troubled debt restructuring teleconference san francisco region february 28, 2012

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Troubled Debt RestructuringTroubled Debt RestructuringTeleconference Teleconference

San Francisco RegionSan Francisco Region

February 28, 2012February 28, 2012

FEDERAL DEPOSIT INSURANCE CORPORATION

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Troubled Debt RestructuringTroubled Debt Restructuring

Presenter: Regional Accountant Robert Coleman

[email protected]

Additional Participants: Assistant Regional Director Paul [email protected]

Case Manager John Johnson

[email protected]

Case Manager Bonn Phillips

[email protected]

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Agenda: Opening Remarks

Recognizing a TDR (ASU 2011-02)

Measuring TDR impairment

Accrual/Non-accrual

Collateral Dependent?

Reporting: Once a TDR always a TDR?

Questions and Answers

Agenda

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► ASC 310-40 Troubled Debt Restructurings (TDRs) by CreditorsASC 310-40 Troubled Debt Restructurings (TDRs) by Creditors► ASC 310-10-35 Impairment MeasurementASC 310-10-35 Impairment Measurement► ASU 2011-02 – Clarification Guidance – Identifying TDRs ASU 2011-02 – Clarification Guidance – Identifying TDRs

Issued April 2011Issued April 2011 Amends ASC Subtopic 310-40Amends ASC Subtopic 310-40 http://www.fasb.org/jsp/FASB/Page/http://www.fasb.org/jsp/FASB/Page/

SectionPage&cid=1176156316498SectionPage&cid=1176156316498► Reports of Condition and Income Instructions – GlossaryReports of Condition and Income Instructions – Glossary

Loan Impairment, pages A-57, A-58Loan Impairment, pages A-57, A-58 Troubled Debt Restructurings, pages A-61, A-62, A-85, A-86Troubled Debt Restructurings, pages A-61, A-62, A-85, A-86 Nonaccrual, page A-59, A-60, A-61, A-62Nonaccrual, page A-59, A-60, A-61, A-62 Reporting, page A-85Reporting, page A-85

► FFIEC December 2011 Call Report Supplemental InstructionsFFIEC December 2011 Call Report Supplemental Instructions► Interagency Policy Statement on Prudent CRE Workouts (2009)Interagency Policy Statement on Prudent CRE Workouts (2009)

Accounting Guidance

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► NOT ALLNOT ALL MODIFICATIONSMODIFICATIONS OR OR RESTRUCTURINGSRESTRUCTURINGS ARE TDR LOANS ARE TDR LOANS

The borrower’s financial capacity and the modified or The borrower’s financial capacity and the modified or restructured terms must meet the definition of a TDR.restructured terms must meet the definition of a TDR.

TDR LoansTDR Loans purchased under ASC 310-30 (AICPA SOP 03-3), that is, purchased under ASC 310-30 (AICPA SOP 03-3), that is, purchased credit-impaired loans, are no longer TDR loans at their purchased credit-impaired loans, are no longer TDR loans at their acquisition date.acquisition date.

Individual purchased credit-impaired loans that are part of Individual purchased credit-impaired loans that are part of a pool a pool accounted for as a single assetaccounted for as a single asset under ASC 310-30 that are under ASC 310-30 that are restructured and would otherwise meet the TDR definition are not restructured and would otherwise meet the TDR definition are not reported or accounted for as TDR loans.reported or accounted for as TDR loans.

TDR Recognition

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► Do we have a TDR loan?Do we have a TDR loan?

A loan that is restructured or modified for economic or legal A loan that is restructured or modified for economic or legal reasons, where,reasons, where,

1. The creditor grants a concession that it otherwise would not consider, but for the

2. borrower’s financial difficulties

Concession and Financial Difficulties - have specific meaning.

TDR Recognition

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Do we have a TDR loan?Do we have a TDR loan?

► A troubled debt restructuring may include, but is not necessarily limited to, one or a combination of the following:

Transfer of assets to the creditor to fully or partially satisfy the borrower’s debt

Issuing an equity interest in the borrower to the creditor. For example, converting the borrower’s debt to equity

Modification of terms of a debt, such as one or a combination of any of the following:

► Reduction (absolute or contingent) of the stated interest rate for the remaining original life of the debt

► Extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk

► Reduction (absolute or contingent) of the face amount or maturity amount of the debt as stated in the instrument or other agreement

► Reduction (absolute or contingent) of accrued interest.

ASC 310-40-15-9

TDR Recognition

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► Concession –Concession –

A creditor has granted a A creditor has granted a concessionconcession when, as a when, as a result result of the restructuring, it does not expect to collect all of the restructuring, it does not expect to collect all amounts due, including interest accrued at the original amounts due, including interest accrued at the original contract rate.contract rate. In that situation, and In that situation, and if the payment of if the payment of principalprincipal at original maturity is primarily dependent on at original maturity is primarily dependent on the value of collateralthe value of collateral, an entity shall consider the , an entity shall consider the current valuecurrent value of that collateral in determining whether of that collateral in determining whether the principal will be paid. ASC 310-40-15-13.the principal will be paid. ASC 310-40-15-13.

In other words, if a loan was originally underwritten as In other words, if a loan was originally underwritten as or has subsequently become a collateral-dependent or has subsequently become a collateral-dependent loan, we would look to the fair value of the collateral loan, we would look to the fair value of the collateral (“as is”) to determine whether principal will be repaid.(“as is”) to determine whether principal will be repaid.

TDR Recognition

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► Concession (continued) –Concession (continued) –

A creditor may restructure a debt in exchange for additional A creditor may restructure a debt in exchange for additional collateral or guarantees from the debtor. In that situation, a creditor collateral or guarantees from the debtor. In that situation, a creditor has granted a concession when the nature and amount of that has granted a concession when the nature and amount of that additional collateral or guarantees received as part of a restructuring additional collateral or guarantees received as part of a restructuring do not serve as adequate compensation for other terms of the do not serve as adequate compensation for other terms of the restructuring. When additional guarantees are received in a restructuring. When additional guarantees are received in a restructuring, an entity shall evaluate both a guarantor’s ability and restructuring, an entity shall evaluate both a guarantor’s ability and its willingness to pay the balance owed. ASC 310-40-15-14.its willingness to pay the balance owed. ASC 310-40-15-14.

If a debtor does not otherwise have access to funds at a market rate If a debtor does not otherwise have access to funds at a market rate for debt with similar risk characteristics as the restructured debt, the for debt with similar risk characteristics as the restructured debt, the restructuring would be considered to be at a below-market rate, restructuring would be considered to be at a below-market rate, which which may indicatemay indicate that the creditor has granted a concession. In that the creditor has granted a concession. In that situation, a creditor shall that situation, a creditor shall consider all aspectsconsider all aspects of the of the restructuring in determining whether it has granted a concession. restructuring in determining whether it has granted a concession. ASC 310-40-15-15.ASC 310-40-15-15.

TDR Recognition

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► Do we have a TDR loan?Do we have a TDR loan? Concession (continued) – Concession (continued) – Insignificant delay in payment?Insignificant delay in payment?

► A restructuring that results in only a delay in payment that is A restructuring that results in only a delay in payment that is insignificantinsignificant is is notnot a concession. The following factors, when considered a concession. The following factors, when considered together, may indicate that a restructuring results in a delay in payment together, may indicate that a restructuring results in a delay in payment that is insignificant:that is insignificant:

a.a. The The amount of the restructured paymentsamount of the restructured payments subject to the delay is subject to the delay is insignificantinsignificant relative to the relative to the unpaid principalunpaid principal or or collateral valuecollateral value of the of the debt and will result in an insignificant shortfall in the contractual debt and will result in an insignificant shortfall in the contractual amount due.amount due.

b.b. The The delay in timingdelay in timing of the restructured payment period is of the restructured payment period is insignificant relative to any one of the following:insignificant relative to any one of the following:

1.1. The frequency of payments due under the debtThe frequency of payments due under the debt

2.2. The debt’s original contractual maturityThe debt’s original contractual maturity

3.3. The debt’s original expected duration.The debt’s original expected duration.

TDR Recognition

ASC 310-40-15-17; ASC 310-10-35-10 (insignificant delay or amount – not impaired).

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► Do we have a TDR loan?Do we have a TDR loan?

Financial Difficulties – The Debtor…Financial Difficulties – The Debtor…

Is in payment default on Is in payment default on anyany of its debt of its debt; or it is probable the debtor ; or it is probable the debtor will be in payment will be in payment defaultdefault on on anyany of its debt in the foreseeable future without the modification. of its debt in the foreseeable future without the modification.

Has or is Has or is declaring bankruptcydeclaring bankruptcy..

Substantial doubt about the business as Substantial doubt about the business as a going concern.a going concern.

Securities delistedSecurities delisted or in the process or threat of being delisted or in the process or threat of being delisted

The creditor forecasts that theThe creditor forecasts that the debtor’s entity-specific cash flows will be insufficient to debtor’s entity-specific cash flows will be insufficient to service service anyany of its debt of its debt in accordance with contractual termsin accordance with contractual terms for the foreseeable future for the foreseeable future

Without the modification,Without the modification, cannot obtain funds from sources other than the existing cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest ratecreditors at an effective interest rate equal to the current market interest rate for for similar debt for a nontroubled debtor.similar debt for a nontroubled debtor.

TDR Recognition

ASC 310-40-15-20; Evaluation supported by well developed financial analysis

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All TDRAll TDR Loans are Impaired Loans Loans are Impaired Loans► Why?Why?

Because when a creditor grants a concession that he otherwise would not consider Because when a creditor grants a concession that he otherwise would not consider but forbut for the borrowers financial difficulties – the creditor is contemplating not being paid according to the borrowers financial difficulties – the creditor is contemplating not being paid according to the contractual terms of the contract. However, if the restructuring results in an insignificant the contractual terms of the contract. However, if the restructuring results in an insignificant delay in payment, it is NOT a TDR. delay in payment, it is NOT a TDR.

The definition of an impaired loan is when it is probable that the creditor will not be able to The definition of an impaired loan is when it is probable that the creditor will not be able to collect all amounts due according to the contractual terms of the original loan agreement. collect all amounts due according to the contractual terms of the original loan agreement. SeeSee ASC 310-10-35-16. ASC 310-10-35-16. See alsoSee also Call Report Instructions, Glossary p. A-57. Call Report Instructions, Glossary p. A-57.

This guidance does not specify how a creditor should determine that it is probable that it will This guidance does not specify how a creditor should determine that it is probable that it will be unable to collect all amounts due according to the contractual terms of a loan. A creditor be unable to collect all amounts due according to the contractual terms of a loan. A creditor shall apply its normal loan review procedures in making that judgment. An insignificant delay shall apply its normal loan review procedures in making that judgment. An insignificant delay or insignificant shortfall in amount of payments does not require application of this guidance. or insignificant shortfall in amount of payments does not require application of this guidance. A loan is A loan is not impairednot impaired during a period of delay in payment if the creditor expects to collect during a period of delay in payment if the creditor expects to collect all amounts due including interest accrued at the contractual interest rate for the period of all amounts due including interest accrued at the contractual interest rate for the period of delay.delay. Thus, a demand loan or other loan with no stated maturity is not impaired if the Thus, a demand loan or other loan with no stated maturity is not impaired if the creditor expects to collect all amounts due including interest accrued at the contractual creditor expects to collect all amounts due including interest accrued at the contractual interest rate during the period the loan is outstanding. ASC 310-10-35-17.interest rate during the period the loan is outstanding. ASC 310-10-35-17.

When a loan not previously considered individually impaired is restructured and determined When a loan not previously considered individually impaired is restructured and determined to be a TDR, absent a partial charge-off, it generally is not appropriate for the impairment to be a TDR, absent a partial charge-off, it generally is not appropriate for the impairment estimate on the loan to decline as a result of the change from the impairment measurement estimate on the loan to decline as a result of the change from the impairment measurement method prescribed in ASC Subtopic 450-20 (FAS 5) to the methods prescribed in ASC method prescribed in ASC Subtopic 450-20 (FAS 5) to the methods prescribed in ASC Subtopic 310-10 (FAS 114). FFIEC Call Report Supplemental Instructions (December 2011)Subtopic 310-10 (FAS 114). FFIEC Call Report Supplemental Instructions (December 2011)

ASU 2011-02, ASU 2011-02, Basis for Conclusions,Basis for Conclusions, Paragraph BC13 states: “The guidance in paragraph ASC Paragraph BC13 states: “The guidance in paragraph ASC 310-10-35-17 about insignificant delays or shortfalls is meant to 310-10-35-17 about insignificant delays or shortfalls is meant to prevent a loan from prevent a loan from being designated as impairedbeing designated as impaired when the resulting impairment calculation would result in a when the resulting impairment calculation would result in a nominal allowance for loan losses.”nominal allowance for loan losses.”

TDR Measurement

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A loan restructured in a TDR is an impaired loan. ASC 310-40-35-10

Once a TDR Loan, always a TDR Loan, unless paid in full, or otherwise settled, sold, or charged-off. Call Report Instructions, RC-N-4.

A TDR loan must always be accounted for as a TDR, that is, as an impaired loan, but it is not always reported as a TDR loan on the Call Report.

TDR Measurement

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When a loan is impaired as defined in paragraphs 310-10-35-16 through 35-17, a creditor shall measure impairment based on the present value of expected future cash flows discounted at the 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. ASC 310-10-35-22

For Call Report purposes, impairment of a collateral-dependent loan is required to be measured using the fair value of collateral method. Call Report Instructions, Glossary p. A-57

A loan is collateral dependent if repayment of the loan is expected to be provided solely by the sale or operation of the underlying collateral and there are no other available and reliable sources of repayment. See ASC 310-10-20; Call Report Instructions, Glossary p. A-57; Policy Statement on Prudent CRE Workouts

TDR Measurement

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If a creditor uses the fair value of the collateral to measure impairment of a collateral-dependent loan and repayment or satisfaction of a loan is dependent on the sale of the collateral, the fair value of the collateral shall be adjusted to consider estimated costs to sell.

However, if repayment or satisfaction of the loan is dependent only on the operation, rather than the sale, of the collateral, the measure of impairment shall not incorporate estimated costs to sell the collateral. ASC 310-10-35-23. (Because the workout plan does not include the sale to liquidate the debt).

TDR Measurement

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► So we have a TDR loan, now what?So we have a TDR loan, now what? Measure the impairmentMeasure the impairment – –

► Is the TDR loan “Collateral Dependent”? Is the TDR loan “Collateral Dependent”? Yes, from Yes, from operation of the collateraloperation of the collateral; where the banker ; where the banker

reasonably expects that repayment of the debt will be solely from reasonably expects that repayment of the debt will be solely from the cash flows from the operation, rather than the sale, of the the cash flows from the operation, rather than the sale, of the collateral. collateral.

MeasureMeasure – the fair value of the collateral less the banker’s recorded – the fair value of the collateral less the banker’s recorded investment in the loan – if positive, no impairment to be recognized investment in the loan – if positive, no impairment to be recognized and no allowance on the loan; if negative – impairment to be and no allowance on the loan; if negative – impairment to be recognized and an allowance for loan losses on the loan for the recognized and an allowance for loan losses on the loan for the difference. difference.

No costs to sell are includedNo costs to sell are included, since the workout plan does not , since the workout plan does not include sale of the collateral.include sale of the collateral.

For For examination classificationexamination classification purposes, the market value purposes, the market value conclusion for the collateral that corresponds to the workout plan conclusion for the collateral that corresponds to the workout plan would be used to determine any Loss classification for the loan, would be used to determine any Loss classification for the loan, which would be subject to charge-off and may be less than the which would be subject to charge-off and may be less than the impairment measured based on the fair value of the collateral.impairment measured based on the fair value of the collateral.

TDR Measurement

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► So we have a TDR loan, now what?So we have a TDR loan, now what? Measure the impairmentMeasure the impairment

► Is the TDR loan “collateral dependent?” Is the TDR loan “collateral dependent?”

► Yes, from Yes, from sale of the collateralsale of the collateral; where the banker reasonably expects ; where the banker reasonably expects repayment of the debt will be solely from the sale of the collateral. repayment of the debt will be solely from the sale of the collateral.

► MeasureMeasure – “the fair value of the collateral less cost to sell” minus the banker’s – “the fair value of the collateral less cost to sell” minus the banker’s recorded investment in the loanrecorded investment in the loan

► if positiveif positive, no impairment to be recognized, no allowance on the loan, and no Loss , no impairment to be recognized, no allowance on the loan, and no Loss classification;classification;

► if negativeif negative – impairment to be recognized with immediate charge-off the difference. – impairment to be recognized with immediate charge-off the difference.

► Costs to sell are includedCosts to sell are included, since the workout plan includes the sale of the collateral , since the workout plan includes the sale of the collateral

to repay the debtto repay the debt

TDR Measurement

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► So we have a TDR loan, now what?So we have a TDR loan, now what? Measure the impairmentMeasure the impairment

► Is the loan “collateral dependent”? Is the loan “collateral dependent”?

► No – where there are “available and reliable” source(s) of cash No – where there are “available and reliable” source(s) of cash flow to repay the debt, besides cash flow from the sale or flow to repay the debt, besides cash flow from the sale or operation of the collateral (if any)operation of the collateral (if any)

The banker The banker must usemust use the present value of the present value of expectedexpected future cash future cash flows, discounted at the flows, discounted at the original effective interest rateoriginal effective interest rate on the on the loan – loan – NOTNOT the interest rate under the restructured terms. The the interest rate under the restructured terms. The original effective interest rate represents the original risk and original effective interest rate represents the original risk and associated pricing in the original credit underwriting.associated pricing in the original credit underwriting.

MeasureMeasure – present value of expected future cash flows less the – present value of expected future cash flows less the banker’s investment in the loanbanker’s investment in the loan► If positive, no impairment to be recognized and no allowance If positive, no impairment to be recognized and no allowance

for loan losses on the loanfor loan losses on the loan► If negative, impairment to be recognized and establish an If negative, impairment to be recognized and establish an

allowance for loan losses on the loan for the difference.allowance for loan losses on the loan for the difference.

Note: Any Note: Any uncollectible amountsuncollectible amounts should be charged off. should be charged off.

TDR Measurement

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► If it’s not collateral dependent?If it’s not collateral dependent?

The banker may measure the loan’s impairment The banker may measure the loan’s impairment based on the based on the loan's observable market price,“ loan's observable market price,“ as a as a practical expedientpractical expedient, instead of using the , instead of using the present value present value of expected future cash flows methodof expected future cash flows method. What does a . What does a "loan's observable market price" mean?"loan's observable market price" mean?

It requires a market with quoted prices for the TDR It requires a market with quoted prices for the TDR loan, loan, which rarely exists.which rarely exists.

A creditor is allowed to use a loan's observable A creditor is allowed to use a loan's observable market price as a practical expedient market price as a practical expedient to discounting to discounting expected future cash flows. expected future cash flows.

TDR Measurement

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► Example 1:Example 1:

Example 1:Example 1: Measure the impairmentMeasure the impairment – Discounted Cash Flow (DCF) approach to measuring – Discounted Cash Flow (DCF) approach to measuring

impairment.impairment.

FACTS: Banker makes a commercial loan to a small wholesale business, for $5,000,000 FACTS: Banker makes a commercial loan to a small wholesale business, for $5,000,000 bearing a contractual interest rate of 10%, which was the market rate at origination. The bearing a contractual interest rate of 10%, which was the market rate at origination. The loan is amortizing over 20 years due in 5 years. The payment amount is $48,251. The loan is amortizing over 20 years due in 5 years. The payment amount is $48,251. The warehouse collateral had original “as is” appraised value of $6,700,000. warehouse collateral had original “as is” appraised value of $6,700,000.

After 24 months the borrower is delinquent on three of his five personal and commercial After 24 months the borrower is delinquent on three of his five personal and commercial loans, including Banker’s $5,000,000 loan ‘A.’ On loan ‘A’ the borrower is 90 days loans, including Banker’s $5,000,000 loan ‘A.’ On loan ‘A’ the borrower is 90 days delinquent (4 payments). After carefully analyzing the borrower’s personal and business delinquent (4 payments). After carefully analyzing the borrower’s personal and business financial statements and credit reports, and after discussions with the borrower, the financial statements and credit reports, and after discussions with the borrower, the Banker determines that the borrower’s business may be able to generate cash flow of Banker determines that the borrower’s business may be able to generate cash flow of $30,100 per month to service loan ‘A.’ The borrower plans to operate the business for $30,100 per month to service loan ‘A.’ The borrower plans to operate the business for five years and believes that economic conditions should improve during this period, five years and believes that economic conditions should improve during this period, enabling him to sell the business, including remaining inventory, and the warehouse at enabling him to sell the business, including remaining inventory, and the warehouse at that time. The current “as is” appraised value of the property is $2,400,000 less cost to that time. The current “as is” appraised value of the property is $2,400,000 less cost to sell of $240,000 or 10%. sell of $240,000 or 10%.

TDR Measurement

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► Example 1 (DCF):Example 1 (DCF):

► Measure the impairmentMeasure the impairment – Discounted Cash Flow (DCF) approach to measuring impairment – Discounted Cash Flow (DCF) approach to measuring impairment (continued).(continued).

► Management decides to amortize the remaining principal balance of $4,849,573 over 20 years Management decides to amortize the remaining principal balance of $4,849,573 over 20 years from the restructure date, but with the balance due in 5 years. Based on the borrower’s from the restructure date, but with the balance due in 5 years. Based on the borrower’s possible cash flows from the business, the Banker lowers the contractual interest rate to possible cash flows from the business, the Banker lowers the contractual interest rate to 4.25%, which is a below market rate because it is less than the rate the bank would charge at 4.25%, which is a below market rate because it is less than the rate the bank would charge at the time of the restructuring for a new loan with comparable risk. The required monthly the time of the restructuring for a new loan with comparable risk. The required monthly payments are $30,030, with the payments expected to come from business operations. The payments are $30,030, with the payments expected to come from business operations. The balloon payment at the end of 5 years equals $3,991,918. balloon payment at the end of 5 years equals $3,991,918.

► However, due to the borrower’s continuing financial difficulties, management determines that However, due to the borrower’s continuing financial difficulties, management determines that their best estimate based on reasonable and supportable assumptions and projections of the their best estimate based on reasonable and supportable assumptions and projections of the expected monthly cash flows over the five year loan term, taking default probability into expected monthly cash flows over the five year loan term, taking default probability into account, is 90% of the contractual cash flows or $27,027 and that the current “as is” account, is 90% of the contractual cash flows or $27,027 and that the current “as is” appraised value of the warehouse is not likely to improve over this period. Based on current appraised value of the warehouse is not likely to improve over this period. Based on current inventory levels and other information, management estimates that the sale of the borrower’s inventory levels and other information, management estimates that the sale of the borrower’s other available business assets would generate an additional $600,000. other available business assets would generate an additional $600,000.

► Example 1: The restructured loan is a TDR loan, but is Example 1: The restructured loan is a TDR loan, but is not collateral dependentnot collateral dependent – the bank – the bank mustmust use the discounted cash flow method to determine the impairment amount. use the discounted cash flow method to determine the impairment amount.

TDR Measurement

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At the date of restructure the bank’s best estimate is that it expects the following At the date of restructure the bank’s best estimate is that it expects the following cash flows from the operation of the business and the sale of the warehouse and cash flows from the operation of the business and the sale of the warehouse and other business assets during the next 5 years (Net of real estate selling costs of other business assets during the next 5 years (Net of real estate selling costs of 10%):10%):

PV of 60 payments of $27,027 discounted @ 10% equalsPV of 60 payments of $27,027 discounted @ 10% equals $1,272,036$1,272,036PV of 1 payment of $2,160,000 (from sale of real estate, net) plusPV of 1 payment of $2,160,000 (from sale of real estate, net) plus$600,000 (from sale of other available assets) discounted @ 10% $600,000 (from sale of other available assets) discounted @ 10% for 60 monthsfor 60 months $1,677,496$1,677,496

Total PV of Expected CFsTotal PV of Expected CFs $2,949,532$2,949,532The bank’s recorded investment equalsThe bank’s recorded investment equals($4,849,573)($4,849,573)

Impairment amountImpairment amount($1,900,041)($1,900,041)

Any amounts deemed uncollectible should be written off. Any amounts deemed uncollectible should be written off.

TDR Measurement

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After 6 monthsAfter 6 months, two 30 days past due payments and the continuing deterioration of the business as shown , two 30 days past due payments and the continuing deterioration of the business as shown in its financial results, management revises its best estimate of the expected future cash flows. They now in its financial results, management revises its best estimate of the expected future cash flows. They now estimate that the borrower’s cash flows will be only $25,000 per month for the remaining term of the loan estimate that the borrower’s cash flows will be only $25,000 per month for the remaining term of the loan and the sale of the real estate collateral will only generate $2,000,000 (less costs to sell of $200,000). and the sale of the real estate collateral will only generate $2,000,000 (less costs to sell of $200,000). Management also reduces its estimate of the proceeds from the sale of the borrower’s other available Management also reduces its estimate of the proceeds from the sale of the borrower’s other available business assets to $550,000:business assets to $550,000:

PV of 54 PV of 54 expectedexpected payments of $25,000 discounted @ 10% equals payments of $25,000 discounted @ 10% equals $1,083,545$1,083,545PV of 1 PV of 1 expectedexpected payment of $1,800,000 (from sale of real estate, payment of $1,800,000 (from sale of real estate, net) plus $550,000 (from sale of other available assets) discounted net) plus $550,000 (from sale of other available assets) discounted @ 10% for 54 months@ 10% for 54 months $1,501,223$1,501,223

New total PV of Expected CFsNew total PV of Expected CFs $2,584,768 $2,584,768

► The bank’s recorded investment (if no charge-off was taken at theThe bank’s recorded investment (if no charge-off was taken at therestructuring date) equalsrestructuring date) equals($4,771,759)($4,771,759)

Impairment amountImpairment amount($2,186,991)($2,186,991)

► The additional impairment of $286,950 would increase the impairment allowance; any amounts deemed The additional impairment of $286,950 would increase the impairment allowance; any amounts deemed uncollectible should be written off.uncollectible should be written off.

NOTE: The additional impairment amount assumes that the bank did not adjust its impairment allowance at any NOTE: The additional impairment amount assumes that the bank did not adjust its impairment allowance at any quarter-end report dates between the restructuring date and 6 months later for time value of money.quarter-end report dates between the restructuring date and 6 months later for time value of money.

TDR Measurement

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► Example 2: Operating - Collateral DependentExample 2: Operating - Collateral Dependent

New Facts: The same basic facts as in example 1; however, the collateral for loan ‘A’ is an apartment New Facts: The same basic facts as in example 1; however, the collateral for loan ‘A’ is an apartment building. The collateral at origination had normal occupancy and rental rates and the building was building. The collateral at origination had normal occupancy and rental rates and the building was appraised at $6,700,000 on an “as stabilized” basis. However, the current appraisal’s prospective “as appraised at $6,700,000 on an “as stabilized” basis. However, the current appraisal’s prospective “as stabilized” market value now equals only $4,000,000 and the “as is” market value equals approximately stabilized” market value now equals only $4,000,000 and the “as is” market value equals approximately $2,400,000, due to a significantly increased vacancy rate and a decline in rental rates. The bank has $2,400,000, due to a significantly increased vacancy rate and a decline in rental rates. The bank has reviewed the appraisals and found their assumptions and conclusions to be reasonable. The bank also reviewed the appraisals and found their assumptions and conclusions to be reasonable. The bank also concludes that, due to the recency of the current appraisal, the “as is” market value conclusion is an concludes that, due to the recency of the current appraisal, the “as is” market value conclusion is an appropriate estimate of the fair value of the collateral for financial reporting purposes. Management appropriate estimate of the fair value of the collateral for financial reporting purposes. Management determines that a prudent loan workout would be in the best interest of the bank and the borrower. In determines that a prudent loan workout would be in the best interest of the bank and the borrower. In order to recover as much of the loan as reasonably possible, the banker negotiates a reduced payment order to recover as much of the loan as reasonably possible, the banker negotiates a reduced payment amount he thinks the borrower can meet and the borrower agrees to a restructure. The economy is amount he thinks the borrower can meet and the borrower agrees to a restructure. The economy is beginning to improve and the banker reasonably believes that the property will reach the current beginning to improve and the banker reasonably believes that the property will reach the current appraisal’s prospective “as stabilized” value within the next two years. The borrower has no other assets appraisal’s prospective “as stabilized” value within the next two years. The borrower has no other assets and his ability to service the debt from other sources is nil. After a thorough analysis of the borrower’s and his ability to service the debt from other sources is nil. After a thorough analysis of the borrower’s financial condition, management concludes that the bank can be repaid only through the operation of the financial condition, management concludes that the bank can be repaid only through the operation of the collateral, but they are reasonably certain as of the restructuring date that the borrower will not have to collateral, but they are reasonably certain as of the restructuring date that the borrower will not have to sell the collateral to repay the debt. sell the collateral to repay the debt.

Bank’s recorded investment in the loan Bank’s recorded investment in the loan $4,849,573$4,849,573Current “as stabilized” market value conclusion Current “as stabilized” market value conclusion $4,000,000 $4,000,000

Amount adversely classified Loss and charged off Amount adversely classified Loss and charged off $ 849,573$ 849,573

Current “as stabilized” market value conclusion, Current “as stabilized” market value conclusion, which is the recorded investment in the loan following which is the recorded investment in the loan following the charge-off the charge-off $4,000,000$4,000,000Fair value of collateral (current “as is” market value conclusion) Fair value of collateral (current “as is” market value conclusion) $2,400,000$2,400,000

Valuation Allowance for impairment Valuation Allowance for impairment $1,600,000$1,600,000

TDR Measurement

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► Example 3: Selling the Collateral- Collateral DependentExample 3: Selling the Collateral- Collateral Dependent

New Facts: The same basic facts as in example 2 -- the borrower has New Facts: The same basic facts as in example 2 -- the borrower has no other assets and after a thorough analysis of the borrower’s no other assets and after a thorough analysis of the borrower’s financial condition and the ability to increase rental rates, financial condition and the ability to increase rental rates, management is not confident that the current appraisal’s prospective management is not confident that the current appraisal’s prospective “as stabilized” market value of $4,000,000 can be achieved within a “as stabilized” market value of $4,000,000 can be achieved within a reasonable time period. As a consequence, management concludes reasonable time period. As a consequence, management concludes that they will be able to be repaid only through the liquidation of the that they will be able to be repaid only through the liquidation of the collateral by the borrower or by the bank through foreclosure. Under collateral by the borrower or by the bank through foreclosure. Under either scenario, management has determined that the well supported either scenario, management has determined that the well supported current appraisal’s “as is” market value conclusion is an appropriate current appraisal’s “as is” market value conclusion is an appropriate estimate of the fair value of the collateral. Costs to sell are 10% or estimate of the fair value of the collateral. Costs to sell are 10% or $240,000. $240,000.

Bank’s recorded investment in the loanBank’s recorded investment in the loan $4,849,573$4,849,573Current “as is” market value conclusion less costs to sell Current “as is” market value conclusion less costs to sell $2,160,000 $2,160,000 Amount Adversely classified Loss and charged offAmount Adversely classified Loss and charged off

$2,689,573$2,689,573

TDR Measurement

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► Impairment analysis on TDR loans is required Impairment analysis on TDR loans is required every quarter as part of the ALLL methodologyevery quarter as part of the ALLL methodology

Because the net carrying amount of an impaired loan Because the net carrying amount of an impaired loan shall be the present value of expected future cash shall be the present value of expected future cash flows (or the observable market price or the fair value flows (or the observable market price or the fair value of the collateral [less costs to sell, if appropriate]) not of the collateral [less costs to sell, if appropriate]) not only at the date at which impairment initially is only at the date at which impairment initially is recognized but also at each subsequent reporting recognized but also at each subsequent reporting period, recognition of changes in that measure is period, recognition of changes in that measure is required. ASC 310-10-35-38required. ASC 310-10-35-38

TDR Measurement

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► Is the loan already on nonaccrual at the time of the restructuring?Is the loan already on nonaccrual at the time of the restructuring?

All TDR loans are All TDR loans are impairedimpaired..

Loans that meet the definition of TDRs, that is, the Banker grants a Loans that meet the definition of TDRs, that is, the Banker grants a “concession”“concession” that he would otherwise not consider but for the borrower’s that he would otherwise not consider but for the borrower’s “financial difficulties,”“financial difficulties,” are impaired loans. are impaired loans.

““A loan A loan identified as impairedidentified as impaired is one for which it is probable that the is one for which it is probable that the institution will be unable to collect all principal and interest amounts due institution will be unable to collect all principal and interest amounts due according to the contractual terms of the original loan agreement.” Call according to the contractual terms of the original loan agreement.” Call Report Instructions, Glossary p. A-58; Report Instructions, Glossary p. A-58; See,See, ASC 310-10-35-16. ASC 310-10-35-16.

The vast majority of loans will have already been identified and placed on The vast majority of loans will have already been identified and placed on nonaccrual by the time the loan is restructured in a troubled debt nonaccrual by the time the loan is restructured in a troubled debt restructuring. Management will usually be aware of problems with the restructuring. Management will usually be aware of problems with the borrower’s capacity to fully repay principal and interest borrower’s capacity to fully repay principal and interest beforebefore there are there are negotiations to preserve as much of the loan as possible through a formal negotiations to preserve as much of the loan as possible through a formal restructuring. See Generally, Call Report Instructions, Glossary – restructuring. See Generally, Call Report Instructions, Glossary – Nonaccrual Nonaccrual StatusStatus, p. A-59 – A-62., p. A-59 – A-62.

Therefore, a loan that is not already in nonaccrual status when it is first Therefore, a loan that is not already in nonaccrual status when it is first identified as impairedidentified as impaired will normally meet the criteria for placement in will normally meet the criteria for placement in nonaccrual status at that time. Call Report Instructions, Glossary – nonaccrual status at that time. Call Report Instructions, Glossary – Loan Loan ImpairmentImpairment, p. A-58., p. A-58.

TDR Accrual/Nonaccrual

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Under certain conditions the TDR can remain as an accruing loan – this topic was addressed in the December Teleconference:

• Most troubled debt restructurings, if they're the larger commercial-type loans and if the bank has an effective loan review process, presumably would have already been identified as impaired loans even before the borrower came in and asked for a concession and so forth, which would have created a TDR.

• So if the loan had already been identified as being an impaired loan, it probably would have been in nonaccrual status. And then we get to the question of once you've gone through a TDR, what are the conditions for returning a nonaccrual TDR back to accrual status, which the Call Report Glossary entry for nonaccrual status addresses.

• On the comment about an exception for mortgage loans, I'm assuming they are probably implying single family residential mortgage loans. The Call Report Instructions don't require single family residential mortgages to be placed on nonaccrual status when they're in default for 90 days or more. It’s permitted, but it's not required. When the bank's policy is not to put them in nonaccrual, the bank has to take other appropriate accounting actions to ensure income is not overstated. So there can be some TDRs that are not in nonaccrual status.

• Another situation in particular on the residential mortgages are the loans that were like the 2/28s and 3/27s where there was the payment shock issue and the borrower could perform under the original terms, but the significant increase in payment was what the borrower didn't have the resources to be able to accommodate.

• If the troubled debt restructuring is designed in such a way that the amount of the payments going forward are equivalent to or less than what the payments the borrower has a demonstrated history of performance were before the modification and financial information indicates the borrower would be able to continue to perform at that original payment level, then there would be no basis for placing that residential mortgage on nonaccrual simply because of the restructuring. Chief Accountant Robert Storch, FDIC Telephone Seminar, P. 48, 49 (December 15, 2011).


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► Can a TDR loan be returned to accrual status?Can a TDR loan be returned to accrual status?

Yes. But only under certain conditions:Yes. But only under certain conditions:

► The restructuring must be The restructuring must be prudently underwrittenprudently underwritten so that it has so that it has economic substance and improves the collectibility of the loan, andeconomic substance and improves the collectibility of the loan, and

► Any Any uncollectible amountsuncollectible amounts are charged off, and are charged off, and

► The banker, based on the prudently restructured terms and The banker, based on the prudently restructured terms and supported supported by a well documented analysis of the borrower’s capacityby a well documented analysis of the borrower’s capacity, is , is reasonably reasonably assuredassured that the borrower will be able to repay the principal and interest that the borrower will be able to repay the principal and interest on the modified debt according to the restructured terms, andon the modified debt according to the restructured terms, and

► The borrower demonstrates repayment performance consistent with the The borrower demonstrates repayment performance consistent with the modified terms for at least six months. (In appropriate cases, the 6 modified terms for at least six months. (In appropriate cases, the 6 month period can begin before the restructuring.)month period can begin before the restructuring.)

SeeSee, Call Report Instructions Glossary – , Call Report Instructions Glossary – Nonaccrual StatusNonaccrual Status, p. A-62, p. A-62


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► Can a TDR loan be returned to accrual status Can a TDR loan be returned to accrual status (continued)?(continued)?

Yes. The return to accrual status may often be successful in Yes. The return to accrual status may often be successful in an A/B note structure.an A/B note structure.

► The A note should be underwritten according to the criteria The A note should be underwritten according to the criteria contained in the Call Report instructions.contained in the Call Report instructions.

► The B note should represent the uncollectible portion of the The B note should represent the uncollectible portion of the original loan and must be charged off.original loan and must be charged off.

► The A/B note restructuring must be done correctly. If the bank The A/B note restructuring must be done correctly. If the bank does not charge off the uncollectible amount before or at the does not charge off the uncollectible amount before or at the time of the restructuring transaction - the collection in full of all time of the restructuring transaction - the collection in full of all principal and interest is not reasonably assured because the principal and interest is not reasonably assured because the portion of the loan that is unlikely to be collected continues to portion of the loan that is unlikely to be collected continues to be reflected as an asset on the bank’s books -- both the A and B be reflected as an asset on the bank’s books -- both the A and B notes should remain on nonaccrual. See, Call Report notes should remain on nonaccrual. See, Call Report Instructions Glossary p. A-62Instructions Glossary p. A-62


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► Is it Collateral Dependent? If repayment of the Is it Collateral Dependent? If repayment of the debt will come from either:debt will come from either:

1) 1) The sale of the collateralThe sale of the collateral ( (SeeSee, Call Report , Call Report Instructions Glossary p. A-57)Instructions Glossary p. A-57)

or or 2) 2) Operating the collateralOperating the collateral for its cash flow, as part of for its cash flow, as part of

a prudently designed workout plan. The workout a prudently designed workout plan. The workout plan includes the reasonable expectation that the plan includes the reasonable expectation that the cash flow will be sufficient to liquidate the debt cash flow will be sufficient to liquidate the debt without turning to the sale of the collateral. without turning to the sale of the collateral. See See generallygenerally, Policy Statement on Prudent Commercial , Policy Statement on Prudent Commercial Real Estate Loan Workouts, p. 6 (2009); Real Estate Loan Workouts, p. 6 (2009);

Collateral Dependent

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► Is it Collateral Dependent?Is it Collateral Dependent?

► A loan is collateral dependent if repayment of the loan is A loan is collateral dependent if repayment of the loan is expected to be provided solely by the underlying collateral expected to be provided solely by the underlying collateral and there are and there are no other available and reliable sources of no other available and reliable sources of repayment. repayment. Call Report Instructions Glossary, Call Report Instructions Glossary, Loan Loan Impairment,Impairment, p. 57. FDIC Risk Management Manual of p. 57. FDIC Risk Management Manual of Examination Policies, Section 3.6, Other Real Estate Examination Policies, Section 3.6, Other Real Estate (February 14, 2005). (February 14, 2005).

► If the creditor If the creditor cannot lookcannot look to the general credit capacity of to the general credit capacity of the borrower or the borrower does not have any significant the borrower or the borrower does not have any significant assets or sources of cash flow outside of the collateral, the assets or sources of cash flow outside of the collateral, the loan is collateral dependent.loan is collateral dependent.

► Available and Reliable means that the borrower or guarantor Available and Reliable means that the borrower or guarantor have the capacity outside of the collateral to contribute to have the capacity outside of the collateral to contribute to the amortization of the loan over a reasonable term.the amortization of the loan over a reasonable term.

Collateral Dependent

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► Once a TDR always a TDR?Once a TDR always a TDR? Unfortunately, Yes.Unfortunately, Yes.

► ReportingReporting TDR loan in accrual status and borrower paying according to the modified terms: TDR loan in accrual status and borrower paying according to the modified terms:

Report on RC-C, part 1, Memorandum item 1. Report on RC-C, part 1, Memorandum item 1.

TDR loan in nonaccrual status and/or borrower TDR loan in nonaccrual status and/or borrower NOTNOT paying according to the paying according to the modified terms: Report on RC-N, by loan category in items 1-7, and in modified terms: Report on RC-N, by loan category in items 1-7, and in Memorandum item 1.Memorandum item 1.

If a TDR loan is underwritten to If a TDR loan is underwritten to yield a market rateyield a market rate at the time of the at the time of the restructuring and is in compliance with its modified terms, i.e., the TDR loan is in restructuring and is in compliance with its modified terms, i.e., the TDR loan is in accrual status and is current or less than 30 days past due under the modified accrual status and is current or less than 30 days past due under the modified terms, then in the calendar year after the year of the restructuring the banker terms, then in the calendar year after the year of the restructuring the banker can cease reporting the loan as a TDR.can cease reporting the loan as a TDR.

► AccountingAccounting The banker must still measure the loan for impairment using the appropriate The banker must still measure the loan for impairment using the appropriate

method under ASC 310-10-35. method under ASC 310-10-35.

The two primary methods are the fair value of collateral method for collateral The two primary methods are the fair value of collateral method for collateral dependent TDR loans and the present value of expected future cash flows dependent TDR loans and the present value of expected future cash flows method for TDR loans that are not collateral dependent. Once selected the method for TDR loans that are not collateral dependent. Once selected the method should remain the same unless the answer to the collateral dependent method should remain the same unless the answer to the collateral dependent question changes. question changes.

Reporting TDRs

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► Once a TDR always a TDR?Once a TDR always a TDR?► Yes, but…Yes, but…

If the borrower’s financial condition has improved to the If the borrower’s financial condition has improved to the extent that he would now qualify for a new loan at a extent that he would now qualify for a new loan at a market rate and other market terms with the standard market rate and other market terms with the standard prudent underwriting for a loan of that type, then the prudent underwriting for a loan of that type, then the banker does not have to send the borrower for banker does not have to send the borrower for financing elsewhere as a means to reduce the bank’s financing elsewhere as a means to reduce the bank’s reported amount of TDRs.reported amount of TDRs.

The Banker can pay-off the TDR note with a new The Banker can pay-off the TDR note with a new conventionally underwritten loan, for which the conventionally underwritten loan, for which the borrower qualifies. The underwriting must be borrower qualifies. The underwriting must be completed and fully documented to support the new completed and fully documented to support the new loan, which would show that the borrower is no longer loan, which would show that the borrower is no longer experiencing financial difficulties. The old TDR note is experiencing financial difficulties. The old TDR note is considered paid.considered paid.

Reporting TDRs

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Questions?

troubled debt restructuring teleconference san francisco region february 28, 2012

Documents

debt restructuringagenda

new debt

tdr definition

tdr asu

longer tdr loans

creditimpaired loans

borrowers debtissuing

contingent of accrued