When can TDRs on non-accrual status be restored to accrual status?

Aug 24, 2015

As the U.S. economy has strengthened, financial institutions have broadly experienced improvements in delinquency rates on loans – a trend that has helped banks release loan-loss reserves and boost their bottom lines in recent quarters.

And while better credit conditions have aided financial institutions in many cases, they have also prompted more frequent discussions about what to do with loans to borrowers who struggled earlier, but for whom the outlook and financial performance have since improved. In some of these situations, banks made concessions on loans to give borrowers relief, designating these loans as troubled debt restructurings, or TDRs, and they placed them on non-accrual status; since then, the borrowers have demonstrated performance under the modified terms.

Must these loans always remain on non-accrual status, or can they be returned to accrual status at some point? Bankers have told Abrigo that accounting for TDRs is among their greatest challenges with respect to restructured loans, and the question of how to transition them to accrual status is a common one.

While loans modified in a TDR in most instances remain impaired for the purpose of calculating the allowance for loan and lease losses, or ALLL, there are cases in which financial institutions can return non-accrual TDR loans to accrual status, according to Todd Sprang, principal at CliftonLarsonAllen.

Indeed, Interagency Supervisory Guidance on TDRs (FIL-50-2013) says: “A loan modified in a TDR that is on nonaccrual at the time of the loan’s modification need not be maintained for its remaining life in nonaccrual status, but can be restored to accrual status if the loan meets the return-to-accrual conditions set forth in the Call Report Glossary (for banks and savings associations) or 12 CFR 741.3(b)(2) and Appendix C to Part 741 (for credit unions).”

Sprang, who will address current developments in TDR accounting at the Risk Management Summit hosted by Abrigo on Sept. 23-25, says that financial institutions considering returning TDR loans to accrual status must:

1. Perform a credit analysis that documents the borrower’s financial condition and projected ability to pay in accordance with the current terms of the loan.
2. Demonstrate that the borrower’s sustained historical payments for the past six consecutive months are equal to or greater than the current required payments.

“Payments other than those in the form of cash or cash equivalents provide weaker evidence of the borrower’s sustained period of repayment performance,” Sprang said. In addition, he said, “interest-only payments or interest-free periods raise doubts about the ability to collect the total principal and interest payments in the future.”

Finally, he noted, payments that were made prior to the modification can be used to satisfy the six-consecutive-month requirement.

Sprang said that the issue of returning non-accrual TDR loans to accrual status TDR loans is not directly tied to the loan’s risk grade or classification, but these should be consistent with the credit analysis.

FIL-50-2013 says, “A TDR designation does not automatically mean that a loan should remain adversely credit risk graded or classified for its remaining life if it already was or becomes adversely credit risk graded or classified at the time of the modification. A TDR loan should be adversely credit risk graded or classified if the loan, as modified, is inadequately protected by the current sound worth and paying capacity of the borrower or the collateral pledged, if any.”

In addition to discussing moving TDRs to accrual from non-accrual status, Sprang’s presentation at the summit will review regulatory guidance offering instructions on moving TDRs from the impaired loan portion of the allowance to the general reserve, and he’ll address the impact on TDRs of the FASB’s guidance on the Current Expected Credit Loss model, or CECL.

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