Accounting and Regulatory Hot Topics for Banks & Financial Institutions

By Jeff Skaggs February 8, 2012

During our discussions with clients and banking regulators, certain questions seem to continually arise.  In order to provide you with some insight as you work with these issues at your institution, we have compiled the following list of common questions and related answers:

Troubled Debt Restructurings (TDRs)

Is a loan always a TDR once it has been classified as such?

Yes.  However, it is useful to note that for financial statement disclosure purposes, a TDR can be removed from being disclosed as such in years subsequent to the restructuring if the following criteria are met:

• the restructured loan 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
• the loan is not impaired based on the terms specified by the restructuring agreement

It is important to note the “comparable risk” criteria in bullet point number one.  In order to meet this criterion, the restructured loan’s interest rate needs to consider the credit risk inherent in the restructured loan.

How do you assess impairment on a TDR?

A creditor shall measure impairment based on the present value of expected future cash flows discounted at the original loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is a collateral-dependent loan.

What is a collateral dependent loan?

A loan for which the repayment is expected to be provided solely by the underlying collateral.

Non-accrual loans

When is it proper to return a loan to accrual status?

A loan may be restored to accrual status when (1) none of its principal and interest is due and unpaid and the institution expects repayment of the remaining contractual principal and interest or (2) when the loan becomes well secured and in the process of collection.  The determination to return a loan to an accrual status should also consider the borrower’s historical payment performance over a reasonable period of time.  The regulators consider a reasonable period of payment performance to generally be a minimum of 6 months.

What do you do with any payments that have been applied to principal?

In instances where recovery of both interest and principal are considered unlikely, cash receipts are recorded as a reduction of principal due.  In these cases, when such a loan is subsequently determined to be fully collectible, interest income should be recognized on the difference between the stated principal balance and the book balance of the loan at the date of such determination.  This difference should be recognized as a yield adjustment over the remaining life of the loan.

Appraisals

When is it advisable to obtain an updated appraisal?

Generally, whenever there is a significant change in the status of the loan related to the collateral (such as becoming impaired or becoming OREO) or a significant change in the factors that would affect an appraisal that is already on-file (such as the passage of a significant amount of time, a significant change in the commercial real estate market, etc.).

How do you assess the fair value of collateral in periods subsequent to the receipt of an appraisal?

In an ideal world, a bank would always have a current appraisal to support fair value.  However, that is not always realistic and it is reasonable practice to use the fair value obtained in an appraisal for a period of time that does not exceed the useful life of the assumptions and factors used to develop the appraised fair value.  During this time, the bank may find it necessary to discount the fair value in the appraisal.  When a bank is deciding to do so, it should have the following in place:

1. 1. Personnel with the expertise to discount the appraisal
   2. A policy discussing when it is appropriate to discount an appraisal, how the discount is to be determined and how the discount should be applied
   3. Current, reasonable support for determining the discount rate utilized