Mind the GAAP
Deutsch, Gary M., Independent Banker
AN EXPERT TALKS FASB ACCOUNTING AND CRE LOAN WORKOUTS
Federal regulators issued in October 2009 a policy statement on commercial real estate loan workouts (FIL- 61-2009). This month's column answers questions on the potential accounting implications of CRE loan workouts following the policy statement, which is designed to guide financial institutions in prudently working with borrowers to restructure CRE loans while avoiding adverse loan classification during subsequent safety and soundness examinations.
The guidance addresses supervisory expectations for an institution's risk management elements for loan workout programs, loan workout arrangements, classification of loans, and regulatory reporting and accounting considerations. (See sidebar on CRE guidance.)
Q Let's say, in practice, a community bank primarily uses the current appraisal method to determine impairment dollars involved with CRE loan workouts. Should it be using the present value of future cash flow more frequently?
Gary M. Deutsch: You should use the present value analysis method when modifying the terms of a loan (including 1-4 single-family residential properties, condos, multifamily properties and CRE loans) that is not collateral-dependent and when the modification meets one or more of the following criteria:
* 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 debt as stated in the instrument or other agreement and
* reduction (absolute or contingent) of accrued interest.
The Financial Accounting Standards Board (FASB) in its Accounting Standards Codification paragraph 310-10-35-22 states that when a loan is impaired, the creditor shall measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate. However, as a practical expedient, the creditor may measure impairment based on the loan's observable market price or the fair value of collateral if the loan is a collateral-dependent loan.
Also, FASB states that a creditor shall measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. Although many institutions use the current appraisal method, this measurement approach is not consistent with generally accepted accounting principles (GAAP) unless the loan can only be repaid through the sale of the collateral or foreclosure is probable.
Q Does a modification of loan terms to extend the maturity or amortization period of a loan to provide a borrower with cash flow relief count as a troubled debt restructuring?
Deutsch: According to the FASB's Accounting Standards Codification in paragraph 310- 40-15-9, troubled debt restructuring (TDR) accounting is required when the extension of a maturity date or dates is at a stated interest rate that is lower than the current market rate for new debt with similar risk. …