Troubled Debt Restructuring A Regulator’s Perspective

Presenters Jane Johnson, Financial Examiner Supervisor, Division of Credit Unions, Department of Financial Institutions Elizabeth Habring, Supervisory Examiner, Region V, National Credit Union Administration Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

‘What is a TDR?’ Troubled Debt Restructuring results when the lender grants concessions, that would not ordinarily be granted, to the member in light of the members' financial difficulties. Concessions often involve a reduced interest rate, payment or principal amount. Routine changes in debt terms and loan deferrals are not considered troubled debt restructurings unless they are granted due to the adverse financial condition of the member. Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

Concessions Include Reduction of the contractual (stated) interest rate Extension of the maturity date Suspension of contractual payments Reduction of the face amount of debt, i.e., forgiveness of a portion of principal Reduction (forgiveness) of accrued interest Reduction (forgiveness) of fees

‘Are TDRs a “bad” thing?’ Not trying to discourage TDR is an expected part of a credit union’s management of assets Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

GAAP is set forth in the FASB CPA firms consider materiality. From a regulatory perspective, materiality is not the only issue. SFAS 15 SFAS 114 SFAS No. 5 EITF 02-4 Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

‘What about refinances?’ When a borrower refinances or restructures a loan, and the terms are at least as favorable to the lender as the terms for comparable loans to other members with similar collection risks who are not refinancing or restructuring, the refinanced loan should be accounted for as a new loan. Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

Example of TDR & Refinance Current used auto loan rate is 5%. TDR: Joe has a 7% used auto loan (pymt $346, 12 month term). Credit Union agrees to accept 3% interest, (pymt $172, 24 month term). Refinance: Sue has a 7% used auto loan (pymt $346, 12 month term). Credit union agrees to accept 5% interest (pymt $342, 12 month term).

‘How is a TDR reported?’ Vast majority of TDR are immaterial for balance sheet purposes BUT: TDRs must be reported on 5300 Call Report Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

5300 Page 9 “Delinquent Loans” by Collateral Type, lines 1 thru 15 Report TDRs as delinquent with original loan contract terms until the borrower is current with the new terms for 6 months Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

Original loan requires monthly payments of $400 at an interest rate of 6% with 9 months left in term of an unsecured loan. The credit union agreed to accept monthly payments of $275 at 10% for 12 months. Example: Report of Consumer Loan TDR MonthPaymentStatus Feb$300Delinquent (60 days) Mar$275Delinquent (90 days) Apr$275Rewrote to new terms (TDR) May$275 June$275Report loan as delinquent on 5300 Delinquent (180 days) July$275 August$275 September$275Report loan as current on 5300.

5300 (continued) Page 15 “Specialized Lending” Section 2 RE Loans, Line 14 RE loans whose terms have been modified due to the inability of the borrower to meet the original terms of the note Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

Accrual For regulatory reporting purposes TDR loans may not be returned to full accrual status until the six-month consecutive payment requirement is met. Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

‘Won’t that increase my delinquency ratio?’ Yes Increases are expected especially in this market Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

‘But what if I’m not losing any money?’ A loan is “impaired” when, based on current information and events, it is probable that an institution will be unable to collect all amounts due according to the contractual terms of the loan agreement. Therefore, impairment is measured using an estimate of the expected future cash flows (NPV). Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

NPV For the majority of TDR loans we see in Credit Unions, there is a loss but it is immaterial for balance sheet purposes. Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

Why do we need to report this? Regulators (and credit union management) look to the delinquent loan reporting to provide insight into the quality of the loan portfolio. Your internal management assessment Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

Internal Management Assessment Top management and the Board should be aware of the level of restructuring TDR is a useful and effective way to manage troubled assets and should be considered in any workout / foreclosure / repo decision By keeping track of the TDRs being done, management can ensure that TDRs are being used as planned Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

Example of Analysis Loan: car loan of $30,000, 6%, 36 months, Pymt = $913 After the Member makes the 12 th monthly payment they tell you their spouse lost their job and they can’t afford the car anymore – they are thinking of turning in the car to you Blue Book says that in today’s market the Credit Union would sustain at least an $8,000 loss if you repo’d it The Member says he could afford a monthly pymt of $750 but only for 2 years Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

What do you do? Repo the car and take the $8K loss? TDR and lower the payment to $750 for next 24 months? Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

TDR is More Beneficial to CU The amount of impairment on the restructured loan (i.e., the FAS 114 allowance) is the excess of the recorded investment in loan over the present value of expected future cash flows =PV(rate,months,pymt) =PV((6%/12),24,750)=$16,922 Loan balance at time of modification = $20,592 Difference (Loss) = $3,370 Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

What’s the bottom line? If a new member walks in your door today, would you make a new loan at the workout rate and terms? If not, it’s a TDR. To leave delinquent loan status, the TDR must perform for 6 months under the new (re-written) contract terms. Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

References NCUA Accounting Bulletin Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”

How to Contact Us Contact Us: Jane Johnson Financial Examiner Supervisor of DCU Elizabeth A. Habring Supervisory Examiner – Region V National Credit Union Administration ext 3548 Washington State Department of Financial Institutions ”Regulating financial services to protect and educate the public and promote economic vitality.”