So far I’ve tried to keep the titles of these posts eye-catching. Sorry for not coming through on this one. Trouble Debt Restructurings may not be exciting, but they have been a hot topic for some time now. I wanted to use the blog to answer some common questions surrounding TDRs.
Are all mortgage modifications TDRs? No. A TDR is characterized as a granted concession that the institution would not otherwise have considered but for the borrower’s financial difficulty. If a member could have obtained funds from another lender at a rate comparable to what the mortgage’s modified rate would be, it would not be considered a TDR.
Are all TDRs impaired? Generally, yes. A concession is required, which could be a reduction in interest rate, forgiveness of accrued interest or a portion of the principal or extended repayment terms. All of these concessions are going to reduce the present value of expected future cash flows, which reduces the value of your loan.
Okay, so my TDR is impaired. How do I measure the impairment? You need to reduce your loan down to its value; the present value of expected future cash flows. The terms of your restructured agreement do not necessarily represent the expected future cash flows. If you have evaluated and believe that additional concessions will need to be granted on this loan, or there is a strong possibility of default, expected future cash flows of the loan may be significantly less than the restructured terms. You can record your impairment via a direct write-off or through your allowance account. It is a good rule of thumb to record concessions, which are a modification of terms and the concession will never be recovered, as a direct write-off to expense. For estimates of future concessions or possible defaults, recording the impairment through your allowance account would be appropriate because you may still collect on the loan, you are just recording an estimate of potential losses.
How do you determine whether a TDR should be on Accrual or Non-Accrual status? Your auditor is going to make you prove two things to accrue revenue; that it is realizable and that it is earned. The latter is simple to prove – Outstanding loan balance * Interest Rate * Duration = Earned Income. But a member owing you an interest payment doesn’t mean much to you unless they are eventually going to pay you. A restructured loan should typically be placed on non-accrual status until there has been a sustained period of repayment performance and collection under the new terms.
Similar to the methods used to determine what credit quality indicators affect likelihood of losses within a loan portfolio, you should be periodically analyzing the types of modifications that impact your loan losses and portfolio yield to create an optimum set of loan modification parameters.
–Dan Price, CPA
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