12 CFR Appendix C to Part 741, Interpretive Ruling and Policy Statement on Loan Workouts, Nonaccrual Policy, and Regulatory Reporting of Troubled Debt Restructured Loans
This Interpretive Ruling and Policy Statement (IRPS) establishes requirements for the management of loan workout1 arrangements, loan nonaccrual, and regulatory reporting of troubled debt restructured loans (herein after referred to as TDR or TDRs).
1 Terms defined in the Glossary will be italicized on their first use in the body of this guidance.
This IRPS applies to all federally insured credit unions.
Under this IRPS, TDR loans are as defined in generally accepted accounting principles (GAAP) and the Board does not intend through this policy to change the Financial Accounting Standards Board's (FASB) definition of TDR in any way. In addition to existing agency policy, this IRPS sets NCUA's supervisory expectations governing loan workout policies and practices and loan accruals.
2 For additional guidance on member business lending extension, deferral, renewal, and rewrite policies, see Interagency Policy Statement on Prudent Commercial Real Estate Loan Workouts (October 30, 2009) transmitted by Letter to Credit Unions No. 10-CU-07, and available at http://www.ncua.gov.
For purposes of this policy statement, types of workout loans to borrowers in financial difficulties include re-agings, extensions, deferrals, renewals, or rewrites. See the Glossary entry on “workouts” for further descriptions of each term. Borrower retention programs or new loans are not encompassed within this policy nor considered by the Board to be workout loans.
Loan workouts can be used to help borrowers overcome temporary financial difficulties, such as loss of job, medical emergency, or change in family circumstances like loss of a family member. Loan workout arrangements should consider and balance the best interests of both the borrower and the credit union.
The lack of a sound written policy on workouts can mask the true performance and past due status of the loan portfolio. Accordingly, the credit union board and management must adopt and adhere to an explicit written policy and standards that control the use of loan workouts, and establish controls to ensure the policy is consistently applied. The loan workout policy and practices should be commensurate with each credit union's size and complexity, and must be in line with the credit union's broader risk mitigation strategies. The policy must define eligibility requirements (i.e., under what conditions the credit union will consider a loan workout), including establishing limits on the number of times an individual loan may be modified. 3 The policy must also ensure credit unions make loan workout decisions based on the borrower's renewed willingness and ability to repay the loan. If a credit union engages in restructuring activity on a loan that results in restructuring the loan more often than once a year or twice in five years, examiners will have higher expectations for the documentation of the borrower's renewed willingness and ability to repay the loan. NCUA is concerned about restructuring activity that pushes existing losses into future reporting periods without improving the loan's collectability. One way a credit union can provide convincing evidence that multiple restructurings improve collectability is to perform validation of completed multiple restructurings that substantiate the claim. Examiners will ask for such validation documentation if the credit union engages in multiple restructurings of a loan.
3 Broad based credit union programs commonly used as a member benefit and implemented in a safe and sound manner limited to only accounts in good standing, such as Skip-a-Pay programs, are not intended to count toward these limits.
In addition, the policy must establish sound controls to ensure loan workout actions are appropriately structured. 4 The policy must provide that in no event may the credit union authorize additional advances to finance unpaid interest and credit union fees. The credit union may, however, make advances to cover third-party fees, excluding credit union commissions, such as force-placed insurance or property taxes. For loan workouts granted, the credit union must document the determination that the borrower is willing and able to repay the loan.
4 In developing a written policy, the credit union board and management may wish to consider similar parameters as those established in the FFIEC's “Uniform Retail Credit Classification and Account Management Policy” (FFIEC Policy). 65 FR 36903 (June 12, 2000). The FFIEC Policy sets forth specific limitations on the number of times a loan can be re-aged (for open-end accounts) or extended, deferred, renewed or rewritten (for closed-end accounts). Additionally, NCUA Letter to Credit Unions (LCU) 09-CU-19, “Evaluating Residential Real Estate Mortgage Loan Modification Programs,” outlines policy requirements for real estate modifications. Those requirements remain applicable to real estate loan modifications but could be adapted in part by the credit union in their written loan workout policy for other loans.
Management must ensure that comprehensive and effective risk management and internal controls are established and maintained so that loan workouts can be adequately controlled and monitored by the credit union's board of directors and management, to provide for timely recognition of losses, 5 and to permit review by examiners. The credit union's risk management framework must include thresholds based on aggregate volume of loan workout activity that trigger enhanced reporting to the board of directors. This reporting will enable the credit union's board of directors to evaluate the effectiveness of the credit union's loan workout program, any implications to the organization's financial condition, and to make any compensating adjustments to the overall business strategy. This information will also then be available to examiners upon request.
5 Refer to NCUA guidance on charge-offs set forth in LCU 03-CU-01, “Loan Charge-off Guidance,” dated January 2003. Examiners will require that a reasonable written charge-off policy is in place and that it is consistently applied. Additionally, credit unions need to adjust historical loss factors when calculating ALLL needs for pooled loans to account for any loans with protracted charge-off timeframes (e.g., 12 months or greater). See discussions on the latter point in the 2006 Interagency ALLL Policy Statement transmitted by Accounting Bulletin 06-1 (December 2006).
To be effective, management information systems need to track the principal reductions and charge-off history of loans in workout programs by type of program. Any decision to re-age, extend, defer, renew, or rewrite a loan, like any other revision to contractual terms, needs to be supported by the credit union's management information systems. Sound management information systems are able to identify and document any loan that is re-aged, extended, deferred, renewed, or rewritten, including the frequency and extent such action has been taken. Documentation normally shows that the credit union's personnel communicated with the borrower, the borrower agreed to pay the loan in full under any new terms, and the borrower has the ability to repay the loan under any new terms.
The past due status of all loans will be calculated consistent with loan contract terms, including amendments made to loan terms through a formal restructure. Credit unions will report delinquency on the Call Report consistent with this policy. 6
6 Subsequent Call Reports and accompanying instructions will reflect this policy, including focusing data collection on loans meeting the definition of TDR under GAAP. In reporting TDRs on regulatory reports, the data collections will include all TDRs that meet the GAAP criteria for TDR reporting, without the application of materiality threshold exclusions based on scoping or reporting policy elections of credit union preparers or their auditors. Credit unions should also refer to the recently revised standard from the FASB, Accounting Standards Update No. 2011-02 (April 2011) to the FASB Accounting Standards Codification entitled, Receivables (Topic 310), “A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring.” This clarified the definition of a TDR, which has the practical effect in the current economic environment to broaden loan workouts that constitute a TDR. This standard is effective for annual periods ending on or after December 15, 2012.
Credit unions must ensure appropriate income recognition by placing loans in nonaccrual status when conditions as specified below exist, reversing or charging-off previously accrued but uncollected interest, complying with the criteria under GAAP for Cash or Cost Recovery basis of income recognition, and following the specifications below regarding restoration of a nonaccrual loan to accrual status. 7 This policy on loan accrual is consistent with longstanding credit union industry practice as implemented by the NCUA over the last several decades. The balance of the policy relates to member business loan workouts and is similar to the FFIEC policies adopted by the federal banking agencies 8 as set forth in the FFIEC Call Report for banking institutions and its instructions. 9
7 Placing a loan in nonaccrual status does not change the loan agreement or the obligations between the borrower and the credit union. Only the parties can effect a restructuring of the original loan terms or otherwise settle the debt.
8 The federal banking agencies are the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.
9 FFIEC Report of Condition and Income Forms and User Guides, Updated September 2011, http://www.fdic.gov.
Credit unions may not accrue interest 10 on any loan upon which principal or interest has been in default for a period of 90 days or more, unless the loan is both “well secured” and “in the process of collection.” 11 Additionally, loans will be placed in nonaccrual status if maintained on a Cash (or Cost Recovery) basis because of deterioration in the financial condition of the borrower, or for which payment in full of principal or interest is not expected. For purposes of applying the “well secured” and “in process of collection” test for nonaccrual status listed above, the date on which a loan reaches nonaccrual status is determined by its contractual terms.
10 Nonaccrual of interest also includes the amortization of deferred net loan fees or costs, or the accretion of discount. Nonaccrual of interest on loans past due 90 days or more is a longstanding agency policy and credit union practice.
11 A purchased credit impaired loan asset need not be placed in nonaccrual status as long as the criteria for accrual of income under the interest method in GAAP is met. Also, the accrual of interest on workout loans is covered in a separate section of this IRPS later in the policy statement.
While a loan is in nonaccrual status, some or all of the cash interest payments received may be treated as interest income on a cash basis as long as the remaining recorded investment in the loan (i.e., after charge-off of identified losses, if any) is deemed to be fully collectable. The reversal of previously accrued, but uncollected, interest applicable to any loan placed in nonaccrual status must be handled in accordance with GAAP. 12 Where assets are collectable over an extended period of time and, because of the terms of the transactions or other conditions, there is no reasonable basis for estimating the degree of collectability - when such circumstances exist, and as long as they exist - consistent with GAAP the Cost Recovery Method of accounting must be used. 13 Use of the Cash or Cost Recovery basis for these loans and the statement on reversing previous accrued interest is the practical implementation of relevant accounting principles.
12 Acceptable accounting treatment includes a reversal of all previously accrued, but uncollected, interest applicable to loans placed in a nonaccrual status against appropriate income and balance sheet accounts. For example, one acceptable method of accounting for such uncollected interest on a loan placed in nonaccrual status is: (1) To reverse all of the unpaid interest by crediting the “accrued interest receivable” account on the balance sheet, (2) to reverse the uncollected interest that has been accrued during the calendar year-to-date by debiting the appropriate “interest and fee income on loans” account on the income statement, and (3) to reverse any uncollected interest that had been accrued during previous calendar years by debiting the “allowance for loan and lease losses” account on the balance sheet. The use of this method presumes that credit union management's additions to the allowance through charges to the “provision for loan and lease losses” on the income statement have been based on an evaluation of the collectability of the loan and lease portfolios and the “accrued interest receivable” account.
13 When a purchased impaired loan or debt security that is accounted for in accordance with ASC Subtopic 310-30, “Receivables-Loans and Debt Securities Acquired with Deteriorated Credit Quality,” has been placed on nonaccrual status, the cost recovery method should be used, when appropriate.
A nonaccrual loan may be restored to accrual status when:
• Its past due status is less than 90 days, GAAP does not require it to be maintained on the Cash or Cost Recovery basis, and the credit union is plausibly assured of repayment of the remaining contractual principal and interest within a reasonable period;
• When it otherwise becomes both well secured and in the process of collection; or
• The asset is a purchased impaired loan and it meets the criteria under GAAP for accrual of income under the interest method specified therein.
In restoring all loans to accrual status, if any interest payments received while the loan was in nonaccrual status were applied to reduce the recorded investment in the loan the application of these payments to the loan's recorded investment must not be reversed (and interest income must not be credited). Likewise, accrued but uncollected interest reversed or charged-off at the point the loan was placed on nonaccrual status cannot be restored to accrual; it can only be recognized as income if collected in cash or cash equivalents from the member.
14 This policy is derived from the “Interagency Policy Statement on Prudent Commercial Real Estate Loan Workouts” NCUA and the other financial regulators issued on October 30, 2009.
A formally restructured member business loan workout need not be maintained in nonaccrual status, provided the restructuring and any charge-off taken on the loan are supported by a current, well documented credit evaluation of the borrower's financial condition and prospects for repayment under the revised terms. Otherwise, the restructured loan must remain in nonaccrual status. The evaluation must include consideration of the borrower's sustained historical repayment performance for a reasonable period prior to the date on which the loan is returned to accrual status. A sustained period of repayment performance would be a minimum of six consecutive payments and would involve timely payments under the restructured loan's terms of principal and interest in cash or cash equivalents. In returning the member business workout loan to accrual status, sustained historical repayment performance for a reasonable time prior to the restructuring may be taken into account. Such a restructuring must improve the collectability of the loan in accordance with a reasonable repayment schedule and does not relieve the credit union from the responsibility to promptly charge off all identified losses.
The graph below provides an example of a schedule of repayment performance to demonstrate a determination of six consecutive payments. If the original loan terms required a monthly payment of $1,500, and the credit union lowered the borrower's payment to $1,000 through formal member business loan restructure, then based on the first row of the graph, the “sustained historical repayment performance for a reasonable time prior to the restructuring” would encompass five of the pre-workout consecutive payments that were at least $1,000 (Months 1 through 5); so, in total, the six consecutive repayment burden would be met by the first month post workout (Month 6). In the second row, only one of the pre-workout payments would count toward the six consecutive repayment requirement (Month 5), because it is the first month in which the borrower made a payment of at least $1,000, after failing to pay at least that amount. The loan, therefore, would remain on nonaccrual for at least five post-workout consecutive payments (Months 6 through 10) provided the borrower continues to make payments consistent with the restructured terms.
|Month 1||Month 2||Month 3||Month 4||Month 5||Month 6||Month 7||Month 8||Month 9||Month 10|
After a formal restructure of a member business loan, if the restructured loan has been returned to accrual status, the loan otherwise remains subject to the nonaccrual standards of this policy. If any interest payments received while the member business loan was in nonaccrual status were applied to reduce the recorded investment in the loan the application of these payments to the loan's recorded investment must not be reversed (and interest income must not be credited). Likewise, accrued but uncollected interest reversed or charged-off at the point the member business workout loan was placed on nonaccrual status cannot be restored to accrual; it can only be recognized as income if collected in cash or cash equivalents from the member.
The following tables summarize nonaccrual and restoration to accrual requirements previously discussed:
Table 1 - Nonaccrual Criteria
|Action||Condition identified||Additional consideration|
|Nonaccrual on All Loans||90 days or more past due unless loan is both well secured and in the process of collection; or
If the loan must be maintained on the Cash or Cost Recovery basis because there is a deterioration in the financial condition of the borrower, or for which payment in full of principal or interest is not expected
|See Glossary descriptors for “well secured” and “in the process of collection.”
Consult GAAP for Cash or Cost Recovery basis income recognition guidance. See also Glossary Descriptors.
|Nonaccrual on Member Business Loan Workouts||Continue on nonaccrual at workout point and until restore to accrual criteria are met||See Table 2 - Restore to Accrual.|
Table 2 - Restore to Accrual
|Action||Condition identified||Additional consideration|
|Restore to Accrual on All Loans except Member Business Loan Workouts||When the loan is past due less than 90 days, GAAP does not require it to be maintained on the Cash or Cost Recovery basis, and the credit union is plausibly assured of repayment of the remaining contractual principal and interest within a reasonable period
When it otherwise becomes both “well secured” and “in the process of collection”; or
The asset is a purchased impaired loan and it meets the criteria under GAAP for accrual of income under the interest method
|See Glossary descriptors for “well secured” and “in the process of collection.”
Interest payments received while the loan was in nonaccrual status and applied to reduce the recorded investment in the loan must not be reversed and income credited. Likewise, accrued but uncollected interest reversed or charged-off at the point the loan was placed on nonaccrual status cannot be restored to accrual.
|Restore to Accrual on Member Business Loan Workouts||Formal restructure with a current, well documented credit evaluation of the borrower's financial condition and prospects for repayment under the revised terms||The evaluation must include consideration of the borrower's sustained historical repayment performance for a minimum of six timely consecutive payments comprised of principal and interest. In returning the loan to accrual status, sustained historical repayment performance for a reasonable time prior to the restructuring may be taken into account.
Interest payments received while the member business loan was in nonaccrual status and applied to reduce the recorded investment in the loan must not be reversed and income credited. Likewise, accrued but uncollected interest reversed or charged-off at the point the member business loan was placed on nonaccrual status cannot be restored to accrual.
15 Terms defined in the Glossary will be italicized on their first use in the body of this guidance.
“Cash Basis” method of income recognition is set forth in GAAP and means while a loan is in nonaccrual status, some or all of the cash interest payments received may be treated as interest income on a cash basis as long as the remaining recorded investment in the loan (i.e., after charge-off of identified losses, if any) is deemed to be fully collectible. 16
16 Acceptable accounting practices include: (1) Allocating contractual interest payments among interest income, reduction of the recorded investment in the asset, and recovery of prior charge-offs. If this method is used, the amount of income that is recognized would be equal to that which would have been accrued on the loan's remaining recorded investment at the contractual rate; and, (2) accounting for the contractual interest in its entirety either as income, reduction of the recorded investment in the asset, or recovery of prior charge-offs, depending on the condition of the asset, consistent with its accounting policies for other financial reporting purposes.
“Charge-off” means a direct reduction (credit) to the carrying amount of a loan carried at amortized cost resulting from uncollectability with a corresponding reduction (debit) of the ALLL. Recoveries of loans previously charged off should be recorded when received.
“Cost Recovery” method of income recognition means equal amounts of revenue and expense are recognized as collections are made until all costs have been recovered, postponing any recognition of profit until that time. 17
17 FASB Accounting Standards Codification (ASC) 605-10-25-4, “Revenue Recognition, Cost Recovery.”
“Generally accepted accounting principles (GAAP)” means official pronouncements of the FASB as memorialized in the FASB Accounting Standards Codification® as the source of authoritative principles and standards recognized to be applied in the preparation of financial statements by federally-insured credit unions in the United States with assets of $10 million or more.
“In the process of collection” means collection of the loan is proceeding in due course either: (1) Through legal action, including judgment enforcement procedures, or (2) in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in its restoration to a current status in the near future, i.e., generally within the next 90 days.
“Member Business Loan” is defined consistent with Section 723.1 of NCUA's Member Business Loan Rule, 12 CFR 723.1.
“New Loan” means the terms of the revised loan are at least as favorable to the credit union (i.e., terms are market-based, and profit driven) as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the credit union, and the revisions to the original debt are more than minor.
“Past Due” means a loan is determined to be delinquent in relation to its contractual repayment terms including formal restructures, and must consider the time value of money. Credit unions may use the following method to recognize partial payments on “consumer credit,” i.e., credit extended to individuals for household, family, and other personal expenditures, including credit cards, and loans to individuals secured by their personal residence, including home equity and home improvement loans. A payment equivalent to 90 percent or more of the contractual payment may be considered a full payment in computing past due status.
“Recorded Investment in a Loan” means the loan balance adjusted for any unamortized premium or discount and unamortized loan fees or costs, less any amount previously charged off, plus recorded accrued interest.
“Troubled Debt Restructuring” is as defined in GAAP and means a restructuring in which a credit union, for economic or legal reasons related to a member borrower's financial difficulties, grants a concession to the borrower that it would not otherwise consider. 18 The restructuring of a loan may include, but is not necessarily limited to: (1) The transfer from the borrower to the credit union of real estate, receivables from third parties, other assets, or an equity interest in the borrower in full or partial satisfaction of the loan, (2) a modification of the loan terms, such as a reduction of the stated interest rate, principal, or accrued interest or an extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk, or (3) a combination of the above. A loan extended or renewed at a stated interest rate equal to the current market interest rate for new debt with similar risk is not to be reported as a restructured troubled loan.
18 FASB ASC 310-40, “Troubled Debt Restructuring by Creditors.”
“Well secured” means the loan is collateralized by: (1) A perfected security interest in, or pledges of, real or personal property, including securities with an estimable value, less cost to sell, sufficient to recover the recorded investment in the loan, as well as a reasonable return on that amount, or (2) by the guarantee of a financially responsible party.
“Workout Loan” means a loan to a borrower in financial difficulty that has been formally restructured so as to be reasonably assured of repayment (of principal and interest) and of performance according to its restructured terms. A workout loan typically involves a re-aging, extension, deferral, renewal, or rewrite of a loan. 19 For purposes of this policy statement, workouts do not include loans made to market rates and terms such as refinances, borrower retention actions, or new loans. 20
19“Re-Age” means returning a past due account to current status without collecting the total amount of principal, interest, and fees that are contractually due.
“Extension” means extending monthly payments on a closed-end loan and rolling back the maturity by the number of months extended. The account is shown current upon granting the extension. If extension fees are assessed, they should be collected at the time of the extension and not added to the balance of the loan.
“Deferral” means deferring a contractually due payment on a closed-end loan without affecting the other terms, including maturity, of the loan. The account is shown current upon granting the deferral.
“Renewal” means underwriting a matured, closed-end loan generally at its outstanding principal amount and on similar terms.
“Rewrite” means significantly changing the terms of an existing loan, including payment amounts, interest rates, amortization schedules, or its final maturity.
20 There may be instances where a workout loan is not a TDR even though the borrower is experiencing financial hardship. For example, a workout loan would not be a TDR if the fair value of cash or other assets accepted by a credit union from a borrower in full satisfaction of its receivable is at least equal to the credit union's recorded investment in the loan, e.g., due to charge-offs.