ALLL – TDR DISCUSSION
Robert B. Coleman
FDIC Regional Accountant
San Francisco
Division of Risk Management Supervision
March 20, 2012
1
Topics

ALLL - Loan impairment
•
•
•
•


ASC Topic 310-10-35
ASC Topic 450-20
Evaluation
Recognition
Measurement
Accounting/layering
TDR
ASC Topic 310-40
Questions
2
Topics
Authorities







ASC 310-40 Troubled Debt Restructurings (TDRs) by Creditors
ASC 310-10-35 Impairment Measurement
ASC 450-20 Loss Contingencies
ASU 2011-02 – Clarification Guidance – Identifying TDRs

Issued April 2011

Amends ASC Subtopic 310-40

http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156316498
Reports of Condition and Income Instructions – Glossary

Loan Impairment, pages A-57, A-58

Troubled Debt Restructurings, pages A-61, A-62, A-85, A-86

Nonaccrual, page A-59, A-60, A-61, A-62

Reporting, page A-85
FFIEC December 2011 Call Report Supplemental Instructions
Interagency Policy Statement on Prudent CRE Workouts (2009)
3
ALLL Methodology
 FDIC ALLL Statement

of Policy
July 2, 2001 - Policy Statement on ALLL
Methodologies and Documentation for Banks
and Savings Institutions
• Implements ASC 450-20 (FAS 5) and ASC 310-1035(FAS 114)

December 13, 2006 - Interagency Policy
Statement on the ALLL
• Replaces the 1993 ALLL Policy Statement
• Provides expanded guidance on the 2001 Policy
Statement
4
Overview of FAS 5/FAS 114
Framework
FAS 5
“Anchor”Pure
Historical
Rate
FAS 114
Q-Factor
Adj.
•Combination = adjusted historical rate
•Pool by Risk Characteristics:
•Pass loans by loan segment or class
•Classified unimpaired by risk pool e.g.
Watch, Special Mention and Sub
Standard
* Unallocated
FAS
114
Calculated
ALLL
ALLL
Impaire
d
Nonaccrual
TDR’s
Disc
Cash
Flow
NonAccrual
No
Coll.
Dep?
Yes
FV of
Collateral
*any amount labeled “unallocated” must be fully supported by documentary
evidence. See Interagency Policy Statement on ALLL (2006), question no. 13.
55
ALLL Methodology
 Directional

The ALLL level, as a percentage of the loan
portfolio, should generally increase as credit
quality deteriorates
 Factors





Consistency
to consider
Internal Adverse Classifications
Level and trend of non-accrual loans
Level and trend of past due loans
Charge off history
Loan concentration levels
6
ASC 450-20 (FAS 5)
 Portfolio

Loan type, past due status, and risk grades
 Call

Report Schedule RC-C
Segments the portfolio by loan type
 Smaller


Segmentation by
Non-Complex Institutions
Smaller non-complex banks may segment the
portfolio into broad loan categories
Appropriate for only small institutions offering
a narrow range of loan products
7
ASC 450-20 (FAS 5)
Portfolio Segmentation
 Larger



Complex Institutions
Typically offer a more diverse and complex
mix of loan product
Start by segmenting into major loan types
Should further segregate the portfolio into
product line segments based on risk
characteristics (i.e., greater granularity)
 Bankers
should ensure ALLL
segmentations reconcile to Call Report
and/or General Ledger
8
ALLL Methodology

Qualitative Factors - An institutions loss rates
should be adjusted for the following factors:




Levels of and trends of delinquencies & impaired
loans
Levels of and trends of charge-offs and recoveries
Trends in volume and terms of loans
Effects of changes in risk selection, underwriting,
lending policies, procedures, and practices
9
ALLL Methodology

Qualitative Factors (Cont.)





Experience, ability, and depth of lending management
National and local economic trends and conditions
Industry conditions
Effects of changes in credit concentrations
Management must maintain sufficient
documentation to support their Q-Factor
adjustments
10
ALLL Methodology

Examiner Responsibilities* - Examiners should
generally accept management's estimates when
management has:




Maintained effective loan review systems and controls
for timely problem loan identification
Analyzed all significant factors affecting collectability
of the portfolio
Established an acceptable ALLL evaluation process
that meets GAAP
Incorporates reasonable and properly supported
assumptions, valuations, and judgments
*Per the 2006 ALLL SOP
11
Examiner Responsibilities

If the examiner concludes that the reported ALLL level is
not appropriate or determines that the ALLL process is
deficient:

Recommendations for correcting these deficiencies, including
any examiner concerns regarding an appropriate level for the
ALLL, should be noted in the report of examination
12
Impairment Overview

Four Major Decisions – ASC 310-10-35 (FAS
114)
• Evaluation - What type of loans will be
reviewed for impairment?
• Recognition - Which loans are considered
to be impaired?
• Measurement - How will the impairment be
measured?
• Accounting for impairment – Layering not
allowed.
13
Impairment Evaluation
 ASC

310-10-35 (FAS 114)
What type of loans will be reviewed for
impairment?
• An institution should apply its normal loan review
procedures when identifying loans to be
individually evaluated for impairment under ASC
Topic 310
• For example: Size, Delinquent, Watch list, other,
etc.
14
Impairment Recognition
 ASC
310-10-35 (FAS 114)
 Impairment Definition
• Loans are considered to be impaired when, based
on current information and events, it is probable
that the creditor will be unable to collect all interest
and principal payments per contractual terms of
the loan agreement.
• Probable - The future event or events are likely to
occur. (As defined and used in FAS 5)

The term "probable" is not intended to be so rigid as to
require virtual certainty.
15
Impairment Recognition



The guidance does not specify how to determine it is
probable that amounts due will not be collected.
Appropriate contractual terms are to be used in
evaluating impairment.
Certain loans may not be impaired if interest
continues to be accrued during the period of delay.
16
Impairment Recognition

Insignificant delays in payment or in timing
are excluded from the criteria for recognition
of impairment.
• A period of less than 90 days is probably an
insignificant delay under FAS 114 par. 8.

Loans whose terms are modified in a troubled
debt restructuring are impaired and must be
evaluated by following the specific guidance
in Section 310-10-35 .
17
Impairment Recognition
When is a loan considered
to be impaired?
Nonaccrual
Impaired!
Current
Possible
Loan Performance
Impaired Loan?
90 Days Past Due
Probable
18
Impairment Per ALLL SOPs
 2006 ALLL



SOP – Question 11
A "Substandard" loan that is individually
evaluated for impairment under FAS 114
would not automatically meet the definition of
impaired.
However, if a "Substandard" loan is
significantly past due or is in nonaccrual
status, the borrower's performance and
condition provide evidence that the loan is
impaired.
Impairment is a performance issue.
19
Impairment per Call Report
Report Glossary – Loan Impairment
(pg. 58)
 Call

Nonaccrual - A loan that is not already in
nonaccrual status when it is first identified as
impaired will normally meet the criteria for
placement in nonaccrual status at that time.

Troubled Debt Restructurings - According to
ASC Topic 310-10-35 (i.e., FASB 114), all loans
restructured in troubled debt restructurings (TDR) are
impaired loans.
20
Impairment Recognition

A loan is impaired, even if it is performing and
 Loan Officer contacts the borrower

The borrower states he/she is:
• Having financial difficulties
• Expresses an inability to:



Continue to make monthly interest payments
Convert the loan to fully amortizing at maturity
The banker now has a reasonable expectation the he
will be unable to collect all principal and interest as
originally contracted. That is it is probable that he will
be unable to collect all principal and interest as
originally scheduled.
21
Impairment Measurement
Relationship between Substandard, Impaired,
and TDR Loans (Generally).
Substandard Loans
Impaired Loans
Troubled Debt
Restructured
Loans
22
Impairment Measurement

THE MEASUREMENT APPROACHES

PRESENT VALUE OF THE DISCOUNTED CASH FLOWS (ASC
Topic 310-10-35– calls for this approach) Shall Use
• Observable market value (as a practical expedient – to the DCF because
impaired loans tend to be unique this approach is very rarely used)

THE FAIR VALUE OF THE COLLATERAL (as a practical expedient if the
loan is collateral dependent)
• A distinction is made between collateral dependent loans where repayment
will come from the operation of the collateral and those loans that will be
repaid from the liquidation of the collateral
23
Impairment Measurement

THE PRESENT VALUE OF THE DISCOUNTED CASH
FLOWS
 Based on the expected cash flow (NOT the
contractual cash flows)
• The banker/examiner must do something when faced with
estimated cash flow’s that are less than contractual amounts.
"Do nothing" is not an alternative; without adjustment the
balance will amortize too fast or too slow.

Discounted at the loan’s original effective interest
rate
• The original discount rate used to value the loan when it was
not impaired is the rate used as the appropriate discount rate
in measuring impairment.
24
Impairment Measurement

THE PRESENT VALUE OF THE DISCOUNTED CASH FLOWS


If the present value of the expected cash flows are less
than the carrying value of the loan then the difference is
established as an allowance.
If the present value of the expected cash flows are more
than the carrying value of the loan then no allowance is
established.
25
Impairment Measurement

THE OBSERVABLE MARKET VALUE APPROACH



It requires a market for the loan, which usually does not exist. In some
cases, prices for a loan may be available based on a loan participation
market, and recent sales or bids from qualified potential buyers. In
addition, market prices can be derived from market activity of loans that
are substantially the same.
This is usually very difficult for an impaired commercial or commercial
real estate loan.
This approach is rarely if ever used.
26
Impairment Measurement
FAIR VALUE OF THE COLLATERAL APPROACH

This approach is used when a loan is collateral dependent:
• When a loan is collateral dependent is a judgment that depends on all
facts and circumstances.
• The definition of collateral dependent dictates that repayment of the
loan is expected to be provided solely by the underlying collateral.
• If the creditor has the ability to look to the general credit of the
borrower for repayment, assuming the borrower has substance
beyond the underlying collateral, repayment would not be expected
solely from the underlying collateral and as such, the loan would not
be deemed collateral dependent.
27
Impairment Measurement
FAIR VALUE OF THE COLLATERAL APPROACH
Operation of the Collateral

This approach is used when a loan is collateral-dependent:
• Loans that are collateral dependent based on the operation of the collateral
should evaluated for ASC Topic 310-10-35 at Fair Value. This may include
collateral dependent loans that will be repaid from the operation rather than
the sale of the collateral.
• For classification purposes, if the market value conclusion in a recent and
well supported appraisal is less than the investment in the loan the
difference should be classified as “Loss.” If the FV is lower that amount
would be established in an allowance.
• Loans categorized as collateral-dependent, but derive the cash flow from
collateral operation, should be valued at fair value (no cost to sell is
included).
• The rationale is the sale of the collateral is not the primary source of
repayment, rather the cash flows from operations. In this scenario
management does not expect to foreclose.
28
Impairment Methodology
 Institutions
should not layer their loan
losses


Layering is the practice of recording in the ALLL more
than one amount for the same probable loan loss
Layering can happen when an institution includes a
loan in one segment and then includes the loan in
another group, which receives an additional ALLL
amount
29
Troubled Debt Restructuring
SUMMARY
ASC Topic 310-40-15-5
The restructuring of a debt is a TDR if all of the following are met:
1. For economic or legal reasons
2. Related to the borrowers financial difficulties (but for test)
3. The creditor grants a concession that it otherwise would not consider
NB: TDRs are often done to alleviate the burden of the debtor’s near
term cash requirements
30
Troubled Debt Restructuring
SUMMARY
When has a concession occurred?
The borrower’s condition is such that:
1. He does not have access to funds at a market interest rate for a
credit with similar risk.
2. An increase in the interest rate does not mean that no concession
has been granted. The rate must match the risk characteristics,
given all facts and circumstances.
NB: TDRs are often done to alleviate the burden of the debtor’s near
term cash requirements
31
Troubled Debt Restructuring
SUMMARY
When has a concession occurred? (Cont.)
The borrower’s condition is such that:
3. A restructuring that results in a delay in payment that is
insignificant is not a concession. However, an entity
should consider various factors in assessing whether a
delay is insignificant. (ASC Topic 310-10-35-17).
ASU 2011-02, Basis for Conclusions, Paragraph BC13 states: “The guidance in
paragraph ASC 310-10-35-17 about insignificant delays or shortfalls is meant to
prevent a loan from being designated as impaired when the resulting
impairment calculation would result in a nominal allowance for loan losses.”
32
Troubled Debt Restructuring
SUMMARY
Is the borrower having financial difficulties?
A borrower can be having financial difficulties, even
though the borrower is not currently in payment
default. The question is whether the borrower
will be in default if the restructure doesn’t
occur.
33
Troubled Debt Restructuring
What is Troubled Debt Restructuring?
ALL TDR LOANS ARE IMPAIRED
•
All TDRs should be measurement for impairment under ASC Topic 310-10-35.
•
Methods are
1) DCF (shall use, unless collateral dependent)
2) Observable market value (rare) (only as a practical expedient to the
DCF approach)
3) Fair Value of the Collateral (if collateral dependent as a practical
expedient – i.e. no outside available and reliable cash flow)
•
Once restructured, homogeneous loans (fall within the scope of 310-40) are
also measured under ASC Topic 310-35 for impairment. Groups of impaired
loans with similar risk characteristics can be aggregated and measured as a
group.
34
Troubled Debt Restructuring
ASC 310-40-15-6 & 7 & 8
The concession is granted by the creditor in an attempt to protect as much
of its investment as possible. If the debtor can obtain funds at a market
interest rate from another creditor then the restructuring is not a troubled
debt restructure.
1. Can be an agreement between the creditor and borrower
2. Or can be imposed by law.
35
Troubled Debt Restructuring
ASC Topic 310-40-15-9
A TDR may include
•
Transfer of assets from the borrower to the creditor
•
Granting an equity interest in the debtor
•
Modification of the debt
•
Reduction in the interest rate
•
Extension of the maturity date at a rate lower rate than for new debt with
similar risks
•
Reduction in the face amount
•
Reduction of accrued interest
36
Troubled Debt Restructuring
ASC Topic 310-40-15-11
A TDR may NOT include:
•
Changes in lease agreements
•
Changes in employment agreements
•
Modifications within a loan pool
•
Changes in expected cash flow related to modifications on loans within
those pools.
37
Troubled Debt Restructuring
ASC Topic 310-40-15-12
A restructured loan may NOT be a TDR even if the borrower is
experiencing financial difficulties:
•
Creditor receives full satisfaction of the debt (based on FV)
•
FV of Cash, other assets or an equity interest equal to the debtor’s
carrying value.
•
The creditor reduces the effective interest rate on the debt primarily
to reflect a decrease in market interest rates in general
•
The debtor issues in exchange for its debt, new marketable debt
having an effective interest rate based on its market price that is at
or near the current market interest rate for similar debt
38
Troubled Debt Restructuring
Has the creditor granted a concession?
Yes, when as a result of the restructure:
• The Creditor does not expect to recover all principal and interest (accrued
at the ORIGINAL interest rate). ASC Topic 310-40-15-13
• has restructured the debt in exchange for additional collateral (or guarantees)
that do not fully compensate the credit for the restructure. ASC Topic 310-40-1514
• DOES NOT otherwise have access to funds at market rate for debt with similar
risk characteristics. ASC Topic 310-40-15-15
• An interest rate increase could still be a concession if a credit with similar risk
would have a higher rate than the new rate. ASC Topic 310-40-15-15
39
Troubled Debt Restructuring
Is the delay in payment insignificant?
• First, A restructure that results in a insignificant delay is NOT a concession.
•The amount of restructured payments is insignificant in relation to the
total balance.
•The time delay in payment is insignificant related to 1) frequency, 2)
the original contract maturity, or 3) the expected duration
ASC Topic 310-40-15-17
• Restructures are cumulative, management should consider the previous
restructures when determining whether the current restructure is
insignificant. ASC Topic 310-40-15-18
40
Troubled Debt Restructuring
Is the Borrower experiencing financial difficulties?
Some of the concepts the creditor should consider (but there are many more)
when determining whether the borrower is experiencing financial difficulties:
• Is the borrower in default or will he probably be in default in the
foreseeable future?
• The borrower has declared bankruptcy or is in the process of doing so?
• is there doubt about his going concern status?
• Have the borrower’s securities been delisted or are under threat of being
delisted?
• the borrower’s cash flows as projected will not fully service all of his
debt
• without the modification the borrower cannot obtain funds from sources
other than the existing creditors at an effective interest rate equal to the
current market rate for credits with similar risk to a non-troubled borrower.
ASC Topic 310-40-15-20
41
Troubled Debt Restructuring
ACCOUNTING STANDARDS UPDATE NO. 2011-02
Effective date for public companies - the annual period beginning on or
after June 15, 2011
This guidance will apply retrospectively to restructurings that occur
during the year of adoption – Early adoption is allowed.
• Example: There is a impaired loan that was accounted for as an
impaired loan on January 1, 2011, but not a TDR. But after
considering this guidance, management now believes the impaired
loan IS a TDR, they would have to report it in the first interim
reporting period occurring (beginning) after June 15, 2011. So the
first reporting period would be September 30, 2011.
Effective date for non-public companies: The annual period ending after
December 15, 2012.
42
Troubled Debt Restructuring

When can a TDR be removed from TDR reporting?

Once an obligation has been restructured in a troubled debt restructuring,
it continues to be considered a troubled debt restructuring until paid-in-full
or otherwise settled, sold, or charged off.

However, if a restructured obligation is in compliance with its modified
terms and the restructuring agreement specifies an interest rate that at
the time of the restructuring is greater than or equal to the rate that the
bank was willing to accept for a new extension of credit with comparable
risk, the loan need not continue to be reported as a troubled debt
restructuring in calendar years after the year in which the restructuring
took place.

A loan extended or renewed at a stated interest rate equal to the current
interest rate for new debt with similar risk is not considered a troubled
debt restructuring. See, Consolidated Reports of Condition and Income,
RC-N definitions (June 2011).
43
Troubled Debt Restructuring
A and B Note Structure
• A formal restructuring may involve a multiple note
structure in which a troubled loan is restructured into two
notes:
• “A” note represents portion of original loan principal
expected to be fully collected
• “B” note represents portion of original loan that has been
charged off
44
Troubled Debt Restructuring
Can Note A be returned to accrual status?
Yes, if all of the following conditions are met:
• Note “A” is rewritten in a prudent manner – such that the
restructure has economic substance.
• Note “B” is Charged-off recorded at time of restructuring
• Ultimate collectability of all amounts contractually due on Note A
is not in doubt, supported by a thorough analysis on the borrowers
capacity. The banker must be Reasonably Assured that they will
collect all principal and interest going forward.
• There is a period of satisfactory payment Performance before
Note A is returned to accrual status (generally six months) –
According to the Call Report glossary the performance period can
45
begin BEFORE the date of the TDR.
Troubled Debt Restructuring
ASC Topic 310-40-50-2 provides conditions relating to when
a loan need not be included in TDR disclosures
50-2 Information about an impaired loan that has been restructured
in a troubled debt restructuring involving a modification of terms
need not be included in the disclosures required by paragraphs 31010-50-15(a) and 310-10-50-15(c) in years after the restructuring if
both of the following conditions exist:
a. The restructuring agreement specifies an interest rate equal to or
greater than the rate that the creditor was willing to accept at the
time of the restructuring for a new loan with comparable risk.
b. The loan is not impaired based on the terms specified by the
restructuring agreement.
46
Troubled Debt Restructuring
THE CALL REPORT TAKE ON NON-REPORTING OF A TDR LOAN
When can a TDR be removed from TDR reporting?
•
Once an obligation has been restructured in a troubled debt restructuring, it continues to
be considered a troubled debt restructuring until paid-in-full or otherwise settled, sold, or
charged off.
•
However, if a restructured obligation is in compliance with its modified terms and the
restructuring agreement specifies an interest rate that at the time of the restructuring is
greater than or equal to the rate that the bank was willing to accept for a new extension
of credit with comparable risk, the loan need not continue to be reported as a troubled
debt restructuring in calendar years after the year in which the restructuring took place.
•
A loan extended or renewed at a stated interest rate equal to the current interest rate for
new debt with similar risk is not considered a troubled debt restructuring. See,
Consolidated Reports of Condition and Income, RC-N definitions (June 2011).
47
Questions?
RColeman@fdic.gov
415-808-8147
KFisher@vtdcpa.com
949-544-7243
48