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One of the biggest open questions my team sees in the field
during our examinations is exactly how to assess our clients’ process for handling
Troubled Debt Restructures ("TDR").
There have been many articles released on the subject, most
recently in the FDIC “Supervisory Insights” bulletin.
What we have found is that many banks are still letting the
fundamentals get away from them in the process of identifying and tracking TDRs. First, let’s define the playing field. According
to ASC 310 -10 and FAS 15, a TDR is
a modification of the terms of a loan is a TDR when a borrower is troubled (i.e.,
experiencing financial difficulties) and a financial institution grants a
concession to the borrower that it would not otherwise consider…” That’s a fantastic, ambiguous proclamation. And if you don’t
have the basics in place to handle those two simple things, an institution is
setting itself up for a world of regulatory hurt. Rather than focus on the bank-end
of the TDR process (impairments, call reporting, non-accrual status), let’s
take a baby step and simply focus on the determination of a TDR based on the
modification” …Modifications are the source of where our TDRs emerge from.
The trick is being able to take the application, disseminate the information,
and make a determination that it is a Modification, or that it should be
elevated to TDR status. More than a few of our clients have set up a “Loan
Workout Committee“ specifically for this purpose. All modifications are brought
before these committees and have the expertise and authority to make the
determination of actual status. After
this, the loan (if closed) is then closed and tracked accordingly.
- “….when a
borrower is troubled (i.e., experiencing financial difficulties)” Many times, an initial TDR request will come
forth as a Modification, as bank personnel do not know all the facts. The
request may state that the borrower is looking for a lower rate, or an
adjustment of terms, but nothing else as to the reason or rationale behind the
request. This is where due diligence on the part of the Loan Officer and documentation
of the borrowers’ financial condition come into play. The borrower may be
afraid to disclose his financial condition for fear of not getting what he
needs, or there may simply be a lack of discernible data present because the
borrower is a known entity of the bank and certain things are overlooked
because of that relationship. There are occasions where a customer will come in
with all his/her cards on the table, but the bank cannot take that for granted.
A solid set of parameters for ANY modification is a must, even if it seems to
be a straight forward transaction. If a
bank has defined procedures as to what to review prior to a loan modification,
the chances of someone’s economic status slipping through the cracks decreases
dramatically. Usually, the aforementioned workout committee sets the guidelines
(approved by the BOD, of course) and, thus, has a framework to use in
determining economic status.
- “….and a
financial institution grants a concession to the borrower that it would not
otherwise consider….” This is a bit easier for a bank to identify, if
the bank takes the time to set the parameters as to what a “typical concession
is.” While some banks will consider a three month
extension of a loan or a similar interest only period as “typical”, some will
not. Determining what is outside the
norm will become easier once the norm is defined. Again, if a bank is using a workout committee
structure, this can be discussed, ratified and utilized by that committee.
Finally, BOTH things have to occur
in order for a modification to become a TDR. The borrower can come in with
clear economic distress, but if the bank offers him only a customary or
“typical” modification, it is not, by definition, a TDR and should not be
tracked as such (this does NOT mean the loan should not be evaluated for
classification and subsequent impairment based on that classification, it’s
simply not a TDR. This is where the waters get muddied).
Similarly, if a borrower is doing
fine economically, and the Bank jumps through hoops to keep them as a customer
by slashing their rate and promising to walk their dog every day, this is also
not a TDR.
Once you have the basics of identifying
TDRs, the “down river” the other activities, such as an impairment analysis,
Call reporting Tracking, non-accrual status become (a bit) easier. The
important thing is to get the process off on the right foot and moving forward
on solid ground, so that your bank is not scrambling after the fact to garner
data or make a decision that should have occurred before the loan was even put
on the books. One last thing I cannot underemphasize is the importance of
sharing information with all relevant parties within the Bank. Loan Work Out or
Modification Committees should include all relevant personnel including
Financial and Accounting personnel and not just the lenders.