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Accounting for Troubled Debt Restructurings
 

Accounting for Troubled Debt Restructurings

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How to credit unions should account for Troubled Debt Restructurings (TDR's)

How to credit unions should account for Troubled Debt Restructurings (TDR's)

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    Accounting for Troubled Debt Restructurings Accounting for Troubled Debt Restructurings Presentation Transcript

    • AICPA - ACCOUNTING FOR TROUBLED DEBT RESTRUCTURINGS AND ALLOWANCE FOR LOAN LOSSES DeLeon & Stang, CPAs and Advisors Allen P. DeLeon, CPA allen@deleonandstang.com USE Federal Credit Union Adele Sanberg asandberg@usecu.org
    • Agenda – Accounting issues  Loan modifications vs. TDR’s  Accounting for Troubled Debt Restructurings (TDR’s)  Allowance for loan losses issues  Accounting for Other Real Estate Owned (OREO)  Regulatory issues
    • LOAN MODIFICATIONS vs. TDR  What is the difference between a loan modification and a Troubled Debt Restructuring? All Loan – All TDR’s are loan modifications but not Modifications all loan modifications are TDR’s. – TDR is a loan modification due to economic or legal reasons related to TDR the debtors financial difficulties.
    • What are “red flags” for TDR’s  Concessions due to economic or legal reasons (member hardship) – Interest rate reduction – Extension of maturity at a favorable interest rate – Reduction in loan balance (forgiveness of debt) – Forgiveness of accrued and delinquent interest – Re-financing the loan at favorable terms
    • NOT ALL LOAN MODIFICATIONS ARE TDR’s  Loan modifications that are NOT TDR’s do not require valuation allowance.  In general, if a member can obtain financing from sources other than the credit union at market interest rates at or near those for non troubled debt, then the re-financing is not a TDR.
    • TDR Accounting  Measuring Impairment for TDR’s – When a loan is impaired, impairment is based on the present value of the future expected cash flows discounted at the original loan’s effective interest rate. – As a practical expedient, FAS 114 allows the impairment to be measured by the loan’s observable market price of the fair value of the collateral, if the loan is collateral dependent – Per FAS 114, par 13 “ A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral”
    • Collateral Dependency  The loan is collateral dependent because the loan is not performing under the provisions of the TDR agreement (i.e. the loan is delinquent). – The Credit Union (CU) should then discount the most recent appraised value for the “cost to sell” and subtract the discounted appraised value from the loan’s current balance.
    • Collateral Dependency (Example) Appraised value $ 300,000 Discount 15% ( 45,000) Discounted value $ 255,000 Loan payoff $ 391,944 Collateral deficiency $(136,944)
    • Collateral Dependency (Continued)  Changes to the base used to measure impairment will most likely occur and should be tested by management quarterly.  Revisions to impairment estimates are debited or credited to the valuation allowance (ALLL) and offset against the provision for loan loss expense (PLL).
    • Example – TDR accounting  $400,000 real estate mortgage loan at 6% thirty year amortization. Originated January 15, 2007 at LTV 80%.  The Borrower is in financial trouble and has asked for special terms to avoid foreclosure. – Last payment was June 1, 2010 – The loan is 60 days delinquent – The loan balance is $388,064 – The current LTV is 113%
    • Example – TDR accounting (Continued)  The credit Union has agreed to: – Reduce the interest rate to 3% for three years, starting September 1, 2010. – Defer accrued and delinquent interest due July 1st and August 1st, $3,880. – The loan balance is $388,064 excluding delinquent interest and late fees. – The payoff amount if $391,944 [$388,064 + $3,880]
    • How do we calculate the TDR loss?  Determine the new payment based on the temporary interest rate reduction. – September 1, 2010 to August 1, 2013 = $1,781 – Loan balance at August 1, 2013 $361,811 – New payment beginning September 1, 2013 at original interest rate of 6% $2,388 [284 payments]
    • How do we calculate the TDR loss?  Determine the present value (PV) of cash flows discounted at the original rate of 6% = $360,883  Difference between the PV of future cash flows $360,883 and the loan payoff $391,944 = $31,061 LOSS FROM TDR CONCESSIONS
    • ACCOUNTING FOR TDR’s  Establish a valuation account (contra asset) and charge ALLL for the amount of the impairment - $31,061.  Recommend a separate ALLL account be used.  If payments are made, reduce the ALLL as payments are made.  Increase or decrease the valuation account for subsequent changes to the impairment, but never below zero.
    • Regulatory & Call Reporting Considerations  Does the TDR make financial sense? Loan payoff $ 391,044 Collateral value $ 255,000 Loss if foreclosed $(136,944) vs. TDR loss $( 31,061) Financial results vs. member’s best interest
    • Regulatory & Call Reporting Considerations (continued)  What is the likelihood the credit union will collect payments on the TDR concessions? $1,781 vs. $2,388 = $617 per month (26% savings)  What is the likelihood the credit union will collect payments starting with payment 37? $608 per month more 34% increase?
    • Regulatory & Call Reporting Considerations (Continued)  Delinquency reporting: – September 2010 call reporting instructions, page 33 “Report TDR loans as delinquent consistent with the original loan contract amount until the borrower/member has demonstrated the ability to make timely and consecutive monthly payments over a six month period consistent with the restructured terms. Likewise, such loans may not be returned to full accrual status until the six month consecutive payment requirement is met”.
    • Regulatory & Call Reporting Considerations (Continued)  Does the TDR make good financial sense?  Delinquency charge-off reporting on the call report  Re-aging of TDR loans – is the DQ bucket the same or has the TDR loan moved the DQ buckets?  Realistic re-default rates. Re-default risk exists (higher LTV loans) and must be captured ) Probability of re-default, default rates based on deficiency bands, etc..)
    • Regulatory & Call Reporting Considerations (Continued)  Tracking and monitoring of TDR loans  TDR focus may be on mortgage loans, but applied to all loans  DOCUMENTATION (Policies, procedures and support)
    • TROUBLED DEBT RESTRUCTURINGS – GAAP Guidance  FAS no. 15 - Accounting by Debtors and Creditors for Troubled Debt Restructurings  FAS N0. 114 – Accounting by Creditors for the Impairment of a Loan  ETIF 2002-04 – Determining Whether a Debtor’s Modification or Exchange of Debt Instruments is within the scope of FAS No, 15
    • ALLOWANCE FOR LOAN LOSS COMPONENTS  FAS 5 – Historical loss rates applied to loan pools (homogeneous loans)  FAS 114 – impaired loans, TDR’s and large loans individually reviewed for impairment  Q&E – Loss ratios are past experience and may not be reflective of current trends
    • ALLOWANCE FOR LOAN LOSSES  Identify problem loans (collection efforts exhausted, bankruptcies, payments skipped or high delinquent balances).  Identify loss ratios for loan categories “pools” (autos, credit card, real estate). Don’t exclude real estate loans even if no loss history.  Identify TDR’s.  Review loan files of large loans (commercial, participations etc..).  Evaluate Q&E factors.  Compute ALLL monthly or quarterly.
    • ALLOWANCE FOR LOAN LOSSES  Loss ratios (charge-offs net of recoveries)  Use 1-3 year average based on most indicative of your current environment – Don’t use 3 year in periods of declining economy – Don’t use 1 year in period of improving economy  Use rolling averages (most current information)  Apply to average loan balance for each pool.  Be realistic and charge loans off timely and consistently.
    • ALLL COMPUTATION CREDIT UNION ANYWHERE Loan Loss Reserve Calculation As of September 30, 2010 Loss FAS 5 Loan Pool Balance Known Losses Adj. Balance Ratio Reserve Credit Line $1,600,000 $25,000 $1,575,000 6.00% $94,500 Unsecured $1,300,000 $89,000 $1,211,000 14.50% $175,595 Visa $56,000,000 $1,100,000 $54,900,000 8.50% $4,666,500 Share Secured - No Risk $1,700,000 $0 $1,700,000 0.25% $4,250 Other Secured $8,500,000 $350,000 $8,150,000 8.25% $672,375 New Auto - Direct $53,500,000 $750,000 $52,750,000 2.00% $1,055,000 New Auto - Indirect $25,700,000 $700,000 $25,000,000 2.75% $687,500 Used Auto - Direct $11,000,000 $150,000 $10,850,000 2.50% $271,250 Used Auto - Indirect $17,400,000 $500,000 $16,900,000 3.00% $507,000 Consumer Subtotal $176,700,000 $3,664,000 $173,036,000 4.70% $8,133,970 First TD - Fixed $95,000,000 $3,200,000 $91,800,000 0.35% $321,300 First TD - ARM $66,000,000 $6,196,000 $59,804,000 2.35% $1,405,395 Second TD $32,000,000 $1,000,000 $31,000,000 3.00% $930,000 HELOCs $77,700,000 $593,000 $77,107,000 1.00% $771,070 Powerhouse $675,000 $0 $675,000 22.00% $148,500 RE Subtotal $271,375,000 $10,989,000 $260,386,000 1.37% $3,576,265 Loan Participations $22,150,000 $0 $22,150,000 2.00% $443,000 Apartments $7,800,000 $0 $7,800,000 2.15% $167,700 Business 1TDs $6,100,000 $0 $6,100,000 2.00% $122,000 Business HELOCs $4,200,000 $0 $4,200,000 2.00% $84,000 MBL Subtotal $40,250,000 $0 $40,250,000 2.03% $816,700 Total FAS 5 $488,325,000 $14,653,000 $473,672,000 2.64% $12,526,935
    • ALLL COMPUTATION (Continued)  TDR Reserve: – Collateral dependent – Present value of cash flows with re-default rate
    • ALLL COMPUTATION (Continued) PV with weighted probability of re-default: Deficiency = $100,000 PV = $15,000 – Determine portfolio re-default rate – 51% – Determine the re-default period – 5 months – Computation: ($100,000 x 51% + ($15,000 x (1-51%)) = 58,350 – $58,350 is the entry value of the TDR through the 5th consecutive on time payment. Upon the 6th on time payment, the reserve is reduced to PV or ($15,000 – (6x$417) = $12,500
    • ALLL COMPUTATION (Continued) PV with re-default rate based on LTV bands: Description Balance Reserve TDR DQ $1,994,000 $ 777,415 TDR Loss Rate (PV=0) $ 786,000 $ 2,751 TDR LTV <100 @ 15% $ 687,000 $ 16,388 TDR LTV 101-120 @ 25% $1,438,000 $ 173,776 TDR LTV 121 – 140 @ 50% $ 620,000 $ 164,251 TDR LTV >140 @ 75% $2,250,500 $ 967,015 Total TDR $7,775,500 $2,101,596 *Loss Rate TDR FAS % $( 786,000) $( 2,751) FAS 114 TDR $6,989,500 $2,098,845 Note: Same concept as weighted-probability of re-default except using bands without application of re-default period. TDRs @ Loss rate are reserved per FAS 5.
    • ALLL SUMMARY Anywhere CU - ALLOWANCE FOR LOAN 09-30-10 LOSSES Amount needed for known losses – FAS 114 $ 5,024,000 Historical loss ratios applied to all loan pools $12,527,000 – FAS 5 Q&E $ 1,375,000 Total $18,926,000
    • Do you have enough ALLL?  Will the ALLL amount today be adequate to cover net charge-offs coming in the next 12 months? – Look back test (12 months ago did you have ALLL reserve to cover the subsequent net charge –offs? – Range of estimates using 3-6-9-12 month loss rates – where is the reserve in relation to the minimum and maximum of the loss rate band? What happens if the bands worsen by 5%? 10%?
    • Do you have enough ALLL? (Continued)  Delinquency coverage ratio – is 1x, 2x, 3x enough? Where is the delinquency moving?  What are the future economic expectations?  For housing?  For SEG’s and membership (unemployment, under-employment)  Is the ALLL directional consistent?
    • REGULATORY AND CALL REPORTING CONSIDERATIONS  ALLL – GAAP compliance – Effective loan review system with strong internal controls (segregation of duties) – Delinquency reports are detailed and considered in the ALLL process – Process for timely charge-offs – Documentation (policies, procedures for ALLL methodology)
    • REGULATORY AND CALL REPORTING CONSIDERATIONS (Continued)  ALLL analytics reviewed by CFO quarterly, documented and signed off y CFO, CLO and CEO  Annual independent review of ALLL methodology  Documentation is provided to Board and Supervisory Committee at least annually
    • REGULATORY AND CALL REPORTING CONSIDERATIONS (Continued)  Board approves recommended charge-offs and actual charge-offs are reconciled to authorize amount  Appropriate grading system for commercial & other large loans
    • Recommendations  Work with your CPA firm, especially with TDR’s, real estate, loan participations, commercial portfolio and Q&E (don’t wait for audit or exam time)  Communication between finance, lending and collections is critical  Documentation – policies, procedures, meeting minutes (get it all in writing)
    • New ALLL GAAP Disclosures  FASB issued Accounting Standards Update (ASU) no. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses  Effective 12/31/11 for non public companies  New or expanded disclosures will include: – Aging of past-due receivables, – Credit quality indicators, and – Modifications of loans
    • OTHER REAL ESTATE OWNED (OREO) What are the accounting considerations for foreclosed real estate?  Remove loan from portfolio at foreclosure decision date and record to OREO account.  Record estimated loss, equal to estimated net sales proceeds less loan balance. Don’t wait until sale date.  Consider fix up expenses and expenses of sale (real estate commissions etc..).  After sale, adjust loss to actual.
    • OTHER REAL ESTATE OWNED (OREO) What If CU is holding OREO as an asset and renting?  It is now an asset on the CU’s books  Reduce loan portfolio and record OREO.  Record loss based on estimated market value  Record rental income as earned and expenses as incurred.  Consider periodic impairment based on market value assessment or appraisal.
    • QUESTIONS