Troubled Debt Restructure (TDR)

July 28, 2012

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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? More

Concentration Risk

July 7, 2012

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CU officials and management have a fiduciary responsibility to identify, measure, monitor, and control concentration risk.  Concentration risk must be managed in conjunction with credit, interest rate and liquidity risks; as a negative event in any category may have significant consequences on the other areas, as well as strategic and reputation risks.

Concentration risk has increased in importance during the recent economic recession.  Poor risk management of residential and commercial mortgage loan concentrations, in particular, is having an adverse effect on credit unions nationwide; resulting in significant loan losses, earnings deterioration, capital depletion, and increased credit union failures.

The board of directors should establish a policy addressing its philosophy on concentration risk, limits commensurate with net worth levels, and the rationale as to how the limits fit into the credit union’s overall strategic plan.  Take a global perspective when developing the policy, including identifying outside forces (such as economic or housing price uncertainty) which will affect the ability to manage concentration risk.

The parameters set by the board should be specific to each portfolio and should include limits on loan types, share types, third party relationship exposure, etc.  The risk limits should correlate to the overall growth objectives, financial targets, and net worth plan.  The risk limits set forth in the concentration risk policy should be closely linked to those codified in related policies, including, but not limited to, real estate loan, member business loan, loan participation, asset/liability management (ALM), investment and liquidity policies.  Any Concentration exceeding 100 percent of net worth must be monitored carefully, and the board of directors should document an adequate rationale for undertaking that level of risk. More

An Understanding of a Credit Union Net Worth Restoration Plan

May 1, 2012

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Due to recent declines in the equity markets, some credit unions may experience an increased flow of funds coming into their organization at a time of weak loan demand and low investment returns. This “flight-to-safety” for some credit unions could result in the need to submit a “Net Worth Restoration Plan”.

The Net Worth Restoration Plan commonly referred to as NWRP serves as a blueprint for the board and management to restore and maintain for four consecutive quarters the credit union’s net worth ratio to 6% or greater and to establish a financial framework for the 1/10th percent (0.1%) quarterly earnings waivers transfers.

Understanding the implications of the credit union having an inadequate level of net worth is important.  Your primary goal should be safeguarding the member’s deposits through sound policies and practices, and by creating and sustaining a sufficient amount of net worth and reserves to absorb possible losses without endangering the stability of the credit union.

Your plan needs to meet the criteria set forth in NCUA Rules and Regulations 702.206-NWRP including: More

Allowance for Loan Loss

February 1, 2012

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The ALL estimate is guided by NCUA Rules and Regulations and Generally Accepted Accounting Principles (GAAP). The following resources were considered in the creation of this article:

  1. FASB ASC Topic 450: Accounting for Contingencies [formerly FAS 5];
  2. FASB ASC Topic 310: Accounting for Receivables [formerly FAS 114];
  3. NCUA Interpretive Ruling and Policy Statement 02-3: ALLL Methodologies and Documentation for Federally Insured Credit Unions;
  4. NCUA Letter to Credit Unions 03-CU-01: Loan Charge-off Guidance; and
  5. NCUA Accounting Bulletin No. 06-01

Because of the newly implemented ASC, it maybe difficult, especially for those, like myself, who are familiar with the original FASB standards, to identify the most current accounting reference materials.

There are two primary topics under the ASC that address the ALL. Key concepts extracted from Topics 450 and 310 of the ASC are summarized below.

  1. Topic 450, Subtopic 20, “Loss Contingencies,” addresses accounting for loss contingencies. Much of this topic is derived from Statement of Financial Accounting Standards (SFAS) Statement 5, “Accounting for Contingencies.  Topic 450 specifically references Topic 310, noting that the ALL is a subset of loss contingencies.
  2. Topic 310, “Receivables,” addresses various issues related to accounting issues subsequent to the origination or acquisition of receivables, such as impairment. Former accounting standards SFAS 5, SFAS 15, and SFAS 114 provide much of the content for this section.

Subjective and Imprecise

The appropriate degree of allowance involves a high degree of “management judgment” within a “range of estimated losses.”  Moreover, determining the allowance for loan and lease loss, hereafter referred to ALL is “subjective and imprecise.”  ALL estimates are based on a comprehensive, well documented and consistently applied analysis of the credit union’s loan portfolio.

ALL takes into consideration available information as of the financial statement date including environmental factors. The ALL provides an estimate of probable but unconfirmed losses in the loan portfolio as of the financial statement date; it is not a reserve for future anticipated losses.    The use of environmental factors may likely cause estimated credit losses associated with the credit union’s existing loan portfolio to differ from the historical loss experience.  Your analysis should consider significant factors affecting the collectibility of the portfolio and attempts to support the credit losses estimated by the ALL process. A credit union should adopt methodologies and documentation practices that are appropriate for their size and complexity.  Credit unions with fewer and less complex loan products, the amount of supporting documentation for the ALL may be less exhaustive than for credit unions with more complex loan products or portfolios. Your methodology and documentation needed to support the ALL estimates should be prepared in accordance with generally accepted accounting principles (GAAP).  The Statement of Financial Accounting Standard (FAS) 5 will be most relevant to the majority of credit unions. Finally, understanding the theory, building strong policies and analytics, and increasing director governance are key to a successful ALL outcomes. More

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