Wipfli's History Leadership Team. Diversity, equity and inclusion Experienced professionals. How we invest in your growth Virtual recruiting. Open positions Alumni Bridge. By: Brett D. Schwantes , Lydia R. Here is how you can determine whether a loan is a TDR and, if so, what that means. Loan modifications A TDR occurs when a financial institution restructures a debt and, for economic or legal reasons related to a borrower's financial difficulties, grants a concession to the borrower that it would not otherwise consider.
Modifications to terms of loans may include, but are not limited to, one or a combination of the following: Reduction of the stated interest rate for some or all of the remaining term of the loan Extension of the maturity date or dates at a stated interest rate lower than the current market rate for new loans with similar risk Reduction of the face amount or maturity amount of the loan as stated in the instrument or other agreement Reduction of accrued interest Regulators have encouraged financial institutions to consider modifications and loan accommodation programs to assist borrowers facing setbacks from the COVID outbreak e.
Determining whether a financial institution has granted a concession A loan modification or restructuring is only considered a TDR if the financial institution grants a concession it would not otherwise consider.
Accounting standards clarify when a concession is granted by noting the following: A financial institution has granted a concession when, as a result of the restructuring, it does not expect to collect all amounts due, including interest accrued at the original contract rate. A concession has been granted by a financial institution if the institution restructures the debt in exchange for additional collateral or guarantees from the borrower and the nature and amount of the additional collateral or guarantees received do not serve as adequate compensation for other terms of the restructuring.
If a borrower does not otherwise have access to funds at a market rate for debt with similar risk characteristics as the restructured debt, the restructuring would be considered to be at a below-market rate, which may indicate that the financial institution has granted a concession. However, as noted in FIL, 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.
A temporary or permanent increase in the contractual interest rate as a result of a restructuring does not preclude the restructuring from being considered a concession because the new contractual interest rate on the restructured debt could still be below the market interest rate for new debt with similar risk characteristics. The following factors, when considered together, may indicate that a restructuring results in an insignificant delay in payment: The 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.
Determining whether a borrower is experiencing financial difficulties A loan modification or restructuring is only deemed a TDR if the borrower is experiencing financial difficulties. When determining whether a borrower is experiencing financial difficulties, the accounting standards clarify that the financial institution should consider whether: The borrower is currently in payment default on any of its debt or it is probable that the borrower would be in payment default on any of its debt without the modification.
In other words, the borrower may be experiencing financial difficulties even though the borrower is not currently in payment default. The borrower has declared or is in the process of declaring bankruptcy. There is substantial doubt as to whether the borrower will continue to be a going concern. Without the current modification, the borrower cannot obtain funds from sources other than the existing financial institution s at an effective interest rate equal to the current market interest rate for similar debt for a nontroubled borrower.
Accounting for troubled debt restructuring TDRs are required to be accounted for as impaired loans under ASC Topic , even if the loan was exempt from the impaired loan accounting standards prior to the restructuring for example, a residential loan that was evaluated collectively as part of a homogenous loan pool. Nonaccrual loans Generally accepted accounting principles do not provide specific guidance as to whether a loan that has been modified in a TDR should be classified as nonaccrual.
Delinquent loans Typically, a loan that is past due 30 days or more is considered delinquent. Concluding thoughts Accounting standards related to TDRs have not changed in recent years, but these standards will be more relevant given recent events and the current world environment. Under GAAP, a credit loss on a loan, which may be for all or part of a particular loan, should be charged-off in the period in which the loan is deemed uncollectible.
When an impaired loan is dependent solely on the sale of the collateral for repayment, a credit union should apply the following formula: any portion of the recorded investment in the loan exceeding the amount adequately secured by the fair value of the collateral, less the estimated costs to sell, is uncollectible and should be charged off. Any remainder of the loan generally should be adversely classified—no worse than substandard.
Determining loss in a partial charge-off requires judgment, and may not be warranted for a collateral-dependent TDR loan if repayment is dependent only on the operation of the collateral, provided a credit union has modified the loan in accordance with a prudent workout strategy. A prudent workout strategy has current financial information that supports the collectability of the debt under reasonable, modified terms and expected future cash flows that are sufficient to repay the loan.
The expected future cash flows should be fully supported by a complete analysis and underwriting of the financial capacity and willingness of the borrower to repay the debt. When measuring impairment on an impaired loan, including a TDR loan, that is not collateral-dependent, a credit union must use the present value of expected future cash flows method, except that as a practical expedient, the creditor may measure impairment based on the loan's observable market price.
A credit union should determine its best estimate of these cash flows based on reasonable and supportable assumptions and projections. The contractual payments required by the newly modified loan may not represent the best estimate of the expected cash flows. As a result, a credit union should consider default and prepayment assumptions, as well as existing environmental factors relevant to the collectability of the loan. Consistent with GAAP, for an impaired loan, including a TDR loan, that is not collateral-dependent, when available information confirms that a specific loan, or a portion of the loan is uncollectible, the amount should be charged-off against the allowance for loan and lease losses.
In sum, a key aspect in assessing impairment for a TDR is determining if the loan is collateral dependent. The Agency staff further indicated that entities in certain industries that may have been experiencing the negative effects of economic conditions before COVID e.
Rather, entities making modifications can consider the fact that the COVID pandemic is affecting all entities. In its evaluation of whether a payment deferral qualifies as short-term under the interagency statement, an entity should assess multiple payment deferrals collectively i.
However, any loan modifications that are made after the initial modification would require evaluation under ASC unless the subsequent modification meets the conditions in Section of the CARES Act or the interagency statement.
Question 2A. Thus, an entity may choose to reduce the interest rate on a loan for a specified period as opposed to forbearing all payments during a specified period. Question 2B. Can the TDR guidance in the interagency statement be applied if an entity makes an interest rate modification to a loan? Any modification that involves the deferral of payments of principal and interest for a short-term period, without the accrual of interest on such deferred payments, is effectively a modification of the interest rate terms on the loan.
If, in lieu of deferring all payments of interest, an entity reduced the contractual interest rate for a short-term period i.
Question 3. Should an entity evaluate whether modified loans that are not considered TDRs under Section of the CARES Act or the interagency statement represent new loans for accounting purposes? However, if new loan accounting is not required, unless fees are received in connection with the modification, there would be no change in the net carrying amount of the loan as a result of the modification.
Under ASC through , a modification results in a new loan for accounting purposes only if all the following conditions are met: The modification is not a TDR.
The terms of the modified loan are at least as favorable to the lender as the terms of comparable loans to other customers with similar collection risks that are not refinancing or restructuring a loan with the lender. The modification is more than minor i. We would generally expect that loan modifications subject to the TDR guidance in Section of the CARES Act or the interagency statement would not represent new loans for accounting purposes.
Without performing a present-value calculation, a lender can appropriately determine that new loan accounting is not required on the basis of a conclusion that the terms of the modified loan are less favorable than the terms of newly originated loans that would be provided to borrowers that are not subject to the modification.
We expect this conclusion to be reached in most cases since these types of modifications arise from the economic difficulties associated with COVID Question 4. Should an entity continue to recognize an allowance for credit losses on modified loans that are not accounted for as TDRs as a result of Section of the CARES Act or the interagency statement?
Entities that grant loan modifications that are not accounted for as TDRs as a result of either Section of the CARES Act or the interagency statement must still recognize appropriate allowances for credit losses. However, entities that have adopted ASU as well as those that have not should consider the increased economic uncertainty associated with the COVID pandemic and any change in credit risk that results from loan modifications.
Question 5. May an entity continue to recognize interest income on modified loans that are not accounted for as TDRs as a result of Section of the CARES Act or the interagency statement if interest does not accrue on deferred payment obligations of the borrower? It depends. ASC a prohibits the recognition of interest income to the extent that the net carrying amount of a loan exceeds the amount for which the borrower could prepay it without penalty.
ASC a does not apply to such a forbearance. An entity that chooses to apply ASC a would generally conclude that interest income is not recognizable on modified loans that do not accrue interest during the payment deferral period.
An entity that chooses not to apply ASC a would recognize interest income at a modified effective rate but would consider whether the loan should be placed on nonaccrual status see Question 6. An entity that chooses not to apply ASC a is not required to estimate prepayments in determining the effective yield; however, estimated prepayments must be considered in the calculation of the allowance for credit losses for entities that have adopted ASU Prepayments are included in the calculation of the effective yield used to recognize interest income only when the guidance in ASC through is applied.
A recalculation is necessary for lenders to apply the interest method during the deferral period and thereafter i. This effective yield recalculation must take into account the payment deferral and any unamortized discounts or premiums. Such calculations may be complex for loans with variable interest rates. An entity that chooses to apply ASC a would not accrue contractual interest payments during the deferral period but would continue to amortize any discounts or premiums.
Once the deferral period ends, the entity would need to recalculate the effective yield to apply the interest method. That guidance states, in part: If [a] loan eventually returns to accrual status, interest income would be recognized based on the new effective yield to maturity on the loan. The new effective yield is the discount rate that would equate the present value of the future cash payments to the recorded amount of the loan. Any interest paid by the borrower and applied to principal while on nonaccrual is accounted for similar to a loan discount upon the loan returning to accruing status.
This amount is accreted into interest income as a yield adjustment over the remaining life of the loan. Interest income on loans classified as held for sale is generally recognized on the basis of the contractually stated coupon. Note that this interpretation does not apply to loans that are originated with an introductory payment deferral or modified loans that are treated as new loans under ASC The election of either of the two interpretations constitutes an accounting policy decision that must be applied consistently to all loans that are modified to incorporate payment deferrals.
While some entities may have already elected an accounting policy i. In accordance with ASC , 11 entities should also disclose the elected accounting policy and consider providing additional information about the amounts of interest accrued.
Note also that an entity that accrues interest under the second alternative discussed above must appropriately recognize an allowance for credit losses on the accrued interest amounts. Such an allowance can be measured separately for accrued interest receivable amounts or measured as part of the total carrying amount of the related loans. Some entities that have adopted ASU have elected, as an accounting policy, not to measure an allowance for credit losses on accrued interest receivable amounts because they write off the uncollectible accrued interest receivable balances in a timely manner.
These entities would generally still need to recognize an allowance for credit losses on accrued interest amounts that result from deferred payments because those amounts would not be considered to be written off in a timely manner. The AICPA has issued a technical question and answer that provides additional considerations related to loan restructurings that result in periods of reduced payments.
The above guidance may not be applied by borrowers. Question 6. Should an entity evaluate the need to report as nonaccrual assets modified loans that are not accounted for as TDRs as a result of Section of the CARES Act or the interagency statement? The interagency statement states, in part: Each financial institution should refer to the applicable regulatory reporting instructions, as well as its internal accounting policies, to determine if loans to stressed borrowers should be reported as nonaccrual assets in regulatory reports.
However, during the short-term arrangements discussed in this statement, these loans generally should not be reported as nonaccrual. As more information becomes available indicating a specific loan will not be repaid, institutions should refer to the charge-off guidance in the instructions for the Consolidated Reports of Condition and Income.
While this guidance indicates that a regulated lender would not be required to report a loan as a nonaccrual asset as a result of modifications made under short-term deferral programs in which the borrower was not 30 days or more past due as of the date on which the program was implemented, it does not imply that all modified loans that are not accounted for as TDRs under Section of the CARES Act or the interagency statement should be reported as accrual assets.
Rather, entities should apply their existing nonaccrual policies to determine whether loans must be reported as accrual assets. Examples of situations that may result in the need to report a modified loan as a nonaccrual asset even though the modification is not accounted for as a TDR may include: 12 Loans for which the borrower declares bankruptcy after the loan modification. Modifications of loans that were current as of December 31, , but were 90 days past due as of the date on which the entity implemented a loan modification program.
Note that while past-due status is considered in the determination of whether a loan represents a nonaccrual asset or should be charged off, it is not the only consideration. That is, a loan that is less than a certain number of days past due is not automatically an accruing asset.
Question 7. How do payment deferrals affect the past-due status of modified loans that are not accounted for as TDRs under Section of the CARES Act or the interagency statement during the payment deferral period? The past-due status of a loan is generally determined on the basis of the contractual terms of the loan. Once a loan has been contractually modified to defer payments, those revised terms represent the contractual terms that are used to determine past-due status.
This is acknowledged as follows in the interagency statement: With regard to loans not otherwise reportable as past due, financial institutions are not expected to designate loans with deferrals granted due to COVID as past due because of the deferral.
If a financial institution agrees to a payment deferral, this may result in no contractual payments being past due, and these loans are not considered past due during the period of the deferral. In accordance with this guidance, for modifications that are not accounted for as TDRs because of the interagency statement, since the loan was current i.
The Agency staff further indicated that loans that were current before COVID would generally remain current after being modified to defer payments of principal and interest assuming that those modifications are not accounted for as TDRs.
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