1. ©2012 CliftonLarsonAllen LLP 1 111 Troubled Debt Restructuring and What It Means to Your Credit Union ACUIA Denver, CO June 20, 2012

2. ©2012 CliftonLarsonAllen LLP 2 Presenter-Greg Schwartz, CPA Principal with LarsonAllen Credit Union Group 30 years of experience working with credit unions Commercial and financial institution clients Speaker/Presenter at: –AICPA national CU conference –ACUIA national conference –Various state league and chapter meetings Graduate of Minnesota State, bachelor of science in accounting Member of: –AICPA –Minnesota Society of CPAs –AICPA Credit Union Committee.

3. ©2012 CliftonLarsonAllen LLP 3 About CliftonLarsonAllen One of the nation’s largest certified public accounting firms Founded in 1953 More than 3,800 professionals serving clients from 90 offices across the country # 1 provider of audit services to credit unions

4. ©2012 CliftonLarsonAllen LLP 4 AGENDA Troubled Debt Restructuring (TDR) – Definition Recent Accounting Change Regarding TDRs TDRs and the Allowance for Loan and Lease Losses (ALLL) How Does this Affect Your Credit Union

5. ©2012 CliftonLarsonAllen LLP 5 Definition Restructuring of debt constitutes a TDR if: The creditor (credit union) for economic or legal reasons related to the debtor’s (member’s) financial difficulties grants a concession to the debtor that it would not otherwise consider Both conditions must be present for a restructuring to be considered a TDR –Grant a concession and –Borrower needs to be experiencing financial difficulty

6. ©2012 CliftonLarsonAllen LLP 6 Definition So what does that mean? –Member has financial difficulties ◊ Bankruptcy (11 or 13) ◊ Slow pay or inability to pay due to hardships Loss of job Decreased pay Divorce or illness –Grant a concession ◊ Extend payment/loan terms ◊ Reduce interest rate ◊ Forgiveness of debt

7. ©2012 CliftonLarsonAllen LLP 7 Definition Do we or have we had any TDR at my credit union? –Unequivocally - Maybe

8. ©2012 CliftonLarsonAllen LLP 8 Recent Accounting Change In April 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-02, Receivables (Topic 310): A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring The ASU is effective for nonpublic entities, (credit unions) for annual periods ending on or after December 15, 2012, and should be applied retrospectively to the beginning of the annual period of adoption –i.e. credit unions with 12/31 year-end to adopt January 1, 2012 –Early adoption is permitted Prospective application –Go forward not look back

9. ©2012 CliftonLarsonAllen LLP 9 Recent Accounting Change Why was this new ASU issued? –Due to economic downturn the number of restructurings increased –Concerns about what constitutes a concession and financial difficulty ASU’s intent is to help clarify what constitutes a concession and financial difficulty, in determining whether a restructuring is considered to be a TDR

10. ©2012 CliftonLarsonAllen LLP 10 Recent Accounting Change Key misconceptions that new ASU did NOT: –Change definition of TDR it only clarified what constitutes a concession and financial difficulty –Change how credit union is to identify, track and allow/reserve for these troubled loans in ALLL –Change how credit union is to report TDR as delinquent on NCUA Call Report until 6 consecutive payments were made by member

11. ©2012 CliftonLarsonAllen LLP 11 Recent Accounting Change Clarification of Concessions: –Objective is to make the best of a difficult situation – creditor expects to: ◊ Obtain more cash or value from debtor ◊ Increase probability of repayment –Granted concession when, as a result of restructuring, you do not expect to collect all amounts due (P&I) at the original contract rate

12. ©2012 CliftonLarsonAllen LLP 12 Recent Accounting Change Indicators of granting concession: –Borrower does not otherwise have access to funds at a market rate for debt with similar risk characteristics as the restructured debt

13. ©2012 CliftonLarsonAllen LLP 13 Recent Accounting Change Indicators of granting concession: –A temporary or permanent increase in the interest rate as a result of a restructuring could still be considered a concession granted by the credit union if the new interest rate is still below the market interest rate

14. ©2012 CliftonLarsonAllen LLP 14 Recent Accounting Change Indicators of granting concession: –More than insignificant payment delays ◊ Typically any extension greater than 3 months (90 days) –Insignificant payment delays that do not constitute a TDR: ◊ Amount of the restructured payments subject to the delay is insignificant relative to the unpaid principal or collateral value of the debt and will result in an insignificant shortfall in the contractual amount due

15. ©2012 CliftonLarsonAllen LLP 15 Recent Accounting Change ◊ Delay of restructured payment period is insignificant relative to any one of the following: Frequency of payments due under the debt Debt's original contractual maturity Debt's original expected duration

16. ©2012 CliftonLarsonAllen LLP 16 Recent Accounting Change ◊ Evaluate cumulative affect of all past restructurings to determine if now a TDR, for example: Original 3 month extension in Year 1 – Not a TDR But extend again in Year 2 for 3 additional months – Now in Year 2 it is a TDR (6 month extension)

17. ©2012 CliftonLarsonAllen LLP 17 Recent Accounting Change Indications of borrower financial difficulty: –Borrower may have financial difficulty even though not currently in payment default with the credit union –Borrower is currently delinquent on any of its debt (with or outside of the credit union) –Borrower has declared/declaring bankruptcy –Substantial doubt as to whether the borrower will continue to be a going concern (MBL)

18. ©2012 CliftonLarsonAllen LLP 18 Recent Accounting Change Indications of borrower financial difficulty: –Forecasted cash flows will be insufficient to service existing debt for foreseeable future –Without modification, borrower cannot obtain funds from other sources at the same rate as a non-troubled borrower

19. ©2012 CliftonLarsonAllen LLP 19 Recent Accounting Change Therefore, you will have to look at the member’s financial condition and ability to pay outside of the performance at your credit union, which may entail: –Gathering current financial statements or records –Pulling a credit report for the member –Performing or reviewing forecasts or projections, and/or –Using judgment

20. ©2012 CliftonLarsonAllen LLP 20 Recent Accounting Change In theory, if the restructuring is outside of the credit unions’ policies and outside of industry guidelines (i.e. terms, rates, loan-to-values, etc.); then it most likely would be considered a TDR

21. ©2012 CliftonLarsonAllen LLP 21 Recent Accounting Change ASU also clarifies that a credit union can no longer use the effective interest rate test as defined in ASC 470-60-55-10 in determining whether a restructuring constitutes a TDR

22. ©2012 CliftonLarsonAllen LLP 22 TDR and ALLL All TDR loans are considered “impaired loans” –It is probable that the credit union will be unable to collect all principal and interest payments as scheduled in the original contractual terms Therefore to be allowed for under ASU … (old FAS 114)

23. ©2012 CliftonLarsonAllen LLP 23 TDR and ALLL TDR reserves are to be based on: –Reserve for difference between cash flows based on discounted present value of original vs. modified terms, plus –Additional reserves for re-default, OR –Collateral based loans - reserve for difference between estimated value of collateral less costs to sell compared to the loan balance

24. ©2012 CliftonLarsonAllen LLP 24 TDR and ALLL Why discounted cash flow method? –Basically you are reserving for lost income/principal due to restructuring ◊ Discounted cash flow model –As time goes by and if member re-paying as agreed this reserve will decline each month and can bring back to income ◊ Lower provision for loan losses (PLL)

25. ©2012 CliftonLarsonAllen LLP 25 TDR and ALLL Why additional amount for re-default risk? –Discounted cash flows does not account for potential loss of principal on these high risk loans –Calculate based on historical re-default loss ◊ Percentage of TDRs gone bad by loan segment times loss estimate per loan

26. ©2012 CliftonLarsonAllen LLP 26 How It Affects Credit Union I believe more restructured and modified loans will qualify as a TDR

27. ©2012 CliftonLarsonAllen LLP 27 How It Affects Credit Union Therefore if a credit union has more restructured loans that will now be considered a TDR: –The total amount of reportable loan delinquencies may increase on quarterly Call Reports, and –The total amount of reserves in the ALLL may also need to be increased for the additional impaired TDR loans

28. ©2012 CliftonLarsonAllen LLP 28 How It Affects Credit Union Risks –Lending and accounting do not talk therefore could have many TDRs not identified and tracked –Not reported properly as delinquent loans

29. ©2012 CliftonLarsonAllen LLP 29 How It Affects Credit Union Regulatory Reporting on TDR –ASU did not change reporting requirements as regulatory matter –Delinquency on TDRs is reported on the Call Report consistent with the original loan contract terms –Return of TDR to full payment status after 6-month period of demonstrated ability to repay consistent with the restructured terms

30. ©2012 CliftonLarsonAllen LLP 30 How It Affects Credit Union Risks –TDRs not reserved for properly ◊ Could have significant financial statement impact Increased ALLL through PLL Decrease in net income

31. ©2012 CliftonLarsonAllen LLP 31 How Affects Credit Union Recommendation: –Early and often communication between accounting and lending departments is essential ◊ Ensures all loans that have been restructured or modified have been evaluated for TDR –Process helps ensure overstatement of earnings is not issued, and examiners and auditors can have confidence in the financial strength of the credit union

32. ©2012 CliftonLarsonAllen LLP 32 Examples #1 –Member delinquent by 2 payments –Lower interest rate by 1% –TDR? #2 –Member not delinquent with you but delinquent on bank credit card –Lower interest rate by 1% –TDR?

33. ©2012 CliftonLarsonAllen LLP 33 Examples #3 –Member not delinquent on any loan –Member has loss of job and/or income reduced (i.e. no overtime, etc) –States cannot make scheduled payments –Lower payment by $100/month by extending loan 12 months –TDR?

34. ©2012 CliftonLarsonAllen LLP 34 Examples #4 –Member not delinquent on any loan –Member has no change in income –Asks for interest rate reduction to match current offered rates –Member qualifies for rate if new loan –Lower interest rate by 0.50% –TDR?

35. ©2012 CliftonLarsonAllen LLP 35 Examples –#5 ◊ Member not delinquent on any loan ◊ Member has no change in income but may be over-extended on credit ◊ States cannot make scheduled payments ◊ Member qualifies loan, except for LTV above policy ◊ Change terms from 5 year balloon to 30 year fixed at going 6% rate ◊ TDR?

36. ©2012 CliftonLarsonAllen LLP 36 Examples #6 –Member not delinquent on any loan –Member has no change in income but has some unexpected medical bills –States cannot make scheduled payments –Grant 2 month extension –TDR?

37. ©2012 CliftonLarsonAllen LLP 37 Examples #7 –Same conditions as #6 but now 2 years later you grant another 2 month extension due to divorce –TDR?

38. ©2012 CliftonLarsonAllen LLP 38 Examples #8 –Member not delinquent on any loan –Member has slight decline in income (no overtime paid) –States cannot make scheduled payments –Member qualifies loan –Lower payment by $400 for 12 months then goes back to original payment –TDR?

39. ©2012 CliftonLarsonAllen LLP 39 ©2012 CliftonLarsonAllen LLP Questions?

40. ©2012 CliftonLarsonAllen LLP 40 Contact Us Greg Schwartz, CPA, CMA greg.schwartz@cliftonlarsonallen.com 612-376-4684