This post was written before regulators provided updated guidance on accounting for TDRs. See this recent blog post for updated information on guidance related to TDRs. CECL adopters can use a single model for loan modification accounting.
Return of the TDR: How to prepare for coronavirus-related loan restructurings
- For the first time in more than a decade, bankers may be dealing with large numbers of TDRs due to the coronavirus crisis.
- The FDIC recently reiterated that financial institutions should determine whether loans affected by COVID-19 should be reported as TDRs.
- A decision by FASB on TDRs and coronavirus modifications will be critical for lenders, given the implications for calculating the allowance for credit losses, or the allowance for loan and lease losses.
It’s been more than a decade since bankers have had to deal with Troubled Debt Restructurings (TDRs) on any kind of scale. As a result, the current coronavirus crisis means many financial institutions are dusting off accounting guidance and their own TDR policies and procedures as they work with borrowers facing lost business, unexpected closings, and new cash needs.
Welcome back, TDRs?
This real and sudden situation on a large scale has many financial institutions seeking novel ways to handle their loans, according to Regan Camp, Abrigo Managing Director of Advisory Services.
“If financial institutions can modify these terms to more attractive, more manageable terms, then we can ultimately maximize what the recovery is to the institution,” Camp says. “It’s not a way for us to mask problems.”
A loan is considered a TDR, by definition, when the lender grants a concession it would not have considered otherwise due to the borrower’s financial difficulties. But of course, determining thresholds for borrower financial difficulty and whether modifications are labeled concessions threshold are where the difficulty lies and where examiners and bankers can sometimes disagree, Camp says.
“What examiners want to see is that the TDRs are us working with the client in a reasonable restructuring agreement that will ultimately result in more recovery for us,” he says.
FDIC issues reminder of TDRs
That’s why it’s important right now for financial institutions to re-examine their accounting procedures as well as accounting guidance, such as ASC 310-40: Receivables – Troubled Debt Restructurings by Creditors, Camp says. This primary source of guidance on TDRs and testing for loan impairment could be especially important as banks and credit unions determine which loans have been affected by the impacts of public health actions to contain the coronavirus.
Indeed, the FDIC on March 19 issued a Financial Institution Letter to all FDIC-supervised institutions that included this reminder about TDRs:
Financial institutions should determine whether loans with payment accommodations made to borrowers affected by COVID-19 should separately be reported as TDRs in separate memoranda items for such loans in regulatory reports. A TDR is a loan restructuring in which an institution, for economic or legal reasons related to a borrower's financial difficulties, grants a concession to the borrower that it would not otherwise consider. However, a loan deferred, extended, or renewed at a stated interest rate equal to the current interest rate for new debt with similar risk is not reported as a TDR. Financial institutions may refer to Accounting Standards Code (ASC) 310-40 (formerly Financial Accounting Standards Board (FASB) Statement No. 15) for additional guidance on determining whether a loan with renegotiated terms should be accounted for as a TDR. ASC 310-10-35 (formerly FASB Statement No. 114) also provides guidance on accounting for impairment losses on TDRs.
Will COVID-19 modifications be TDRs?
The same day, FDIC Chairman Jelena McWilliams urged the Financial Accounting Standards Board (FASB) to exclude modifications related to coronavirus-related issues from being considered a concession when determining a TDR. She said that while the FDIC has encouraged institutions to work with affected borrowers, institutions are worried about a modification being classified as a TDR in FASB’s view.
“Based on our initial review of the letter, we agree with the need for close coordination with the SEC and banking regulators to address issues associated with loan modifications,” said FASB spokeswoman Christine Klimek in an email statement to Abrigo. She did not have an estimated timeline for announcing how to address the issues.
A decision on this issue will be critical for lenders. Camp said if loans are determined to be TDRs, financial institutions still calculating the allowance for loan and lease losses under the incurred loss method will, of course, be required to consider the loan impaired for allowance purposes. Valuation and measurement of required reserves for the impaired loans can be cumbersome if a financial institution is handling those processes manually, Camp notes.
“Consider what automated options you have,” he says. “Now might be a good time to ramp up your capacity knowing that the effects of this are coming. There are many other benefits to automation anyway, but let this be a catalyst to convincing internal management that it’s a good idea to automate the allowance.”
CECL & TDRs
Financial institutions that will soon be estimating losses under the current expected credit loss standard, or CECL, haven’t had to think much about TDRs so far, as they’ve been relatively non-existent, but that may change, Camp says. “Under CECL, when considering the expected life of an asset, you don’t take into account extensions or modifications to the loan terms unless a TDR is reasonably expected; so, any potential renewal or extensions, we’re just looking at the cash flow today. But with a TDR, if you can reasonably expect a TDR, we need to factor in what those expected terms would be. So financial institutions need to factor in the expectations of TDRs – not just is a TDR going to happen but what are the anticipated terms of modifications and how might that affect your assumptions that go into your CECL model.”
Camp expects financial institutions will be “thinking outside of the box” in restructurings during the current crisis. “We have a unique opportunity to not only increase goodwill with our current customer base, but also from a competitive landscape perspective,” he said.
Banks or credit unions that demonstrate a willingness to work with clients during this coronavirus crisis will find that customers develop an allegiance to them – and will spread the word. As a result, they may also find, Camp says, potential customers saying, “That’s who I want to bank with.”
Other guidance to review includes:
- Statement of Financial Accounting Standards No. 15: Accounting by Debtors and Creditors for Troubled Debt Restructurings. Financial Accounting Standards Board. 1977.
- ASU 2016-13, Financial Instruments -- Credit Loses (Topic 326). FASB. 2016.
- ASU 2010-20 - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. Financial Accounting Standards Board. 2010.
- ASU 2011-02 - Determination of Whether a Restructuring is a Troubled Debt Restructuring. Financial Accounting Standards Board. 2011
- Interagency Policy Statement on the Allowance for Loan and Lease Losses. FDIC, OCC, FED. 2006
- Policy Statement on Prudent Commercial Real Estate Loan Workouts. FDIC. 2011
- Interagency Policy Statement on TDRs (FIL-50-2013). FDIC, OCC, FED. 2013