©2012 CliftonLarsonAllen LLP 1 111 Troubled Debt Restructuring and What It Means to Your Credit Union ACUIA Denver, CO June 20, 2012

©2012 CliftonLarsonAllen LLP1 111

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Troubled Debt Restructuring and What It Means to Your Credit Union

ACUIADenver, CO

June 20, 2012

©2012 CliftonLarsonAllen LLP2

Presenter-Greg Schwartz, CPA

• Principal with LarsonAllen Credit Union Group • 30 years of experience working with credit unions • Commercial and financial institution clients • Speaker/Presenter at:

– AICPA national CU conference – ACUIA national conference – Various state league and chapter meetings

• Graduate of Minnesota State, bachelor of science in accounting• Member of:

– AICPA– Minnesota Society of CPAs – AICPA Credit Union Committee.


About CliftonLarsonAllen

• One of the nation’s largest certified public accounting firms

• Founded in 1953• More than 3,800 professionals

serving clients from 90 offices across the country• # 1 provider of audit services to credit unions


AGENDA

• Troubled Debt Restructuring (TDR) – Definition• Recent Accounting Change Regarding TDRs• TDRs and the Allowance for Loan and Lease Losses

(ALLL)• How Does this Affect Your Credit Union


Definition

Restructuring of debt constitutes a TDR if:

The creditor (credit union) for economic or legal reasons related to the debtor’s (member’s) financial difficulties grants a concession to the debtor that it would not otherwise consider

Both conditions must be present for a restructuring to be considered a TDR– Grant a concession and – Borrower needs to be experiencing financial

difficulty


Definition

• So what does that mean?– Member has financial difficulties

◊ Bankruptcy (11 or 13)◊ Slow pay or inability to pay due to hardships

• Loss of job• Decreased pay• Divorce or illness

– Grant a concession◊ Extend payment/loan terms◊ Reduce interest rate◊ Forgiveness of debt


Definition

• Do we or have we had any TDR at my credit union?– Unequivocally - Maybe


Recent Accounting Change• In April 2011, the Financial Accounting Standards Board

(FASB) issued Accounting Standards Update (ASU) No. 2011-02, Receivables (Topic 310): A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring

• The ASU is effective for nonpublic entities, (credit unions) for annual periods ending on or after December 15, 2012, and should be applied retrospectively to the beginning of the annual period of adoption– i.e. credit unions with 12/31 year-end to adopt January 1,

2012– Early adoption is permitted

• Prospective application– Go forward not look back


Recent Accounting Change

• Why was this new ASU issued?– Due to economic downturn the number of restructurings

increased– Concerns about what constitutes a concession and

financial difficulty• ASU’s intent is to help clarify what constitutes a

concession and financial difficulty, in determining whether a restructuring is considered to be a TDR



• Key misconceptions that new ASU did NOT:– Change definition of TDR it only clarified what constitutes

a concession and financial difficulty– Change how credit union is to identify, track and

allow/reserve for these troubled loans in ALLL– Change how credit union is to report TDR as delinquent on

NCUA Call Report until 6 consecutive payments were made by member



• Clarification of Concessions:– Objective is to make the best of a difficult situation –

creditor expects to:◊ Obtain more cash or value from debtor◊ Increase probability of repayment

– Granted concession when, as a result of restructuring, you do not expect to collect all amounts due (P&I) at the original contract rate



• Indicators of granting concession:– Borrower does not otherwise have access to funds at a

market rate for debt with similar risk characteristics as the restructured debt



• Indicators of granting concession:– A temporary or permanent increase in the interest rate as

a result of a restructuring could still be considered a concession granted by the credit union if the new interest rate is still below the market interest rate



• Indicators of granting concession:– More than insignificant payment delays

◊ Typically any extension greater than 3 months (90 days)– Insignificant payment delays that do not constitute a TDR:

◊ Amount of the restructured payments subject to the delay is insignificant relative to the unpaid principal or collateral value of the debt and will result in an insignificant shortfall in the contractual amount due


Recent Accounting Change◊ Delay of restructured payment period is insignificant relative to

any one of the following:• Frequency of payments due under the debt• Debt's original contractual maturity• Debt's original expected duration


Recent Accounting Change◊ Evaluate cumulative affect of all past restructurings to determine if

now a TDR, for example:• Original 3 month extension in Year 1

– Not a TDR• But extend again in Year 2 for 3 additional months

– Now in Year 2 it is a TDR (6 month extension)



• Indications of borrower financial difficulty:– Borrower may have financial difficulty even

though not currently in payment default with the credit union

– Borrower is currently delinquent on any of its debt (with or outside of the credit union)

– Borrower has declared/declaring bankruptcy– Substantial doubt as to whether the borrower will

continue to be a going concern (MBL)•



• Indications of borrower financial difficulty:– Forecasted cash flows will be insufficient to

service existing debt for foreseeable future– Without modification, borrower cannot obtain

funds from other sources at the same rate as a non-troubled borrower



• Therefore, you will have to look at the member’s financial condition and ability to pay outside of the performance at your credit union, which may entail:– Gathering current financial statements or records– Pulling a credit report for the member– Performing or reviewing forecasts or projections, and/or– Using judgment



• In theory, if the restructuring is outside of the credit unions’ policies and outside of industry guidelines (i.e. terms, rates, loan-to-values, etc.); then it most likely would be considered a TDR



• ASU also clarifies that a credit union can no longer use the effective interest rate test as defined in ASC 470-60-55-10 in determining whether a restructuring constitutes a TDR


TDR and ALLL

• All TDR loans are considered “impaired loans”– It is probable that the credit union will be unable to collect

all principal and interest payments as scheduled in the original contractual terms

• Therefore to be allowed for under ASU … (old FAS 114)


TDR and ALLL

• TDR reserves are to be based on:– Reserve for difference between cash flows based on

discounted present value of original vs. modified terms, plus

– Additional reserves for re-default, OR– Collateral based loans - reserve for difference between

estimated value of collateral less costs to sell compared to the loan balance


TDR and ALLL

• Why discounted cash flow method?– Basically you are reserving for lost income/principal due to

restructuring◊ Discounted cash flow model

– As time goes by and if member re-paying as agreed this reserve will decline each month and can bring back to income

◊ Lower provision for loan losses (PLL)


TDR and ALLL

• Why additional amount for re-default risk?– Discounted cash flows does not account for potential loss

of principal on these high risk loans– Calculate based on historical re-default loss

◊ Percentage of TDRs gone bad by loan segment times loss estimate per loan


How It Affects Credit Union

• I believe more restructured and modified loans will qualify as a TDR



• Therefore if a credit union has more restructured loans that will now be considered a TDR:– The total amount of reportable loan delinquencies may

increase on quarterly Call Reports, and– The total amount of reserves in the ALLL may also need to

be increased for the additional impaired TDR loans



• Risks– Lending and accounting do not talk therefore could have

many TDRs not identified and tracked– Not reported properly as delinquent loans



• Regulatory Reporting on TDR– ASU did not change reporting requirements as regulatory

matter– Delinquency on TDRs is reported on the Call Report

consistent with the original loan contract terms– Return of TDR to full payment status after 6-month period

of demonstrated ability to repay consistent with the restructured terms



• Risks– TDRs not reserved for properly

◊ Could have significant financial statement impact• Increased ALLL through PLL• Decrease in net income


How Affects Credit Union

• Recommendation:– Early and often communication between accounting and

lending departments is essential◊ Ensures all loans that have been restructured or modified have

been evaluated for TDR– Process helps ensure overstatement of earnings is not

issued, and examiners and auditors can have confidence in the financial strength of the credit union


Examples

• #1– Member delinquent by 2 payments– Lower interest rate by 1%– TDR?

• #2– Member not delinquent with you but delinquent on bank

credit card– Lower interest rate by 1%– TDR?


Examples

• #3– Member not delinquent on any loan– Member has loss of job and/or income reduced (i.e. no

overtime, etc)– States cannot make scheduled payments– Lower payment by $100/month by extending loan 12

months– TDR?


Examples

• #4– Member not delinquent on any loan– Member has no change in income– Asks for interest rate reduction to match current offered

rates– Member qualifies for rate if new loan– Lower interest rate by 0.50%– TDR?


Examples– #5

◊ Member not delinquent on any loan◊ Member has no change in income but may be over-extended on

credit◊ States cannot make scheduled payments◊ Member qualifies loan, except for LTV above policy◊ Change terms from 5 year balloon to 30 year fixed at going 6% rate◊ TDR?


Examples

• #6– Member not delinquent on any loan– Member has no change in income but has some

unexpected medical bills– States cannot make scheduled payments– Grant 2 month extension– TDR?


Examples

• #7– Same conditions as #6 but now 2 years later you grant

another 2 month extension due to divorce– TDR?


Examples

• #8– Member not delinquent on any loan– Member has slight decline in income (no overtime paid)– States cannot make scheduled payments– Member qualifies loan– Lower payment by $400 for 12 months then goes back to

original payment– TDR?


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Questions?


Contact Us

Greg Schwartz, CPA, CMA [email protected]

Documents

©2012 CliftonLarsonAllen LLP 1 111 Troubled Debt Restructuring and What It Means to Your Credit Union ACUIA Denver, CO June 20, 2012