LOANS
2A. Troubled Debt Restructurings
Bank Accounting Advisory Series
28
August 2018
Question 12
Given that evidence of performance under the restructured terms will likely be relied upon to
determine whether to place a TDR on accrual status, may performance before the restructuring
be considered?
Staff Response
Performance before the restructuring should be considered in assessing whether the borrower can
meet the restructured terms. Often the restructured terms reflect the level of debt service that the
borrower has already been making. If this is the case, and the borrower will likely be able to
continue this level of performance and fully repay the new contractual amounts due, continued
performance after the restructuring may not be necessary before the loan is returned to accrual
status.
Question 13
How would the absence of an interest rate concession on Note B affect the accrual status of
Note A?
Staff Response
If the bank does not grant an interest rate concession on Note B nor make any other concessions,
the restructuring would not qualify as a TDR. Accordingly, ASC 310-40 would not apply.
In substance, the bank has merely charged down its $10 million loan by $1 million, leaving a
$9 million recorded loan balance. The remaining balance should be accounted for and reported
as a nonaccrual loan. Partial charge-off of a loan does not provide a sufficient basis by itself for
restoring the loan to accrual status.
Furthermore, the bank should record loan payments as principal reductions as long as any doubt
remains about the ultimate collectibility of the recorded loan balance. When that doubt no longer
exists, interest payments may be recorded as interest income on the cash basis.
Question 14
Assume the bank forgives Note B. How would that affect the accounting treatment?
Staff Response
Forgiving debt is a form of concession to the borrower. Therefore, a restructuring that includes
the forgiveness of debt would qualify as a TDR and ASC 310-40 would apply. It is not necessary
to forgive debt for ASC 310-40 to apply, as long as some other concession is made.
LOANS
2A. Troubled Debt Restructurings
Bank Accounting Advisory Series
29
August 2018
Question 15
Assume that Note B was not charged off but was on nonaccrual. How would that affect the
accrual status and call report TDR disclosure for Note A?
Staff Response
Because the restructured loans are supported by the same source of repayment and collectibility
is in doubt (cash flows can only service $9 million), both loans would be reported on nonaccrual.
Additionally, because the interest rate on Note B was below a market rate, both notes would be
reported in the TDR disclosures on the call report.
Facts
Assume, as discussed in question 15, that Note B was not charged off before or at the
time of restructuring. Also, expected cash flows will not be sufficient to repay Notes A and B at
a market rate. The cash flows would be sufficient to repay Note A at a market rate.
Question 16
When appropriate allowances, if necessary, have been established for Note B, would Note A be
reported as an accruing market-rate loan and Note B as nonaccrual?
Staff Response
No. Even after a TDR, the two separate recorded balances are supported by the same source of
repayment and should not be treated differently for nonaccrual or TDR disclosure. Both loans
must be disclosed as nonaccrual, unless the combined contractual balance and the interest
contractually due are expected to be collected in full.
Facts
A bank negotiates a TDR on a partially charged-off real estate loan. The borrower has
been unable to make contractually owed payments, sell the underlying collateral at a price
sufficient to repay the obligation fully, or refinance the loan. The bank grants a concession in the
form of a reduced contractual interest rate. In the restructuring, the bank splits the loan into two
notes that require final payment in five years. The bank believes that market conditions will
improve by the time the loan matures, enabling a sale or refinancing at a price sufficient to repay
the restructured obligation in full. The original interest rate was 9 percent.
Note A carries a 9 percent contractual interest rate. Note B, equal to the charged- off portion,
carries a 0 percent rate. Note A requires that interest be paid each year at a rate of 5 percent, with
the difference between the contractual rate of 9 percent and the payment rate of 5 percent
capitalized. The capitalized interest and all principal are due at maturity. Additionally, interest on
the capitalized interest compounds at the 9 percent rate to maturity.
LOANS
2A. Troubled Debt Restructurings
Bank Accounting Advisory Series
30
August 2018
Question 17
If the borrower makes the interest payments at 5 percent as scheduled, may Note A be on accrual
status?
Staff Response
No. The terms of the restructured loan allow for the deferral of principal payments and
capitalization of a portion of the contractual interest requirements. Accordingly, these terms
place undue reliance on the balloon payment for a substantial portion of the obligation.
Generally, capitalization of interest is precluded when the creditworthiness of the borrower is in
question. Other considerations about the appropriateness of interest capitalization are
•
whether interest capitalization was included in the original loan terms to compensate for a
planned temporary lack of borrower cash flow.
•
whether similar loan terms can be obtained from other lenders.
In a TDR, the answer to each consideration is presumed to be negative, absent objective
evidence to the contrary. First, the bank, in dealing with a troubled borrower, must overcome the
doubt associated with the borrower’s inability to meet the previous contractual terms. To do this,
objective and persuasive evidence must exist for the timing and amount of future payments of
the capitalized interest.
In this case, the repayment of the capitalized interest is deferred contractually until the
underlying loan is refinanced or sold. A refinancing, or sale at a price adequate to repay the loan,
was not possible at the time of restructuring. The bank has offered no objective evidence to
remove the doubt about repayment that existed before the restructuring. It is relying solely on a
presumption that market conditions will improve and enable the borrower to repay the principal
and capitalized interest. Accordingly, the timing and collectibility of future payments of this
capitalized interest are uncertain.
Second, the temporary lack of cash flow is generally a reason for a TDR. The capitalization of
interest was not provided for in the original loan terms. Finally, the concession was granted
because of the borrower’s inability to find other market financing to repay the original loan.
Some loans, such as this example, are restructured to reduce periodic payments by deferring
principal payments, lengthening the amortization term relative to the loan term, and/or
substantially reducing or eliminating the rate at which interest contractually due is periodically
paid. These provisions create or increase the balloon payment significantly. Sole reliance on
those types of payments does not overcome the doubt as to full collectibility that existed before
the restructuring. Other evidence should exist to support the probability of collection before
return to accrual status.
In this example, the conditions for capitalization of interest were not met, and sole reliance for
the full repayment was placed on the sale/refinancing. Accordingly, Note A should be
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