Loan modifications equaled 2.08% of total credit union loans at year-end 2010.
Credit unions reported more than $11.7 billion in modified real estate, consumer, and member business loans last year, according to NCUA. Credit unions have helped members throughout the recession in managing financial difficulties.
It’s challenging, though, for chief financial officers (CFOs) to properly identify and account for these modifications.
In 1977, the Statement of Financial Accounting Standard 15 (FAS 15) introduced the concept of troubled debt restructuring (TDR). Thirty-four years later, we continue to search for a consistent application method.
The ultimate goals of modifications are to improve repayments, minimize credit losses in an unstable environment, and give members opportunities to “right” themselves. While auditors and examiners understand these goals, they also realize loan modifications, if not correctly recorded and reported, could be used improperly to cure or hide delinquencies and overstate interest income.
Current accounting standards leave enough room for interpretation to allow inconsistent application. And the Financial Accounting Standards Board (FASB) recently issued proposed clarifications—adding to the uncertainty.
A modified loan doesn’t always indicate a TDR. To meet the TDR definition under current accounting standards, the loan modification must include both of these criteria:
1. The member must be experiencing financial difficulties; and
2. The credit union must be granting a concession it wouldn’t otherwise consider.
Applying the criteria can be confusing. Nowhere does it say, for example, that a member experiencing financial difficulties must first be delinquent on a loan prior to modification. A member might keep loans current at the credit union while neglecting payments at other financial institutions.
And the new FASB guidelines extend TDR classification to potential defaults considered “probable in the foreseeable future”—meaning more modifications are considered TDRs.
While current accounting standards provide examples of concessions other than current market rates, the standards don’t address all concessions offered today, nor do they define concessions that credit unions wouldn’t consider under normal circumstances.
An insignificant delay or partial payments can exclude a loan from TDR reporting. Under the proposed guidelines, however, these items fall back under consideration for TDR, which could mean most or all delays would be considered TDRs.
Once a loan is classified a TDR, financial institutions should:
- Monitor the loan for timely payments during the first six months of the modified terms; and
- Report the loan as delinquent during this probationary period. Note that consecutive payments made before the modification can count toward the six months.
Under what delinquency category should you report TDRs on your 5300 Call Report? Credit unions are using several options, including:
- Reporting under the delinquency category of the original loan;
- Reporting according to the original loan terms with the modified payment structure applied; or
- Reporting all TDRs in the same category, such as two to six months.
The exact delinquency category isn’t as important as continuing to report delinquencies.
Two other CFO concerns: ensuring proper suspension of interest income accruals during the probationary period and designating adequate additional reserves to recognize TDRs’ inherent credit risks.
Accounting for and reporting TDRs continues to overwhelm many CFOs. No two credit unions use the same practices because of room for interpretation and unique situations.
Seek counsel from a trusted and respected auditor regarding your practices. NCUA requires credit unions with more than $10 million in assets to file call report information in accordance with generally accepted accounting principles (GAAP). If your auditor says your report matches GAAP, rely on it. This doesn’t guarantee, however, that you won’t have to defend your accounting and reporting under examination.
There’s no easy answer…and that’s the trouble with TDRs.
PAM FINCH is vice president of administration/CFO for Mid Minnesota FCU, Baxter, Minn., and chair of the CUNA CFO Council. Contact her at 218-822-5101. Click here to learn more about the CUNA Councils.