Troubled Debt Restructuring Final Rule

The NCUA board recently adopted a final TDR rule (Part 741) and loan workout guidance (Part 741, Appendix C). The final rule sets no limit on the amount of troubled loans that credit unions can work out with members. The rule also removes unnecessary manual tracking procedures and allows credit unions to modify loans without having to immediately classify TDRs as delinquent. Specific changes include:

  • October 2012-Requiring federally-insured credit unions to adopt and adhere to written policies that govern loan workout arrangements that assist borrowers.
  • June 2012-Allowing credit unions to calculate the past due status of all loans consistent with loan contract terms, including amendments made to loan terms through a formal TDR.
  • June 2012-Eliminating the dual and often manual delinquency tracking burden on credit unions for managing and reporting TDR loans.
  • October 2012-Reaffirming current industry practices by requiring credit unions to discontinue interest accrual on loans past due by 90 days or more and to establish requirements for returning such loans to accrual status.

Key TDR Accounting Guidance

• Codification Topic 310-40 (Receivables/Troubled Debt Restructurings by Creditors)

• Formerly: • FAS 15, Accounting by Debtors and Creditors for Troubled Debt Restructuring

      • FAS 114, Accounting by Creditors for Impairment of a Loan

      • FAS 118, Accounting by Creditors for Impairment of a Loan, Income Recognition and Disclosures

Loans that fit the troubled debt restructuring definitions share the traits of modified loans yet have two additional characteristics:

  1. The modification is due to economic or legal reasons related to the debtor’s financial difficulties; and
  2. The modification provides for a reduction in interest and principal.
All TDRs are modified loans; however, not all modified loans are considered TDRs.
In a trouble debt restructuring, the credit union, the creditor, grants a concession to the member, the debtor, that the creditor would otherwise not consider if it were not for the financial difficulties being experienced by the debtor.  These difficulties could be either legal or economic.  Trouble debt restructures are always evidence by an agreement between the parties or based on terms imposed by a court of law.
The benefits of a TDR for the member are as follows:
  1. Assist the debtor through a period of financial difficulty; and
  2. Assist the debtor avoid a repossession or foreclosure.
The benefits of a TDR for the credit union are as follows:
  1. Increases the likelihood of repayment on loans by members having financial difficulty;
  2. Lessens the likelihood of repossession or foreclosure; and
  3. Increases member retention.

Loans that are refinanced or modified just to keep members whose loans are current from refinancing elsewhere for a better rate are not modified loans.

How do I calculate a loss on a TDR?

When available information reveals that it is probable that a creditor- the Credit Union- will be unable to collect all amounts due according to the contractual terms of the loan agreement then that amount deemed unlikely to be collectible should be charged against the allowance for loan losses (ALL) at the time of the restructuring subject to FAS 114.  A Credit Union can use the  3). fair-value method to determine the collateral value, including the basis of any adjustments made to appraised values and the costs of disposition, 2). the observable market price, or 3). the present value of the expected cash flows, discounted at the effective interest rate.

Calculating the TDR loss using appropriate present value methodology is a matter of developing two amortization schedules and calculating the difference between the two resulting loan balances. The first schedule will be the actual modified or restructured loan (TDR) based on the loan’s carrying value. It is important that this schedule agrees with the actual restructured note. The second schedule will use the actual cash flows from the modified loan or TDR, adjusted for any rates changes or interest only payments, and then calculate a present value (PV) of the future cash flows at the effective or original interest rate.

Allowance for Loan Loss Implications

Calculating accurate TDR provisions for Allowance for Loan Losses (ALL) is a critical component for regulatory and financial statement disclosures and requires comparative present value of cash flows calculations in accordance with Codification 310 (FAS 114), Accounting by Creditors for Impairment of a Loan.

The Credit Union calculates the present value of future cash flows in a restructured loan at the effective interest rate. This is a key step in completing the calculations for TDRs. The difference between the present value calculation of the restructured loan and the current loan balance is the allowance for loan loss subject to ASC 310 (FAS 114).  The present value of this TDR versus the loan balance would be the amount charged to the ALL and accreted accordingly.  Present Value calculations and accretion adjustments to the ALL are done in totality on a monthly basis.

Under GAAP’s definition, the TDR classification can be removed if (1) when the loan returns to its market rate, and (2) there is a sustained period of performance on the loan.

This blog entry you have just read was written by Edward Lis, Vice President of Finance and a former senior executive. If you enjoyed this article I encourage you to learn more about Edward by visiting www.edwardlis.com.

Edward B. Lis is a well respected  credit union executive  known by his peers as being decisive; a visionary; communicative; and energetic.  He has led during difficult economic times driving change, achieving objectives, and effectively managing projects moving from a vision and strategy phase to implementation and final execution.

 Additional Resources:

NCUA Presentation: Calculating the ALLL and What is a TDR?

Slideshow from January 2011 NCUA webcast on Troubled Debt Restructuring

To view the webcast in its entirety to go www.ncua.gov under News & Events then Archived Webcasts.