and remainder at $45,000 in year three. $3,000,000 total.

• The bank agrees to a $3,000,000 loan, with $2,800,000 applied tooriginal development loan and $200,000 held in reserve for taxesand interest. Interest rate on loan is at market terms.

• The bank moved the $556,000 deficiency to the excess land as azero interest hope note with a second behind its own $450,000first. Dirtmover agrees he can service interest on the first lien at4% in exchange for avoiding litigation. He places $54,000 in apledged account to service interest at 4% for 3 years.

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– Original project failed.– New deal not sufficient repay outstanding loan.

• Concessions?– The deficiency of $1mm results in two loans. The first is a $450k

loan with a below market interest rate and the second for $556kcarrying a 0% rate.

TDR?YES

– $3mm loan must be reported as a TDR and depending onperformance this loan can return to performing. Remaining creditsmust remain TDRs as their loan terms are not at market.



– Original project failed.– New deal not sufficient repay outstanding loan.

• Concessions?– The deficiency of $1mm results in two loans. The first is a $450k

loan with a below market interest rate and the second for $556kcarrying a 0% rate.

TDR?YES

– $3mm loan must be reported as a TDR and depending onperformance this loan can return to performing. Remaining creditsmust remain TDRs as their loan terms are not at market.

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Owner OccupiedManufacturing Facility

Loan Summary• In 2009 the bank loaned $2,500,000 to Missouri Manufacturing

to acquire a building with a beautiful view of the MississippiRiver to house its manufacturing operation.

• The loan was structured on a 25-year amortization with a three-year call provision during which time it was anticipated that thefirm would develop the financial history necessary to tap into thecommercial mortgage market at more favorable terms.

• The loan had a P+2 rate adjusted annually. The debt servicecoverage ratio was 1.15X, but the enhanced efficiencyassociated with the new facility was expected to improve thisratio and allow for a refinance.


Loan Summary• In 2009 the bank loaned $2,500,000 to Missouri Manufacturing

to acquire a building with a beautiful view of the MississippiRiver to house its manufacturing operation.

• The loan was structured on a 25-year amortization with a three-year call provision during which time it was anticipated that thefirm would develop the financial history necessary to tap into thecommercial mortgage market at more favorable terms.

• The loan had a P+2 rate adjusted annually. The debt servicecoverage ratio was 1.15X, but the enhanced efficiencyassociated with the new facility was expected to improve thisratio and allow for a refinance.

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Owner OccupiedManufacturing Facility (cont)

Bumps in the Road• In 2011 extraordinary weather conditions caused flooding in the

area. Although the building was not damaged a number of localsuppliers experience damage and all business in the area,customers as well as suppliers, suffered.

• Production suffered, inventory built up waiting for customerbusiness resumption, and accounts receivable collection fromlocal customers slowed.

• Missouri Manufacturing requested a forbearance in themortgage payments to allow them to conserve cash until normalbusiness operations resumed.


Bumps in the Road• In 2011 extraordinary weather conditions caused flooding in the

area. Although the building was not damaged a number of localsuppliers experience damage and all business in the area,customers as well as suppliers, suffered.

• Production suffered, inventory built up waiting for customerbusiness resumption, and accounts receivable collection fromlocal customers slowed.

• Missouri Manufacturing requested a forbearance in themortgage payments to allow them to conserve cash until normalbusiness operations resumed.

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Debt Restructure• The bank agreed to cease and capitalize interest payments for

three months.• After the three-month period the company would make interest

only payments at 3% but the loan would accrue at the contractrate for nine months.

• At the end of the year the bank would begin amortization on thenew loan balance consistent with the original maturity. Thatbalance is the total of old principal plus capitalized interest.


Debt Restructure• The bank agreed to cease and capitalize interest payments for

three months.• After the three-month period the company would make interest

only payments at 3% but the loan would accrue at the contractrate for nine months.

• At the end of the year the bank would begin amortization on thenew loan balance consistent with the original maturity. Thatbalance is the total of old principal plus capitalized interest.

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– Requested forbearance of mortgage payments.• Concessions?

– Deferral of a portion of interest payment although the loancontinues to accrue at original contract rate.

– Period of interest only.– Capitalize interest for three months.

TDR?NO

– Resulting delay in payment is insignificant and payments will becollected over original terms.



– Requested forbearance of mortgage payments.• Concessions?

– Deferral of a portion of interest payment although the loancontinues to accrue at original contract rate.

– Period of interest only.– Capitalize interest for three months.

TDR?NO

– Resulting delay in payment is insignificant and payments will becollected over original terms.

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Forthcoming Guidance onTDRs

• Forthcoming Guidance on TDRs– Interagency Guidance on Troubled Debt Restructurings

(TDRs)• Clarifying supervisory guidance• Companion Q&A

– FAQs– Responds to more specific questions

• If conducted in a prudent manner, modifications arein the best interest of both the institution and theborrower and are viewed positively by the regulatoryagencies.


• Forthcoming Guidance on TDRs– Interagency Guidance on Troubled Debt Restructurings

(TDRs)• Clarifying supervisory guidance• Companion Q&A

– FAQs– Responds to more specific questions

• If conducted in a prudent manner, modifications arein the best interest of both the institution and theborrower and are viewed positively by the regulatoryagencies.

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Forthcoming TDR Guidance:Expected Content

• Accrual Status– Not all TDRs are nonaccrual– TDRs need not be kept on nonaccrual status over their life– TDRs can be maintained on accrual status at the time of the

modification

• Classification– TDR designation does not automatically translate into an

adverse classification– TRDs adversely classified at the time of the modification are

not expected to remain adversely classified over their life


• Accrual Status– Not all TDRs are nonaccrual– TDRs need not be kept on nonaccrual status over their life– TDRs can be maintained on accrual status at the time of the

modification

• Classification– TDR designation does not automatically translate into an

adverse classification– TRDs adversely classified at the time of the modification are

not expected to remain adversely classified over their life

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Forthcoming TDR Guidance:Expected Content (cont)

• When is a loan considered collateral dependent?– Includes loans repaid solely through operation of the

collateral• What is solely?

– Guarantors should be considered when evaluating whether aloan is collateral dependent

– Includes income-producing property where repayment of theloan will come solely from the collateral

• Charge-offs– Clarify when charge-offs are required for regulatory

purposes and how to determine the amount of the charge-off


• When is a loan considered collateral dependent?– Includes loans repaid solely through operation of the

collateral• What is solely?

– Guarantors should be considered when evaluating whether aloan is collateral dependent

– Includes income-producing property where repayment of theloan will come solely from the collateral

• Charge-offs– Clarify when charge-offs are required for regulatory

purposes and how to determine the amount of the charge-off

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Forthcoming TDR Guidance:Expected Content (cont)

• Treatment of capitalized costs– Disbursements to protect a bank’s collateral position can be

capitalized

• Modifications of loans facing payment shock– For any modification of a loan facing payment shock (for

example HELOCs converting to amortizing loans) a bankmust evaluate whether the modification meets the criteria ofa TDR.

• Substandard loans– Substandard loans that are on accrual that are renewed,

extended or otherwise modified are not automaticallyconsidered TDRs


• Treatment of capitalized costs– Disbursements to protect a bank’s collateral position can be

capitalized

• Modifications of loans facing payment shock– For any modification of a loan facing payment shock (for

example HELOCs converting to amortizing loans) a bankmust evaluate whether the modification meets the criteria ofa TDR.

• Substandard loans– Substandard loans that are on accrual that are renewed,

extended or otherwise modified are not automaticallyconsidered TDRs

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THANKS!


THANKS!

slide 68

TDRs: Determining TDR Status and Valuation Methodologies · TDR Agenda • Current landscape and...

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