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

1. 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

2. 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

3. 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.

4. 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

5. 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.

6. 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”

7. 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.

8. Collateral Dependency (Example)
Appraised value $ 300,000
Discount 15% ( 45,000)
Discounted value $ 255,000
Loan payoff $ 391,944
Collateral deficiency $(136,944)

9. 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).

10. 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%

11. 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]

12. 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]

13. 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

14. 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.

15. 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

16. 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?

17. 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”.

18. 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..)

19. 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)

20. 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

21. 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

22. 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.

23. 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.

24. 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

25. ALLL COMPUTATION (Continued)
 TDR Reserve:
– Collateral dependent
– Present value of cash flows with re-default rate

26. 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

27. 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.

28. 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

29. 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%?

30. 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?

31. 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)

32. 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

33. 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

34. 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)

35. 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

36. 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.

37. 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.

38. QUESTIONS