Efforts by financial institutions over the past couple of years to modify loan terms for some small business and commercial real estate borrowers have often resulted in the creation of troubled debt restructures, or TDRs.
In order for a loan modification to be considered a TDR, two specific conditions must be present:
- A concession must be granted by the lender.
- The borrower must be experiencing financial difficulty.
Note that all loans that have undergone a troubled debt restructuring are considered to be impaired loans. Due to the divergence in how financial institutions determine which loan modifications constitute a TDR, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-02 last spring to help clarify and offer guidance. Specifically, the ASU helps financial institutions determine whether a concession has been granted and whether a debtor is experiencing financial difficulty.
According to ASU 2011-02, a concession may have been granted if the borrower does not otherwise have access to funds at a market rate for debt with similar risk characteristics, or if there are more than insignificant payment delays, among other factors.
Indications of financial difficulty may include delinquency on any debt, whether within or outside your bank; a declaration of bankruptcy; substantial doubt as to whether the borrower will continue as a going concern; or a forecast that the borrower’s cash flows will be insufficient to service existing debt for the foreseeable future, among other factors.
The standards update also precludes banks from using a borrower’s effective interest rate to determine whether a loan modification constitutes a TDR, regardless of whether or not this test was used in the past.
ASU 2011-02 is effective for annual periods ending on or after December 15, 2012, for non-public entities. It should be applied retroactively to the beginning of the annual period of adoption.
Please give us a call if you have more specific questions about ASU 2011-02.