In a time of financial crisis many community banks had to work with borrowers to restructure their small business and commercial real estate loans so the customer had the ability to make the payments.
After the most recent financial crisis banks had to modify loan terms and grant concessions. These actions are creating troubled debt restructures, or TDRs, which is something that must be segregated on a bank’s financial statements and call reports.
Now that the economy is seeing an upswing and the financial crisis is getting further behind us, community banks are now focused on removing some of these loans away from their TDR status. To remove the TDR designation from a loan, you must demonstrate that the borrower has met the terms of the restructured debt for six to 12 months. If so, you can stop reporting the loan as a TDR on your call report.
From an accounting standpoint, however, once a loan is classified as a TDR, it remains a TDR until fully repaid. It must continue to be segregated on the bank’s financial statements.
What Classifies a Loan as a TDR?
A loan must meet two different criteria in order to be classified as a TDR:
1)The borrower has to be troubled (i.e., experiencing financial difficulty).
2)The bank has to offer modified terms or make concessions it wouldn’t normally offer if not for the fact that the borrower is troubled.
This could include a lower interest rate, forgiven principal or accrued interest, and an extended maturity date or longer amortization schedule.
There is guidance in accounting for these TDRs in ASC 310-40. It outlines that these loans are required to be tested for impairment and that the impairment should be measured based on the present value of future cash flow, less the original loan’s effective interest rate.
It is important to note that just because a loan falls under the criteria to be a TDR doesn’t automatically make the loan a TDR. An example is, if the modified terms of a loan are consistent with market conditions and they could have gotten the same terms from another bank right now, the restructured loan would not need to be designated as a TDR.
FASB’s Accounting Standards Update (ASU) No. 2011-02 offers guidance to help community banks determine when a loan concession or modification does and does not result in a TDR. This guidance helps you determine what specifically qualifies as “financial difficulty” and whether or not a “concession” has been made.
“Financial difficulty” is considered to be when a borrower declares bankruptcy, is behind on any of their debt payments, or there is substantial doubt as to whether or not the business will continue as a going concern.
A concession may have been granted if the business could not borrow a similar amount of money with a similar rate now, with similar risk characteristics. Also, if the bank is experiencing significant payment delays with the business, it could also signify a concession.
Use Caution when Reclassifying
As community banks continue to remove the TDR designation from their loans, regulators are looking much closer at TDRs. This is why it is very important for banks to use caution as you consider which TDRs you can and cannot reclassify for regulatory and reporting purposes.
Contact us if you have any questions when it comes to reclassifying TDRs 417-881-0145.