Loan Workouts, Nonaccrual Policy & Reporting TDRs. Presented By Daniel R. Loritz, Esq. OKUN LORITZ, LLP. NCUA Final Rule Issued: May 31, 2012 Applies to All Federally-Insured CUs. Part I: Loan Workout Policies. NCUA Rules & Regulations Part 741.3.
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Daniel R. Loritz, Esq.
OKUN LORITZ, LLP
★ The Final Rule revises NCUA Rules & RegulationsSection 741.3:
“In determining the insurability of a credit union . . . , the following criteria shall be applied:
(b) Financial condition and policies. The following factors are to be considered in determining whether the credit union’s financial condition and policies are both safe and sound:
(2) The existence of written lending policies, including . . . loan workout arrangements, and nonaccrual standards that include the discontinuance of interest accrual on loans past due by 90 days or more and requirements for returning such loans, including member business loans, to accrual status.”
★ What Does it Mean?
Your Credit Union must:
1. Adopt policies that govern loan workouts and nonaccrual practices.
2. Your written nonaccrual standards must include the discontinuance of interest accrual when the loan is past due by 90 days or more.
Current widespread industry practice?
3. Your written policies must address requirements for returning loans to “accrual” status.
★ Appendix C to the Final Rule Adds an Interpretive Ruling and Policy Statement (IRPS)
Addresses loan workout account management and reporting standards.
Explains how credit unions should report TDR data on Call Reports.
Very important to discuss this with your CFO and/or CPA firm.
★ Why Does the NCUA Care?
The lack of an appropriate, written Loan Workout Policy can mask the true performance and past due status of a loan portfolio.
★ What Do You Have to Do?
1. The Credit Union’s Board must adopt a written Loan Workout Policy by October 1, 2012;
2. Establish controls to ensure that the Policy is consistently applied;
3. The Loan Workout Policy should be commensurate with your Credit Union’s size and complexity; and
4. Must be “in line with” the Credit Union’s broader risk-mitigation strategy.
★ What Must the Policy Address?
1. Define eligibility requirements;
Under what circumstances will the Credit Union consider a loan workout?
2. Establish limits on the number of times an individual loan may be modified;
Note that if the Credit Union restructures a loan more than once per year or twice in 5 years, the NCUA will impose strict requirements for documenting that the borrower has a renewed willingness and ability to repay.
One way to provide this additional documentation is to perform validations on completed restructurings that have improved collectability. When the NCUA asks, you can show them that you have restructured similar loans and that you have been successful.
State Chartered CUs: See California Code of Regulations Part 30.401 and 30.801.
★ California Code of Regulations Part 30.401(a)
“(a) Obligations shall not be extended, refinanced, renegotiated, or revised unless there is evidence that the borrower will be able to adhere to the terms of the extended, refinanced, renegotiated, or revised obligation.”
★ California Code of Regulations Part 30.801
“(a) A loan officer . . . may:
(1) Extend a close-ended obligation, provided, however, a close-ended obligation shall not be extended more than twice (2x) during the term of the obligation, and any one extension may not be for more than two consecutive contractual payments.
(2) Defer contractual payments due with respect to open-ended obligations, provided that contractual payments with respect to any open-ended obligation shall not be deferred more than once (1x) during any twelve (12) month period.
(b) Any extension or deferral in excess of the limitations specified in this Section shall be approved by the board of directors, the credit committee or the credit manager.
★ What Must the Policy Address (Continued)?
3. The Policy must ensure that your Credit Union makes loan workout decisions based on the borrower’s renewed willingness and ability to repay the loan;
4. The Policy should include controls to ensure that loan workouts are appropriately structured; and
For example: Your Policy could include a listing of various methods and combination of methods that are acceptable when restructuring a loan.
5. The Policy must provide that in no event will the Credit Union authorize additional advances to finance unpaid interest and Credit Union fees. However, the Credit Union may make advances to cover 3rd party fees (excluding Credit Union commissions), such as force-placed insurance and property tax payments.
★ What Are the Documentation Requirements?
The Credit Union must have documentation that substantiates its determination that the borrower is willing and able to repay the loan.
★ What Should Management Do?
1.Management must ensure that comprehensive and effective risk management and internal controls are established and maintained:
a. So that loan workouts can be adequately controlled and monitored by the Board of Directors and management;
b. To provide for timely recognition of losses; and
c. To permit review by examiners.
2. The Credit Union’s risk management framework should include thresholds based on total loan workout activity that trigger enhanced reporting to the Board of Directors.
★ What Should the Board of Directors Do?
1.The Board of Directors must evaluate the effectiveness of:
a. The Credit Union’s loan workout program; and
b. Any implications to the Credit Union’s overall financial condition.
2. Make any compensating adjustments to the overall business strategy.
★ Management Information Systems
To be effective, management information systems must:
1.Track the principal reductions and charge-off history of loans in workout programs by type of program;
2. Support any decision to re-age, extend, defer, renew, or rewrite a loan; and
3. Be able to identify and document any loan that is re-aged, extended, deferred, renewed, or rewritten, including the frequency and extent of such action.
The required documentation should show (at a minimum):
a. That the Credit Union’s personnel communicated with the borrower; and
b. The borrower agreed to pay the loan in full under any new terms and has the ability to do so.
★ What Resources are Available to Help Draft your Policy?
1.The FFIEC’s “Uniform Retail Credit Classification and Account Management Policy” 65 FR 36903 (June 12, 2000);
Sets forth specific limitations on the number of times a loan can be re-aged (for open-end accounts) or extended, deferred, renewed, or re-written (for closed-end loans).
2. NCUA Letter to Credit Unions 09-CU-19: “Evaluating Residential Real Estate Mortgage Loan Modification Programs.”
Outlines policy requirements for real estate modifications, but could be adapted by your Credit Union for use in its Loan Workout Policy.
3. Call or email me.
(818) 956-8052 or [email protected]
★ What is a Workout Loan?
1. A loan to a borrower in financial difficulty;
2. That has been formally restructured;
3. So as to be reasonably assured of repayment (of principal and interest) and of performance according to the restructured terms.
1. Re-aging; 4. Renewals; or
2. Extensions; 5. Rewrites
★ What is a TDR?
A “troubled debt restructuring” is as defined in GAAP and means:
1. A restructuring in which a credit union;
2. For economic or legal reasons related to a member borrower’s financial difficulties;
3. Grants a concession to the borrower that it would not otherwise consider.
★ When is a Loan Workout NOT a TDR?
Example: When the Credit Union accepts cash and/or other assets in full satisfaction of the debt in an amount that is at least equal to the unpaid balance of the loan less any amounts previously charged-off.
This is not a TDR because the Credit Union is getting the full unpaid balance of the loan (after charge-off), which means that the Credit Union is not granting a concession that it would otherwise not consider.
★ What is Changing?
1. Calculating Past Due Status: As of July 2, 2012, all federally-insured credit unions must calculate past due status of workout loans consistent with the loan contract (as modified).
2. June Call Reports: Data collection for the Call Report for the quarter ending June 30, 2012 must reflect the revised calculation requirements for TDR loans (see above).
3. December Call Reports:For the quarter ending December 31, 2012, the Call Report will be revised with new instructions on how to complete the Report in accordance with the new IRPS on reporting TDRs.
In order for credit unions to file the data related to loans placed in “nonaccrual” status in accordance with the Final Rule and the IRPS, they must have written nonaccrual policies and loan workout policies in effect at the beginning of the quarter. Therefore, these policies must be in place no later than October 1, 2012.
★ Accounting Treatment - What Do You Have to Do?
When a loan is in default, you must do the following to ensure appropriate income recognition:
1. Place loans in “nonaccrual” status when the loan is 90 or more days past due;
Important Note: This does not mean that your Credit Union cannot collect interest payments in accordance with the loan contract (as modified). The collection of payments is different from the accounting treatment.
2. Reverse or charge-off previously accrued but uncollected interest;
3. Comply with the criteria under GAAP for Cash or Cost Recovery basis of income recognition;
★ Accounting Treatment - What Do You Have to Do (Continued)?
4. Report TDRs on the new Call Reports; and
5. Follow the specifications in the IRPS for restoration of a “nonaccrual” loan to “accrual” status.
★ Reporting TDRs on Call Reports
1. Credit Unions must report delinquencies on Call Reports consistent with the requirements set forth in the IRPS.
2. For the December 31, 2012 Call Report, the NCUA will provide instructions, addressing the requirement to focus data collection on loans meeting the definition of TDR under GAAP.
★ For All Loans Except MBLs
A “nonaccrual” loan may be restored to “accrual” status when:
a. Its past due status is less than 90 days;
b. GAAP does not require the loan to be maintained on the Cash or Cost Recovery Basis; and
c. The Credit Union is plausibly assured of repayment of the remaining contractual principal and interest within a reasonable period;
2. When the loan otherwise becomes both“well secured”and“in the process of collection;”OR
3. The asset is a “purchased impaired loan” and it meets the criteria under GAAP for accrual of income under the interest method stated in GAAP.
As noted above, you can restore a “nonaccrual” loan to “accrual” status if it is both“well secured”and“in the process of collection.”
1. Collateralized by a perfected security interest in an amount sufficient to cover the loan balance (less unpaid amounts, amounts charged-off, and recorded accrued interest) plus a reasonable return on that amount; OR
2. By a guarantee of a financially responsible party.
“In the Process of Collection”means:
Collection is proceeding in due course through either:
1. Legal Action;
2. Other collection efforts expected to result in repayment of the debt or restoration to current status within 90 days.
★ For MBLs
1. A formally restructured member business loan workout may be restored to “accrual” status when:
a. The restructuring and any charge-off taken on the loan are supported by a current, well-documented credit evaluation of the borrower’s financial condition and prospects for repayment under the revised terms; and
b. The borrower has made a minimum of 6 consecutive payments under the restructured terms.
2. Otherwise, the restructured loan must remain on “nonaccrual” status.
★ For MBLs
Original loan payment = $1,500. Restructured to reduce payment to $1,000.
Month 1 Month 2 . . .Month 5 Month 6 Month 7 Month 8 Month 9 Month 10
$1,500 $950 $1,000 $1,000 $1,000 $1,000 $1,000 $1,000
# of Consecutive Pmts: 1 2 3 4 5 6
Given the above, the loan would remain in “nonaccrual” status until the 5th post-workout payment is received in month 10). Note: Therestructuring and any charge-off taken on the loan must also be supported by a current, well-documented credit evaluation of the borrower’s financial condition and prospects for repayment under the revised terms.
1. Adopt a written Loan Workout and Nonaccrual Policy by October 1, 2012.
2. Report delinquencies on the Call Report for the quarter ending on June 30, 2012 by calculating the past due status based on the contract terms, including any modifications.
3. Report TDRs on the new Call Report in accordance with the IRPS (see Appendix C to the Final Rule) and instructions to be given by the NCUA for Call Reports beginning with the Call Report for the quarter ending December 31, 2012.
4. If necessary, make an appointment with your CPA firm to go over the nonaccrual and other reporting requirements in the Final Rule and IRPS.
5. Beginning October 1, 2012, follow the proper accounting treatment described in the IRPS, including coding the loan as “nonaccrual” if the loan is delinquent for 90 or more days.
6. Beginning October 1, 2012, restore “nonaccrual” loans to “accrual” status in accordance with the IRPS. Remember that there are different rules for MBLs.