Troubled Debt Restructuring Course

Troubled Debt Restructurings Job Aid: Workflow, Case Studies, and Q&As
Table of Contents
Introduction and definitions ......................................................................... 2

Workflow Diagram ........................................................................................ 4
Case Studies1
Case A: Income Producing Property—Office Building .................................. 5
Case B: Income Producing Property—Shopping Mall ................................... 6
Case C: Construction Loan—Single family residence .................................... 8
Case D: Construction Loan—ADC loan ........................................................10
Case E: Commercial Operating Line of Credit .............................................11
Case F: Land Loan ........................................................................................12
Questions & Answer Examples2
Q&A .............................................................................................................13
1
Policy Statement on Prudent Commercial Real Estate Loan Workouts, October 2009
2
Comptroller of the Currency, Bank Accounting Advisory Series, October 2010
1 © 2011 Conference of State Bank Supervisors
Introduction:
Troubled Debt Restructurings (TDR) is an accounting mechanism under which a lender modifies an existing debt agreement with a borrower. More specifically, a TDR occurs
when a bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the bank would not otherwise consider.
The process of determining whether or not a loan modification qualifies as a TDR can be complex. This document offers examiners a workflow diagram to aid in the proper
identification of TDRs, examples of situations and the resulting TDR determination, and common questions and answers. While mentioned, this document is not intended to
offer guidance on some aspects of TDR accounting. Accounting guidance published by the federal agencies, as well as the FASB, can be found in the references section. This
document references those publications, as well materials provided by the state banking departments.
The basics:
Determining whether a loan modification is a TDR is a two-step process. Step one is to determine whether the borrower is experiencing financial difficulty. The key to that
delineation is that a restructuring is deemed troubled because of a borrower’s financial difficulty. Step two is to determine whether the bank has granted a concession. It is
important to highlight that not all loan modifications constitute a TDR, and not all TDRs involve a modification of terms.
Accounting:
The accounting standards for TDRs are set forth in FASB Accounting Standards Codification™ Subtopic 310-40, Troubled Debt Restructurings by Creditors. In April 2011, the
FASB issued Accounting Standards Update 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring, which provided greater clarity
when determining whether a modification is a TDR. Some of the provisions in this update become effective for nonpublic entities beginning with periods after December 15,
2012. Entities are permitted to adopt these provisions early. Prior to the codification standards, TDRs were addressed by Statement of Financial Accounting No. 15,
Accounting by Debtors and Creditors for Troubled Debt Restructurings, and by Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment
of a Loan. The Call Report Glossary has an entry for TDR accounting and reporting.
Responsibilities of the institution:

Institutions are expected to have adequate procedures and policies in place that facilitate the identification and reporting of Troubled Debt Restructurings. During an
examination, examiners are encouraged to determine whether the institution has established policies and procedures for assessing the accounting consequences of loan
modifications that include determining whether the loan modification meets the definition of a TDR. This procedure is outlined in Examination Documentation Module: TDR
Core Analysis linked below.

References:
 Examination Documentation Module: TDR Core Analysis (Links to CSBS website)
 Policy Statement on Prudent Commercial Real Estate Loan Workouts (October 30, 2009)
 FDIC Risk Management Manual of Examination Policies – Loan Problems
 FRB Commercial Bank Examination Manual – Section 2040 (Loan Portfolio Management) – Page 15
 OCC Banking Circular 255: Troubled Loan Workouts & Loans to Borrowers in Troubled Industries
 Comptroller of the Currency Bank Accounting Advisory Series: Troubled Debt Restructurings, October 2010 (Pages 28-51)
 FASB Accounting Standards Update No. 2011-02, Receivables (Topic 310) (April 2011)
3
Definitions :
Financial difficulties:
In making a determination whether a borrower is experiencing financial difficulties, a creditor shall consider the following indicators of financial
difficulty: (1) the borrower is currently in payment default on any of its debt, or that payment default is probable in the foreseeable future on any
of its debt, (2) the borrower has declared, or is in the process of declaring, bankruptcy, (3) there is substantial doubt as to whether the debtor will
continue to be a going concern, (4) the debtor has securities that have been , or are in the process of being, delisted, (5) the creditor’s forecasts of
the debtor’s entity-specific cash flows will be insufficient to service any of its debt in accordance with the contractual terms of the existing
agreement and for the foreseeable future, (6) the borrower cannot obtain funds from sources other than the existing creditors at an effective
interest rate equal to the current market interest rate for similar debt for a non-troubled borrower. There may be other indicators of a borrower’s
financial difficulty not listed here.
Concession:
A creditor has granted a concession when, as a result of the restructuring, it does not expect to collect all amounts due, including interest accrued
at the original contract rate. A concession has not been granted when a delay in payments is considered insignificant.
Insignificant delay in payment:

A restructuring that results in only an insignificant delay in payment is not a concession. Certain factors, when considered together, may indicate
that a restructuring results in an insignificant delay in payment. Examples of these factors include, but are not limited to (1) the amount of the
restructured payments subject to a delay is insignificant relative to the unpaid principal or collateral value of the debt, (2) the delay in timing of the
restructured payment period is insignificant relative to the frequency of payments due, the debt’s original contractual maturity, or the debt’s
original expected duration, (3) the cumulative effect of past restructurings, if any.
3
Financial Accounting Standards Board Accounting Standards Update No. 2011-02, Receivables (Topic 310) A Creditor’s Determination of Whether a Restructuring is a
Troubled Debt Restructuring [April 2011]
Workflow Diagram
Identifying a Troubled Debt Restructuring (TDR)
Is the debtor experiencing financial difficulties?

Common examples are:
•Default
•Bankruptcy, or in process of declaring bankruptcy
•Substantial doubt as to whether debtor will continue as a going concern
•De-listing of securities
No
•Insufficient cash flow to service debt
•Inability to obtain funding at a market rate for comparable debt
•Creditor determines default is probable in the foreseeable future
And
Do not
Does the restructuring constitute a concession that, for No report as
economic or legal reasons related to the debtor’s financial TDR
difficulties, the creditor would not otherwise have considered?
Common examples of a concession are:
•Reduction of contractual interest rate to a below-market rate
•Extension of maturity date
•Reduction in the face amount (principal) of the debt
•Reduction or forgiveness of accrued interest
While not a concession, the following indicate a TDR:

•Transfer of assets to the creditor, as partial or full satisfaction of debt
•Issuance or granting of an equity interest to the creditor in full or
partial satisfaction of debt
Report as
Yes TDR

Case Studies
A. Income Producing Property – Office Building
BASE CASE: A lender originated a $15 million loan for the purchase of an office building with
monthly payments based on an amortization of 20 years and a balloon payment of $13.6 million at the Classification Nonaccrual Treatment TDR Treatment
end of year three. At origination, the loan had a 75 percent loan-to-value (LTV) based on an appraisal Special Mention Accrual Not TDR
reflecting a $20 million market value on an “as stabilized” basis, a debt service coverage ratio of 1.35x,
and a market interest rate. The lender expected to renew the loan when the balloon payment became While the borrower has the The borrower has While the borrower is experiencing
due at the end of year three. The project’s cash flow has declined, as the borrower granted rental ability to continue to make demonstrated the ability to some financial deterioration, the
concessions to existing tenants in order to retain the tenants and compete with other landlords in a payments, there has been a make regularly scheduled borrower is not experiencing
weak economy. declining trend in the payments and, even with the financial difficulties as the
property’s income stream, decline in the borrower’s borrower has sufficient cash flow
SCENARIO 1: At maturity, the lender renewed the $13.6 million loan at a market rate of interest that continued potential rental creditworthiness, cash flow is to service the debt, and there was
provides for the incremental credit risk and amortized the principal over the remaining 17 years. The concessions, and a reduced sufficient at this time to make no history of default.
borrower had not been delinquent on prior payments and has sufficient cash flow to service the collateral margin. In addition, payments and full repayment
market rate terms at a debt service coverage ratio of 1.12x. A review of the leases reflects the the lender’s failure to request of principal and interest are
majority of tenants are now stable occupants with long-term leases and sufficient cash flow to pay current financial information expected.
their rent. A recent appraisal reported an “as stabilized” market value of $13.1 million for the and to obtain an updated
property, reflecting an increase in market capitalization rates, which results in a 104 percent LTV. collateral valuation represents
administrative deficiencies.
Classification Nonaccrual Treatment TDR Treatment
Pass Accrual Not TDR SCENARIO 3: At maturity, the lender restructured the $13.6 million loan on a 12-month interest-only
basis at a below market rate of interest. The borrower has been sporadically delinquent on prior
The borrower has the The borrower has demonstrated While the borrower is experiencing payments and projects a debt service coverage ratio of 1.12x based on the preferential terms. A
ability to continue making the ability to make the regularly some financial deterioration, the review of the leases, which were available to the lender at the time of the restructuring, reflects the
payments on reasonable scheduled payments and, even borrower has sufficient cash flow majority of tenants have short-term leases and that some were behind on their rental payments to the
terms despite a decline in with the decline in the to service the debt and has no borrower. According to the lender, this situation has not improved since the restructuring. A recent
cash flow and in the market borrower’s creditworthiness, record of payment default; appraisal reported a $14.5 million “as stabilized” market value for the property, which results in a 94
value of the collateral. cash flow appears sufficient to therefore, the borrower is not percent LTV.
make these payments and full experiencing financial difficulties.
repayment of principal and Classification Nonaccrual Treatment TDR Treatment
interest is expected. Substandard Nonaccrual TDR
SCENARIO 2: At maturity, the lender renewed the $13.6 million loan at a market rate of interest that The borrower has limited Because the loan was not The borrower is experiencing
provides for the incremental risk and amortized the principal over the remaining 17 years. The ability to service a below restructured with reasonable financial difficulties: the project’s
borrower had not been delinquent on prior payments. The building’s net operating income has market rate loan on an repayment terms, the ability to generate sufficient cash
decreased and current cash flow to service the new loan has declined, resulting in a debt service interest-only basis, sporadic borrower has limited capacity flows to service the debt is
coverage ratio of 1.12x. Some of the leases are coming up for renewal and additional rental delinquencies, and the to service a below market rate questionable, the lease income
concessions may be necessary to keep the existing tenants in a weak economy. However, the project’s reduced collateral position. on an interest-only basis, and from the tenants is declining, loan
debt service coverage is not expected to drop below 1.05x. A current valuation has not been ordered. the reduced estimate of cash payments have been sporadic, and
The lender estimates the property’s current “as stabilized” market value is $14.5 million, which results flow from the property collateral values have declined. In
in a 94 percent LTV. In addition, the lender has not asked the borrower to provide current financial indicates that full repayment of addition, the lender granted a
statements to assess the borrower’s ability to service the debt with cash from other sources. principal and interest is not concession (i.e., reduced the
reasonably assured. interest rate to a below market
level and deferred principal
payments).

B. Income Producing Property – Shopping Mall to allow a project to achieve interest reserves).
stabilized occupancy, but any
BASE CASE: A lender originated a 36-month $10 million loan for the construction of a shopping mall to subsequent loan terms
occur over 24 months with a 12-month lease-up period to allow the borrower time to achieve should likely have a principal
stabilized occupancy before obtaining permanent financing. The loan had an interest reserve to cover amortization component. The
interest payments over the three-year term of the credit. At the end of the third year, there is $10 LTV should be based on the
million outstanding on the loan, as the shopping mall has been built and the interest reserve, which “as stabilized” market value
has been covering interest payments, has been fully drawn. At the time of origination, the appraisal as the lender is financing the
reported an “as stabilized” market value of $13.5 million for the property. In addition, the borrower project through the leaseup
had a take-out commitment that would provide permanent financing at maturity. A condition of the period.
take-out lender was that the shopping mall had to achieve a 75 percent occupancy level.
SCENARIO 2: The lender restructured the loan on an interest-only basis at a below market rate for one
Due to weak economic conditions, the property only reached a 55 percent occupancy level at the end year to provide additional time to increase the occupancy level and thereby enable the borrower to
of the12-month lease up period and the original takeout commitment became void. Mainly due to a arrange permanent financing. The level of lease-up remains relatively unchanged at 55 percent and
tightening of credit for these types of loans, the borrower is unable to obtain permanent financing the shopping mall projects a debt service coverage ratio of 1.02x based on the preferential loan terms.
elsewhere when the loan matured in February (i.e., due to market factors and not due to the At the time of the restructuring, the lender inappropriately based the selection of the below market
borrower’s financial condition). interest rate on outdated financial information, which resulted in a positive cash flow projection even
though file documentation available at the time of the restructuring reflected that the borrower
anticipates the shopping mall’s income stream will decline due to rent concessions, the loss of a
SCENARIO 1: The lender renewed the loan for an additional year to allow for a higher lease-up rate
tenant, and limited prospects for finding new tenants.
and for the borrower to seek permanent financing. The extension is at a market rate that provides for
the incremental credit risk and on an interest-only basis. While the property’s historical cash flow was
Current financial statements indicate the builder, who personally guarantees the debt, is highly
insufficient at 0.92x debt service ratio, recent improvements in the occupancy level now provides
leveraged, has limited cash or liquid assets, and has other projects with delinquent payments. A recent
adequate coverage. Recent improvements include the signing of several new leases with other leases
appraisal on the shopping mall reports an “as is” market value of $9 million, which results in a LTV
currently being negotiated.
ratio of 111 percent.
In addition, current financial statements reflect that the builder, who personally guarantees the debt,
has sufficient cash on deposit at the lender plus other liquid assets. These assets provide sufficient Classification Nonaccrual Treatment TDR Treatment
cash flow to service the borrower’s global debt service requirements on a principal and interest basis, Substandard/Loss Nonaccrual TDR
if necessary. The guarantor covered the initial cash flow shortfalls from the project and provided a
good faith principal curtailment of $200,000 at renewal. A recent appraisal on the shopping mall The amount not protected by The partial charge-off This is TDR because (a) the
reports an “as is” market value of $10 million and an “as stabilized” market value $11 million. the collateral value, $1 is indicative that full collection borrower is experiencing financial
million, is Loss and should be of principal is not anticipated difficulties as evidenced by the
Classification Nonaccrual Treatment TDR Treatment charged off. The examiner and the lender has continued high leverage, delinquent
did not factor costs to sell exposure to additional loss due payments on other projects, and
Pass Accrual Not TDR
into the loss classification to the project’s insufficient inability to meet the proposed exit
analysis, as the source of cash flow and reduced strategy because of the inability to
The project continues to The guarantor has sufficient While the borrower has been
repayment is not reliant on collateral margin, and the lease the property in a reasonable
progress and now cash flows funds to cover the borrower’s affected by declining economic
the sale of the collateral at guarantor’s limited ability to timeframe; and (b) the lender
the interest payments. The global debt service conditions, the level of
this time. The remaining loan provide further support. granted a concession as evidenced
guarantor currently has the requirements over the one- deterioration does not warrant
balance, based on the by the reduction in the interest
ability and demonstrated year period of the renewed TDR treatment. The borrower
property’s “as is” market rate to a below market rate.
willingness to supplement loan. Full repayment of was not experiencing financial
value of $9 million, as
the project’s cash flow and principal and interest is difficulties because the borrower
Substandard given the
service the borrower’s global reasonably assured from the and guarantor have the ability to
borrower’s uncertain
debt service requirements. project’s and guarantor’s cash service the renewed loan, which
repayment capacity and
The interest-only terms were flow despite a decline in the was prudently underwritten at a
weak financial support.
reasonable because the collateral margin. market rate of interest, plus the
renewal was short-term and borrower’s other obligations on a
the project and the guarantor timely basis, and the lender’s SCENARIO 3: Current financial statements indicate the borrower and the guarantor have minimal
have demonstrated expectation to collect the full other resources available to support this credit. The lender chose not to restructure the $10 million
repayment capacity. In amount of principal and interest loan into a new single amortizing note of $10 million at a market rate of interest because the project’s
addition, this type of loan from the borrower’s or guarantor’s projected cash flow would only provide a 0.88x debt service coverage ratio as the borrower has been
structure is commonly used sources (i.e., not from unable to lease space. A recent appraisal on the shopping mall reported an “as is” market value of $9
million, which results in a LTV of 111 percent.

continues to perform according to
Therefore, at the original loan’s maturity in February, the lender restructured the $10 million debt into the modified terms.
two notes. The lender placed the first note of $7.2 million (i.e., the A note) on monthly payments that SCENARIO 4: Current financial statements indicate the borrower and the guarantor have minimal
amortize the debt over 20 years at a market rate of interest that provides for the incremental credit other resources available to support this credit. The lender restructured the $10 million loan into a
risk. The project’s debt service coverage ratio equals 1.20x for the $7.2 million loan based on the new single note of $10 million at a market rate of interest that provides for the incremental credit risk
shopping mall’s projected net operating income. The lender placed the second note of the remaining and is on an amortizing basis. The project’s projected cash flow reflects a 0.88x debt service coverage
principal balance of $2.8 million (i.e., the B note) into a 2 percent interest-only loan that is scheduled ratio as the borrower has been unable to lease space. A recent appraisal on the shopping mall reports
to reset in five years to an amortizing payment. The lender then charged-off the $2.8 million note due an “as is” market value of $9 million, which results in a LTV of 111 percent. Based on the property’s
to the project’s lack of repayment capacity and to provide reasonable collateral protection for the current market value of $9 million, the lender charged-off $1 million immediately after the renewal.
remaining on-book loan of $7.2 million. Since the restructuring, the borrower has made payments on
both loans for more than six consecutive months. Classification Nonaccrual Treatment TDR Treatment
Substandard Nonaccrual TDR
Pass Accrual TDR Even though the project’s Because the lender restructured The loan should be reported as
cash flow indicated a 1.05x the debt into a single note and TDR because (a) the borrower is
The lender restructured the The loan of $7.2 million is The loan should be reported as a debt service coverage ratio had charged-off a portion of the experiencing financial
original obligation into A and returned to accrual status TDR because (a) the borrower is when just considering the loan, the repayment of the difficulties as evidenced by the
B notes. The lender charged as the borrower has the ability experiencing financial difficulties as on-book balance, the $9 interest and principal high leverage, delinquent
off the B note, and the to repay the loan, has a record evidenced by the borrower’s high million is Substandard due contractually due on the entire payments on other projects, and
borrower has demonstrated of performing at the revised leverage, delinquent payments on to the borrower’s marginal debt is not reasonably assured. inability to meet the original exit
the ability to repay the A terms for more than six other projects, and failure to financial condition, lack of The loan can be returned to strategy because the borrower
note. Using this multiple months, and full repayment of meet the proposed exit strategy guarantor support, and accrual status if the lender can was unable to lease the property
note structure with the principal and interest is because of the inability to lease uncertainty over the source document that subsequent in a reasonable timeframe; and
charge-off of the B note expected. the property in a reasonable of repayment. improvement in the borrower’s (b) the lender granted a
enables the lender to timeframe and the unlikely financial condition has enabled concession as evidenced by
recognize interest income Interest payments received on collectability of the charged-off the loan to be brought fully deferring payment beyond the
and limit the amount the off-book loan have been loan; and (b) the lender granted a current with respect to principal repayment ability of the
reported as a TDR in future recorded as recoveries concession. The concessions and interest and the lender borrower.
periods. If the lender had because, in this case, full included a below market interest expects the contractual balance
restructured the loan into a recovery of principal and rate and protracted payment of the loan (including the partial The charge-off indicates that the
single note, the credit interest on this loan was not requirements on the charged-off charge-off) will be fully collected. lender does not expect full
classification and the reasonably assured. portion of the debt and extending In addition, interest income may repayment of principal and
nonaccrual and TDR the on-book loan beyond expected be recognized on a cash basis for interest, yet the borrower
treatments would have been timeframes. the partially charged-off portion remains obligated for the full
different. of the loan when the remaining amount of the debt and
If the borrower continues to recorded balance is considered payments, which is at a level that
perform according to the modified fully collectible. However, the is not consistent with the
terms of the restructured loan, the partial charge-off cannot be borrower’s repayment capacity.
lender plans to stop reporting the reversed. Because the borrower is not
on-book loan as a TDR after the expected to be able to comply
regulatory reporting defined with the loan’s restructured
time period expires because it was terms, the lender would likely
restructured with a market rate of continue to report the loan as a
interest. For example, since TDR.
the restructuring occurred in
February, the $7.2 million on-book
loan should be reported as a
TDR on the lender’s March, June,
September, and December
regulatory reports. The TDR
reporting could cease on the
lender’s following March
regulatory report if the borrower

C. Construction Loan – Single Family Residence The lender initially assigned a The lender initially maintained The lender reported the first
Substandard grade. The loan the loan on nonaccrual, but restructuring as a TDR. However,
is now considered a Pass due returned it to an accruing the second restructuring would not
BASE CASE: The lender originated a $400,000 construction loan on a single family “spec” residence to the borrower’s status after the borrower made be reported as a TDR. The lender
with a 15-month maturity to allow for completion and sale of the property. The loan required monthly demonstrated ability to make six consecutive monthly determined that the borrower is
interest-only payments at a market rate and was based on a LTV of 70 percent at origination. During payments according to the payments. Full repayment of experiencing financial difficulties as
the original loan construction phase, the borrower made all interest payments from personal funds. modified terms for over six principal and interest from the indicated by depleted cash
At maturity, the home had not sold and the borrower was unable to find another lender willing to consecutive months. rental income is expected. resources and a weak financial
finance this property under similar terms. condition; however, the lender did
not grant a concession on the
SCENARIO 1: At maturity, the lender restructured the loan for one year on an interest-only basis at a second restructuring as the loan
below market rate to give the borrower more time to sell the “spec” home. Current financial is at market rate and terms.
information indicates the borrower has limited ability to continue to pay interest from personal funds.
If the residence does not sell by the revised maturity date, the borrower plans to rent the home. In this SCENARIO 3: The lender restructured the loan for one year on an interest-only basis at a below market
event, the lender will consider modifying the debt into an amortizing loan with a 20-year maturity, rate to give the borrower more time to sell the “spec” home. The restructured loan has become 90+
which would be consistent with this type of income-producing investment property. Any shortfall days past due and the borrower has not been able to rent the property. Based on current financial
between the net rental income and loan payments would be paid by the borrower. Due to declining information, the borrower does not have the capacity to service the debt. The lender considers
home values, the LTV at the renewal date was 90 percent. repayment to be contingent upon the sale of the property. Current market data reflects few sales and
similar new homes in this property’s neighborhood are selling within a range of $250,000 to $300,000
Classification Nonaccrual Treatment TDR Treatment with selling costs equaling 10 percent, resulting in anticipated net sales proceeds between $225,000
Substandard Nonaccrual TDR and $270,000.
The loan is Substandard due Though the borrower The should be reported as TDR Classification Nonaccrual Treatment TDR Treatment
to the borrower’s diminished demonstrated an ability to because the borrower is $225,000 Substandard Nonaccrual TDR
ongoing ability to make make interest payments during experiencing financial difficulties as $45,000 Doubtful
payments and the reduced the construction phase, the indicated by depleted cash $130,000 Loss The lender placed the loan on The lender plans to continue
collateral position. loan was not restructured on reserves, inability to refinance nonaccrual when it became 60 reporting this loan as a TDR until
reasonable repayment terms, this debt from other sources with The Loss amount results from days past due (reversing all the lender forecloses on the
the borrower has limited similar terms, and the inability to the $400,000 loan balance accrued but unpaid interest) property, and transfers the asset
capacity to service a below repay the loan at maturity in a less estimated net sales because the lender determined to the other real estate owned
market rate on an interest-only manner consistent with the proceeds of $270,000. The that full repayment of principal category. The lender determined
basis, and the reduced original exit strategy. A concession Doubtful amount is based on and interest was not that the borrower was continuing
collateral margin indicates that was provided by renewing the loan the range in the anticipated reasonably assured. to experience financial difficulties
full repayment of principal and with a deferral of principal net sales proceeds, with the as indicated by depleted cash
interest is questionable. payments, at a below market rate remaining balance being resources, inability to refinance
(compared to the rate charged on Substandard. This this debt from other sources with
an investment property) for an classification results in the similar terms, and the inability to
additional year when the loan was recognition of the credit risk repay the loan at maturity in a
no longer in the construction in the collateral dependent manner consistent with the
phase. loan based on the property’s original exit strategy. In addition,
value less costs to sell. A the lender granted a concession by
SCENARIO 2: At maturity of the original loan, the lender restructured the debt for one year on an current valuation on the reducing the interest rate to a
interest-only basis at a below market rate to give the borrower more time to sell the “spec” home. property should be obtained. below market level.
Eight months later, the borrower rented the property. At that time, the borrower and the lender
agreed to restructure the loan again with monthly payments that amortize the debt over 20 years at a SCENARIO 4: The lender committed an additional $16,000 for an interest reserve and extended the
market rate for a residential investment property. Since the date of the second restructuring, the $400,000 loan for 12 months at a below market rate of interest with monthly interest-only payments.
borrower has made all payments for over six consecutive months At the time of the examination, $6,000 of the interest reserve had been added to the loan balance.
Current financial information that the lender obtained at examiner request reflects the borrower has
no other repayment sources and has not been able to sell or rent the property. An updated appraisal
supports an “as is” value of $317,650. Selling costs are estimated at 15 percent, resulting in
Classification Nonaccrual Treatment TDR Treatment anticipated net sales proceeds of $270,000.

$270,000 Substandard Nonaccrual TDR
$130,000 Loss
The loan was not restructured The loan should be reported as
The examiner instructed the on reasonable repayment TDR because the borrower is
lender to reverse the $6,000 terms, the borrower has experiencing financial difficulties as
of capitalized interest. The limited capacity to service a indicated by depleted cash
loan was not restructured on below market rate on an reserves, inability to refinance
reasonable repayment terms interest-only basis, and the this debt from other sources with
because the borrower has reduced collateral margin similar terms, and the inability to
limited capacity to service indicates that full repayment of repay the loan at maturity in a
the debt and the reduced principal and interest is not manner consistent with the
collateral margin indicated assured. original exit strategy. A concession
that full repayment of was provided by renewing the
principal and interest is not The lender’s decision to loan with a deferral of principal
assured. This classification advance a $16,000 interest payments, at a below market rate
recognizes the credit risk in reserve was inappropriate (compared to investment
the collateral dependent loan given the borrower’s inability property) for an additional year
based on the property’s to repay it. The lender should when the loan was no longer in the
market value less costs to reverse the capitalized interest construction phase.
sell. in a manner consistent with
regulatory reporting
The examiner also criticized instructions and should not
management for the recognize any further interest
inappropriate use of interest income from the interest
reserves. The remaining reserve.
interest reserve of $10,000 is
not classified because the
loan should be placed on
nonaccrual.

D. Construction Loan – Land Acquisition, Condominium Construction and of $60 million upon conversion to an apartment building and a $67 million prospective “as stabilized”
market value upon the property reaching stabilized occupancy. The borrower agrees to grant the
Conversion
lender a second lien on certain assets, which provides about $5 million in additional collateral support.
BASE CASE: The lender originally extended a $50 million loan for the purchase of vacant land and the In return, the lender advanced the borrower $10 million, which is needed to convert the project to an
construction of a condominium project. The loan was interest-only and included an interest reserve to apartment complex and finish construction. The lender also agreed to extend the $54 million loan for
cover the monthly payments. The developer bought the land and began construction after obtaining 12 months at a market rate of interest that provides for the incremental credit risk to give the
purchase commitments for about a third of the planned units. Many of these pending sales were with borrower time to lease the apartments. The $60 million “as complete” market value plus the $5
speculative buyers who committed to buy multiple units with minimal down payments. As the real million in other collateral results in a LTV of 83 percent. The prospective “as complete” market value is
estate market softened, most of the speculative buyers failed to perform on their purchase contracts used because the loan is funding the construction of the apartment building. The lender may utilize
and only a limited number of the other planned units have been pre-sold. the prospective “as stabilized” market value when funding is provided for the lease-up period.
The developer subsequently determined it was in the best interest to halt construction with the Classification Nonaccrual Treatment TDR Treatment
property 80 percent complete. The loan balance was drawn to $44 million to pay construction costs
(including cost overruns) and interest and the borrower estimates another $10 million is needed to
complete construction. Current financial information reflects that the developer does not have
The project has limited ability The borrower ability to lease The loan is reported as TDR
sufficient cash flow to service the debt; and while the developer does have equity in other assets,
to service the debt despite the units and service the debt because the borrower is
there is a question about the borrower’s ability to complete the project.
the 1.2x gross collateral is untested, raising concerns as experiencing financial difficulties,
margin to the full repayment of as demonstrated by the
SCENARIO 1: The borrower agrees to grant the lender a second lien on certain assets, which provides principal and interest. insufficient cash flow to service the
about $5 million in additional collateral support. In return, the lender advanced the borrower $10 debt, concerns about the project’s
million to finish construction and the condominium was completed. The lender also agreed to extend viability, and the borrower’s
the $54 million loan for 12 months at a market rate of interest that provides for the incremental credit inability to obtain financing from
risk to give the borrower time to market the property. The borrower agreed to pay interest whenever other sources. In addition, the
a unit was sold with any outstanding balance due at maturity. The lender obtained a recent appraisal lender provided a concession by
on the condominium building that reported a prospective “as complete” market value of $65 million, advancing additional funds to
reflecting a 24-month sell-out period and projected selling costs of 15 percent. The $65 million finish construction and deferring
prospective “as complete” market value plus the $5 million in other collateral results in a LTV of 77 payments until the maturity date
percent. The lender used the prospective “as complete” market value in its analysis and decision to without a defined exit strategy.
fund the completion and sale of the units, and to maximize its recovery on the loan.

The project has limited ability The loan should be placed on The loan is reported as TDR
to service the debt despite nonaccrual due to the because the borrower is
the 1.3x gross collateral borrower’s questionable experiencing financial difficulties,
margin ability to sell the units and as demonstrated by the
service the debt, raising insufficient cash flow to service the
concerns as to the full debt, concerns about the project’s
repayment of principal and viability, and the borrower’s
interest. inability to obtain financing from
other sources. In addition, the
lender provided a concession by
advancing additional funds to
finish construction and deferring
payments except from sold units
until the maturity date when
any remaining accrued interest
plus principal are due.
SCENARIO 2: A recent appraisal of the property reflects that the highest and best use would be
conversion to an apartment building. The appraisal reports a prospective “as complete” market value

E. Commercial Operating Line of Credit in Connection with Owner Occupied Real
Estate Classification Nonaccrual Treatment TDR Treatment
Substandard Nonaccrual Operating LOC: TDR
Real Estate Loan: Not TDR
BASE CASE: Two years ago, the lender originated a CRE loan at a market rate to a borrower whose
The classification is due to The operating line of credit was
business occupies the property. The loan was based on a 20-year amortization period with a balloon
deterioration in the not renewed on market rate The operating line of credit is
payment due in three years. The LTV equaled 70 percent at origination. A year ago, the lender
borrower’s business repayment terms, the reported as TDR because (a) the
financed a $5 million interest-only operating line of credit for seasonal business operations at a market
operations and insufficient borrower has an increasingly borrower is experiencing financial
rate. The operating line of credit had a one-year maturity and was secured with a blanket lien on all
cash flow to repay all debt. limited capacity to service the difficulties (as evidenced by the
the business assets. To better monitor the ongoing overall collateral position, the lender established a
The lender needs to monitor below market rate on an borrower’s sporadic payment
borrowing base reporting system, which included monthly accounts receivable aging reports. At
the trend in the business interest-only basis and there is history, an increasing trend in
maturity of the operating line of credit, the borrower’s accounts receivable aging report reflects a
operations profitability and insufficient support to accounts receivable delinquencies,
growing trend of delinquency, which is causing the borrower some temporary cash flow difficulties.
cash flow. The lender may demonstrate an ability to meet and uncertain ability to repay the
The borrower has recently initiated more aggressive collection efforts.
need to order a new the new payment loans); and (b) the lender granted a
appraisal if the debt service requirements. Since debt concession on the line of credit
SCENARIO 1: The lender renewed the $5 million operating line of credit for another year, requiring coverage ratio continues to service for both loans is through a below market interest
monthly interest payments at a market rate of interest. The borrower’s liquidity position has fall and the overall collateral dependent on business rate. The real estate loan should
tightened but remains satisfactory, cash flow to service all debt is 1.2x, and both loans have been paid margin further declines. operations, the borrower’s not be reported as TDR since that
according to the contractual terms. The primary repayment source is from business operations, which ability to continue to perform loan had not been restructured.
remain satisfactory and an updated appraisal is not considered necessary. on the real estate loan is not
assured. In addition, the
Classification Nonaccrual Treatment TDR Treatment collateral margin indicates that
Pass Accrual Not TDR full repayment of all of the
borrower’s indebtedness is
A Pass is assigned with the The borrower has While the borrower has been questionable, particularly if the
understanding that the demonstrated an ongoing affected by declining economic company fails to continue
lender is monitoring the ability to perform, has the conditions, the renewal of the being a going concern.
trend in the accounts financial capacity to pay a operating line of credit did not
receivables aging report, and market rate of interest, and full result in a TDR because the
the borrower’s ongoing repayment of principal and borrower is not experiencing
collection efforts. interest is reasonably assured. financial difficulties and has the
ability to repay both loans
(which represent most of its
outstanding obligations) at a
market rate of interest. The lender
expects full collection of principal
and interest from the borrower’s
operating income.
SCENARIO 2: The lender reduced the operating line of credit to $4 million and restructured the terms
onto monthly interest-only payments at a below market rate. This action is expected to alleviate the
business’ cash flow problem. The borrower’s company is still considered to be a going concern even
though the borrower’s financial performance has continued to deteriorate and sales and profitability
are declining. The trend in delinquencies in accounts receivable is worsening and has resulted in
reduced liquidity for the borrower.
Cash flow problems have resulted in sporadic delinquencies on the operating line of credit. The
borrower’s net operating income has declined, but reflects the capacity to generate a 1.08x debt
service coverage ratio for both loans, based on the reduced rate of interest for the operating line of
credit. The terms on the real estate loan remained unchanged. The lender internally updated the
assumptions in the original appraisal and estimated the LTV on the real estate loan was 90 percent.
The operating line of credit has an LTV of 80 percent with an overall LTV for the relationship of 85
percent for the relationship.

F. Land Loan SCENARIO 2: The borrower provided the lender with current financial information that indicated the
borrower is unable to continue to make interest-only payments. The borrower has been sporadically
BASE CASE: Three years ago, the lender originated a $3.25 million loan to a borrower for the purchase delinquent up to 60 days on payments. The borrower is still seeking a loan to finance construction of
of raw land that the borrower was seeking to have zoned for residential use. The loan had a three- the townhouse development, but has not been able to obtain a takeout commitment. A recent
year term and required monthly interest-only payments at a market rate that the borrower has paid appraisal of the property reflects an “as is” market value of $3 million, which results in a 108 percent
from existing financial resources. An appraisal obtained at origination reflected an “as is” market LTV. The lender extended a $3.25 million loan at a market rate of interest for one year with principal
value of $5 million, which resulted in a 65 percent LTV. The borrower was successful in obtaining the and interest due at maturity.
zoning change and has been seeking construction financing for a townhouse development and to
repay the land loan. At maturity, the borrower requested an extension to provide additional time to Classification Nonaccrual Treatment TDR Treatment
secure construction financing that would include repayment of the land loan. $2,700,000 Substandard Nonaccrual TDR
$550,000 Loss
The loans should be on The borrower is experiencing
SCENARIO 1: The borrower provided the lender with current financial information, demonstrating the
Though the loan is currently nonaccrual because the financial difficulties as indicated by
ability to make principal and interest payments. Further, the borrower made a principal payment of
not past due and at a market loan was not restructured on the inability to refinance this debt
$250,000 in exchange for an extension of the maturity date of the loan. The borrower also pledged
rate of interest, the loan was reasonable repayment terms, and the inability to repay the loan
additional unencumbered collateral, granting the lender a first lien on an office building with an “as
not restructured on the borrower does not have at maturity in a manner consistent
stabilized” market value of $1 million. The financial information also demonstrates that cash flow
reasonable repayment terms the capacity to service the with the original exit strategy. A
from the borrower’s personal assets and the office building generate sufficient stable cash flow to
because the borrower does debt, and full repayment of concession was provided by
amortize the land loan over a reasonable period of time. A recent appraisal of the raw land reflects an
not have the capacity to principal and interest is not renewing the loan with a deferral
“as is” market value of $3 million, which results in a 75 percent LTV when combined with the
service the debt and full assured. of principal and interest payments
additional collateral and the principal reduction. The lender restructured a $3 million loan with
repayment of principal and for an additional year when the
monthly principal and interest payments for another year at a market rate that provides for the
interest is not assured. The borrower was unable to obtain
incremental credit risk.
Substandard portion is based takeout financing.
on the current appraisal of $3
million less estimated cost to
sell of 10 percent or
$300,000). The remainder is
The loan is Pass due to the The borrower has sufficient While the borrower has been
classified Loss. This
adequate cash flow to pay funds to cover the debt service affected by declining economic
classification recognizes the
principal and interest from requirements for the next year. conditions, the level of
credit risk in the collateral
the borrower’s personal Full repayment of principal and deterioration does not warrant
dependent loan based on the
assets and the office building. interest is reasonably assured TDR treatment. The borrower
property’s market value less
Also the borrower provided a from the collateral and the was not experiencing financial
costs to sell.
curtailment and additional borrower’s financial resources difficulties because the borrower
collateral to maintain a has the ability to service the
reasonable LTV. renewed loan, which was
prudently underwritten and has a
market rate of interest.

Questions and Answers Question 3:

Must a loss be recorded on the permanent loan financings?
Source: Comptroller of the Currency, Bank Accounting Advisory Series
October 2010 Staff Response:
Yes. The bank is granting a concession it would not have allowed otherwise, because of the
developer’s financial condition. Therefore, this transaction is a troubled debt restructuring.
Question 1: (December 2008) Furthermore, it represents an exchange of assets. The permanent loans provided to the home buyers
What are some examples of modifications that may represent troubled debt restructurings? must be recorded at their fair value. The difference between fair value and recorded value in the loan
satisfied is charged to the allowance for loan and lease losses.
Staff Response:
SFAS 15 provides the following examples of modifications that may represent troubled debt
restructurings: Facts:
 Reduction (absolute or contingent) of the stated interest rate for the remaining original life Assume that the real estate developer in question 3 has not yet defaulted on the construction loan.
of the debt. He is in technical compliance with the loan terms. However, because of the general problems within
 Extension of the maturity date or dates at a stated interest rate lower than the current the local real estate market and specific ones affecting this developer, the bank agrees to give the
market rate for new debt with similar risk. home buyers permanent financing at below market rates.
 Reduction (absolute or contingent) of the face amount or maturity amount of the debt as
stated in the instrument or other agreement.
Question 4:
 Reduction (absolute or contingent) of accrued interest. Must a loss be recorded on these permanent loan financings?
Said another way, the modification is a TDR if the borrower cannot go to another lender and qualify Staff Response:
for and obtain a loan with similar modified terms. Yes. Even though the loan is not technically in default, the staff believes that the concession was
granted because of the developer’s financial difficulties. SFAS 15 does not require that a debtor’s
Question 2: (December 2008) obligations be in default for a troubled debt restructuring to occur. It only requires that concession it
How should a bank evaluate TDR loans for impairment? would not have permitted otherwise. Therefore, this restructuring would be accounted for as an
exchange of assets under the provisions of SFAS 15. Again, the permanent loans provided to the home
Staff Response: buyers must be recorded at their fair value.
Loans whose terms have been modified in troubled debt restructuring transactions should be
evaluated for impairment, with the appropriate allowance for loan and lease losses (ALLL) adjustments
under SFAS 114. This includes loans that were originally not subject to SFAS 114 prior to the
Facts:
restructuring, such as individual loans that were included in a large group of smaller-balance
A borrower owes the bank $100,000. The debt is restructured because of the borrower’s precarious
homogeneous loans collectively evaluated for impairment (i.e., retail loans).
financial position and inability to service the debt. In satisfaction of the debt, the bank accepts
A loan is impaired when, based on current information and events, it is probable that an institution will
preferred stock of the borrower with a face value of $10,000, but with only a nominal market value.
be unable to collect all amounts due according to the original contractual terms of the loan
The bank agrees to reduce the interest rate from 10% to 5% on the remaining $90,000 of debt. The
agreement. Usually, a commercial restructured troubled loan that had been individually evaluated
present value of the combined principal and interest payments due over the next five years,
under SFAS 114 would already have been identified as impaired because the borrower’s financial
discounted at the effective interest rate in the original loan agreement, is $79,000.
difficulties existed before the formal restructuring. For a restructured troubled loan, all amounts due
according to the contractual terms means the contractual terms specified by the original loan
agreement, not the contractual terms in the restructuring agreement. Therefore, if impairment is Question 5: (December 2008)
measured using an estimate of the expected future cash flows, the interest rate used to calculate the How should the bank account for this transaction?
present value of those cash flows is based on the original effective interest rate on the loan (the
original contractual interest rate adjusted for any net deferred loan fees or cost or any premium or Staff Response:
discount existing at the origination or acquisition of the loan) and not the rate specified in the Securities (either equity or debt) received in exchange for cancellation or reduction of a troubled loan
restructuring agreement. should be recorded at fair value. The recorded amount of the debt ($100,000) is reduced by the fair
value of the preferred stock received. Any impairment in the remaining recorded balance of the
restructured loan would be measured according to the requirements of SFAS 114. In this case, if the
securities have a fair value of $1,000, the remaining loan balance of $99,000 would be compared with
Facts:
the present value of the expected future payments, discounted at the effective interest rate in the
A bank makes a construction loan to a real estate developer. The loan is secured by a project of new
original loan agreement. An allowance of $20,000 is established through a provision for loan and lease
homes. The developer is experiencing financial difficulty and has defaulted on the construction loan.
losses. This represents the difference between the recorded balance ($99,000) and the present value
To assist him in selling the homes, the bank agrees to give the home buyers permanent financing at a
of the expected future payments ($79,000), discounted at 10% (the original effective interest rate).
rate that is below the market rate being charged to other new home buyers.

Staff Response: (December 2008)

Facts: AICPA Practice Bulletin 5 (PB 5) requires some period of performance for loans to troubled countries.
Assume a borrower owes the bank $100,000, which is secured by real estate. The loan is restructured The staff generally believes this guidance should also apply to domestic loans. Accordingly, the bank
to release the real estate lien and requires no principal or interest payments for 10 years. At the end of normally may not return Note A to accrual status until or unless this period of performance is
the tenth year, the borrower will pay the $100,000 principal. No interest payments are required. demonstrated, except as described in Question 7.
As security, the borrower pledges a $100,000 zero coupon bond that matures at the same time the However, neither PB 5 nor regulatory policy specify a particular period of performance. This will
loan is due (10 years). The borrower purchased the bond with funds borrowed from another financial depend on the individual facts and circumstances of each case. Generally, we believe this period would
institution. The real estate released in this restructuring was used as security to obtain those funds. be at least six months for a monthly amortizing loan.
The current fair value of the zero coupon bond is $40,000. Accordingly, if the borrower was materially delinquent on payments prior to the restructure, but
shows potential capacity to meet the restructured terms, the loan would likely continue to be
Question 6: recognized as nonaccrual until the borrower has demonstrated a reasonable period of performance;
How should the bank account for this restructuring? again, generally at least six months (removing doubt as to ultimate collection of principal and interest
in full).
Staff Response: If the borrower does not perform under the restructured terms, the TDR probably was not
In essence, the bank has received the security (zero coupon bond) as satisfaction of the loan. Because appropriately structured, and it should be recognized as nonaccrual. In this case the decision regarding
loan repayment is expected only from the proceeds of the security, the bank has effectively obtained accrual status would be based solely on a determination of whether full collection of principal and
control of the collateral. Accordingly, the loan should be removed from the books of the bank, and the interest is in doubt.
security should be recorded in the investment account at its fair value ($40,000). The $60,000
difference is charged to the allowance for loan and lease losses. This conclusion is consistent with FASB Question 9: (September 2001)
Emerging Issues Task Force Consensus No. 87-18. The previous response indicates that performance is required before a formally restructured loan can
be returned to accrual status. When can a restructured loan be returned to accrual status without
performance?
Facts:
Staff Response:
A $10 million loan is secured by income producing real estate. Cash flows are sufficient to service only
The staff continues to believe that evidence of performance under the restructured terms is one of the
a $9 million loan at a current market rate of interest. The loan is on nonaccrual. The bank restructures
most important considerations in assessing the likelihood of full collectability of the restructured
the loan by splitting it into two separate notes. Note A is for $9 million. It is collateral dependent and
principal and interest. However, in rare situations, the TDR may coincide with another event that
carries a current market rate of interest. Note B is for $1 million and carries a below-market rate of
indicates a significant improvement in the borrower’s financial condition and ability to repay. These
interest. The bank charges off all of Note B, but does not forgive it.
might include substantial new leases in a troubled real estate project, significant new sources of
business revenues (i.e., new contracts), and significant new equity contributed from a source not
Question 7: financed from the bank, etc. A preponderance of this type of evidence could obviate the need for
Can the bank return Note A to accrual status? performance or lessen the period of performance needed to assure ultimate collectability of the loan.
Staff Response: Question 10:
Yes, but only if all of the following conditions are met: Given that evidence of performance under the restructured terms will likely be relied upon to
• The restructuring qualifies as a troubled debt restructuring (TDR) as defined by SFAS 15. In this determine whether to place a TDR on accrual status, can performance prior to the restructuring be
case, the transaction is a TDR, because the bank granted a concession it would not consider considered?
normally, a below market rate of interest on Note B.
• The partial loan charge off is supported by a good faith credit evaluation of the loan(s). The Staff Response:
charge off should also be recorded before or at the time of the restructuring. Under SFAS 5, a Performance prior to the restructuring should be considered in assessing whether the borrower can
partial charge off may be recorded only if the bank has performed a credit analysis and meet the restructured terms. Often the restructured terms reflect the level of debt service that the
determined that a portion of the loan is uncollectible. borrower has already been making. If this is the case, and the borrower will likely be able to continue
• The ultimate collectability of all amounts contractually due on Note A is not in doubt. If such this level of performance and fully repay the new contractual amounts due, continued performance
doubt exists, the loan should not be returned to accrual status. after the restructuring may not be necessary before the loan is returned to accrual status.
• There is a period of satisfactory payment performance by the borrower (either immediately Question 11: (September 2001)
before or after the restructuring) before the loan (Note A) is returned to accrual status. How would the absence of an interest rate concession on Note B affect the accrual status of Note A?
If any of these conditions are not met, or the terms of the restructuring lack economic substance, the Staff Response:
restructured loan should continue to be accounted for and reported as a nonaccrual loan. If the bank does not grant an interest rate concession on Note B nor make any other concessions, the
restructuring would not qualify as a TDR. Accordingly, SFAS 15 would not apply. In substance, the
Question 8: bank has merely charged down its $10 million loan by $1 million, leaving a $9 million recorded loan
What constitutes a period of satisfactory performance by the borrower?

balance. The remaining balance should be accounted for and reported as a nonaccrual loan. Partial and all principal are due at maturity. Additionally, interest on the capitalized interest compounds at
charge off of a loan does not provide a sufficient basis by itself for restoring the loan to accrual status. the 9 percent rate to maturity.
Furthermore, the bank should record loan payments as principal reductions as long as any doubt
remains about the ultimate collectability of the recorded loan balance. When that doubt no longer Question 15: (April 2005)
exists, interest payments may be recorded as interest income on the cash basis. If the borrower makes the interest payments at 5 percent as scheduled, can Note A be on accrual
status?
Question 12:
Assume the bank forgives Note B. How would that affect the accounting treatment? Staff Response:
No. The terms of the restructured loan allow for the deferral of principal payments and capitalization
Staff Response: of a portion of the contractual interest requirements. Accordingly, these terms place undue reliance
Forgiving debt is a form of concession to the borrower. Therefore, a restructuring that includes the on the balloon payment for a substantial portion of the obligation. Generally, capitalization of interest
forgiveness of debt would qualify as a TDR and SFAS 15 would apply. It is not necessary to forgive debt is precluded when the creditworthiness of the borrower is in question. Other considerations about
for SFAS 15 to apply, as long as some other concession is made. the appropriateness of interest capitalization are:
 Whether interest capitalization was included in the original loan terms to compensate for
Question 13: (September 2001) a planned temporary lack of borrower cash flow, or;
Assume that Note B was not charged off, but was on nonaccrual. How would that affect the accrual  Whether similar loan terms can be obtained from other lenders.
status and call report TDR disclosure for Note A?
In a TDR, the answer to each of these considerations is presumed to be negative. First, the bank, in
Staff Response: dealing with a troubled borrower, must overcome the doubt associated with the borrower’s inability
When a loan is restructured into two or more notes in a TDR, the restructured loans should be to meet the previous contractual terms. To do this, objective and persuasive evidence must exist for
evaluated separately. However, since the restructured loans are supported by the same source of the timing and amount of future payments of the capitalized interest.
repayment, both would be reported as nonaccrual. Additionally, because the interest rate on Note B
was below a market rate, both notes would be reported in the TDR disclosures on the call report. In this case, the repayment of the capitalized interest is deferred contractually until the underlying
loan is refinanced or sold. A refinancing, or sale at a price adequate to repay the loan, was not
possible at the time of restructuring. The bank has offered no objective evidence to remove the doubt
Facts: about repayment that existed prior to the restructuring. It is relying solely on a presumption that
Assume, as discussed in question 13, that Note B was not charged off prior to or at the time of market conditions will improve and enable the borrower to repay the principal and capitalized
restructuring. Also, expected cash flows will not be sufficient to repay Notes A and B at a market rate. interest. Accordingly, the timing and collectability of future payments of this capitalized interest are
The cash flows would be sufficient to repay Note A at a market rate. uncertain.
Question 14: (September 2001) Second, the temporary lack of cash flow is generally the reason for a TDR. Thus, capitalization of
When appropriate allowances, if necessary, have been established for Note B, would Note A be interest was not provided for in the original loan terms. Finally, the concession was granted, because
reported as an accruing market-rate loan and Note B as nonaccrual? of the borrower’s inability to find other market financing to repay the original loan. Some loans, such
as this example, are restructured to reduce periodic payments by deferring principal payments,
Staff Response: increasing the amortization term relative to the loan term, and/or substantially reducing or eliminating
No. Even after a TDR, two separate recorded balances, supported by the same source of repayment, the rate at which interest contractually due is periodically paid. These provisions create or increase
should not be treated differently for nonaccrual or TDR disclosure. All loans must be disclosed as the balloon payment significantly. Sole reliance on those types of payments does not overcome the
nonaccrual, unless the combined contractual balance and the interest contractually due is expected to doubt as to full collectability that existed prior to the restructuring. Other evidence should exist to
be collected in full. support the probability of collection before return to accrual status.
In this example, the conditions for capitalization of interest were not met, and sole reliance for the full
Facts: repayment was placed on the sale/refinancing. Accordingly, Note A should be maintained on
A bank negotiates a troubled debt restructuring on a partially charged-off real estate loan. The nonaccrual status. To the extent that the recorded principal remains collectible, interest may be
borrower has been unable to make contractually owed payments, sell the underlying collateral at a recognized on a cash basis.
price sufficient to repay the obligation fully, or refinance the loan. The bank grants a concession in the
form of a reduced contractual interest rate. In the restructuring, the bank splits the loan into two
notes that require final payment in five years. The bank believes that market conditions will improve
by the time the loan matures, enabling a sale or refinancing at a price sufficient to repay the Facts:
restructured obligation in full. The original interest rate was 9 percent. Note A carries a 9 percent A bank restructures a loan by forgiving a portion of the loan principal due and charging it off.
contractual interest rate. Note B, equal to the charged off portion, carries a zero percent rate. Note A Additionally, the bank requires that, should the borrower’s financial condition recover, the borrower
requires that interest be paid each year at a rate of 5 percent, with the difference between the must pay a sum in addition to the principal and interest due under the restructured terms.
contractual rate of 9 percent and the payment rate of 5 percent capitalized. The capitalized interest
Question 16:

For the restructured loan to be eligible for return to accrual status, must the contingent payment  Insufficient cash flows to service the debt.
also be deemed fully collectible?  Inability to obtain funds from other sources at a market rate for similar debt to a non-
troubled borrower.
Staff Response:
No. Contingent cash payments should not be considered in assessing the collectability of amounts In this case, the borrower was experiencing financial difficulties, because the primary source of
contractually due under the restructured terms. repayment (cash flows from the shopping center) was insufficient to service the debt, without reliance
on the guarantors. Further, it was determined that the borrower could not have obtained similar
Facts: financing from other sources at this rate, even with the increase in the guarantee percentage. The
A $10 million loan is secured by income-producing real estate. As a result of a previous $1 million capacity of the guarantor to support this debt may receive favorable consideration when determining
charge-off, the recorded balance is $9 million. Cash flows are sufficient to service only $9 million of loan classification or allowance provisions. However, since the borrower was deemed to be
debt at a current market rate of interest. The loan is classified as nonaccrual and is restructured. experiencing financial difficulties and the bank granted an interest rate concession it normally would
However, the bank protects its collateral position by restructuring the loan into two separate payment not have given, this restructuring would be considered a TDR.
“tranches,” rather than two separate notes. Tranche A requires $9 million in principal payments and
carries a current market rate of interest. Tranche B requires $1 million in principal payments and
carries a below-market rate of interest. Facts:
Bank A made a $95 million term loan with a maturity of June 2006 to a power company in 2001. The
Question 17: loan was secured by all of the property, plant, and equipment of the power plants and had an
Can the bank return Tranche A to accrual status? estimated fair value of $98 million. Under the terms of the note, periodic interest payments were
required. Principal payments were based on a cash flow formula.
Staff Response:
The use of one note with two payment tranches, instead of two separate notes, does not prevent The power plants did not generate sufficient cash flows in 2002 or 2003 to fully service the interest
Tranche A from being returned to accrual status, as long as it meets the conditions set forth in the staff payments. The parent company of the power company funded the deficiencies in 2002and 2003. In
response to question 7. April 2004, the power company failed to make the required interest payment because of its inability to
generate sufficient cash flows. Principal payments, based on the contractual cash flow formula, had
not been required in any period between 2001 and 2004.
Facts:
A bank has a commercial real estate loan secured by a shopping center. The loan, which was In July 2004, the parent paid $10 million of the principal, plus all outstanding interest and fees, thereby
originated 13 years ago, provides for a 30-year amortization with interest at Prime plus 2 percent. bringing the loan fully current. This reduced the outstanding loan balance from $95 million to $85
Two financially capable guarantors, A and B, each guarantee 25 percent of the debt. The shopping million. The loan was then restructured and the remaining $85 million was split into two notes.
center lost its anchor tenant two years ago and is not generating sufficient cash flow to service the
debt. The guarantors have been providing funds to make up the shortfall. Because of the decrease in • Note A is for $45 million, with interest at current market rates. Periodic interest payments are
the cash flow, the borrower and guarantors asked the bank to modify the loan agreement. The bank required, and the principal is due at maturity in 2010. The bank received a first lien on the
agrees to reduce the interest rate to Prime, and in return, both guarantors agreed to increase their collateral. The bank maintained this note on accrual status.
guarantee from 25 percent to 40 percent each. The guarantors are financially able to support this • Note B is for $40 million, with interest at current market rates capitalized into the loan
guarantee. However, even with the increased guarantee, the borrower could not have obtained balance. All principal and interest is due at maturity in 2010. The bank received a second lien
similar financing from other sources at this rate. The fair market value of the shopping center is on the collateral. This loan was placed on nonaccrual status.
approximately 90 percent of the current loan balance.
The parent agreed to inject $4 million in new equity into the power company in July 2005 and July
Question 18: (September 2002) 2006 to pay the required interest on Note A for two years. While the company continues to
Should the debt modification be reported as a troubled debt restructuring (TDR) since only the interest experience net losses in 2005, it is expected that cash flows will be sufficient to cover interest by the
rate was reduced? third quarter of 2006. Further, the parent has indicated that it will continue to cover interest
payments on Note A until the company can generate sufficient cash flows. In addition, the fair value
Staff Response: of the collateral is estimated at $98 million, exceeding the combined amount of the restructured notes
SFAS 15 states that a restructuring of a debt is a TDR if a creditor for economic or legal reasons related by approximately $13 million.
to the debtor’s financial difficulties grants a concession that it would not otherwise consider. This may
include a reduction of the stated interest rate for the remaining original life of the debt. However, no Question 19: (October 2005)
single characteristic or factor taken alone determines whether a modification is a TDR. Should this restructuring be accounted for as a troubled debt restructuring (TDR)?
The following factors, although not all inclusive, may indicate the debtor is experiencing financial
difficulties: Staff Response:
 Default. Yes. SFAS 15 states that the restructuring of a debt is a TDR if a creditor for economic or legal reasons
 Bankruptcy. related to the debtor’s financial difficulties grants a concession that it would not otherwise consider.
 Doubt as to whether the debtor will continue as a going concern. The company was experiencing financial difficulties as demonstrated by the default on the interest
 De-listing of securities.

payments. Further, while there was no forgiveness of interest or principal, a concession was granted Staff Response:
by extending the maturity date and agreeing to capitalize interest on Note B. SFAS 114 specifically scopes out large groups of smaller-balance homogeneous loans that are
collectively evaluated for impairment. Those loans may include but are not limited to credit card,
Question 20: (October 2005) residential mortgage, and consumer installment loans. As a result, residential mortgage loans are
Should both Notes A and B be on a nonaccrual status? generally evaluated for impairment as part of a group of homogenous loans under SFAS 5. The only
time a residential mortgage loan is required to be analyzed for impairment under SFAS 114 is when the
Staff Response: residential mortgage loan is modified and classified as a TDR. In the scenario described above, Bank B
Not necessarily, while the nonaccrual rules would normally require that both notes be on nonaccrual will include the second lien mortgage loan in its SFAS 5 allowance methodology; the second loan has
status, Note A has a unique structure and financial backing that distinguishes it from most restructured not been modified and is therefore not a TDR subject to SFAS 114.
loans. Although both notes are supported by the same cash flows and secured by the same collateral,
these unique structural differences result in different conclusions for each note regarding the In addition, while the borrower’s first lien mortgage has been modified by Bank A, Bank B may not be
appropriateness of interest accrual. These structural differences also result in a different conclusion aware of this action. However, when Bank B becomes aware of a first lien modification, Bank B should
than was reached in certain of the previous examples in this Topic. The parent paid $10 million (plus recognize that the second lien mortgage loan borrower is facing financial difficulties and that the
interest and fees) to bring all past due amounts current and has demonstrated the intent and ability to second lien mortgage has different risk characteristics than other second lien mortgage loans that
continue to support the power company by its commitment to inject $4 million capital into the have not had their first lien mortgage modified or are not suffering financial difficulties. Following the
company in 2005 and 2006. The parent has also indicated that additional financial support will be modification of the first lien mortgage, Bank B should consider segmenting the loan into a different
provided, as necessary. This capital injection and future support is sufficient to meet all required SFAS 5 group that reflects the increased risk associated with this loan. Alternatively, the bank may
payments on Note A. Further, the previous actions of the parent sufficiently demonstrate its intent to consider applying additional environmental or qualitative factors to this loan pool to reflect the
support the borrowing. In addition, after the $10 million payment by the parent, the collateral value different risk characteristics.
exceeds all current outstanding balances by approximately $13 million and exceeds the balance of
Note A by approximately $53 million. Based on these factors, the collection of all principal and
interest is deemed reasonably assured for Note A. Accordingly accrual status is appropriate for Note A.
All questions and answers in this section were selected, based on their relevance, from the
Comptroller of the Currency’s Bank Accounting Advisory Series, October 2010. For more questions
Facts: and answers, view the original document at:
A bank executes short-term modifications (i.e., 12 months or less) to troubled borrowers that meet http://www.occ.gov/publications/publications-by-type/other-publications-reports/BAAS.pdf
the definition of a TDR. The bank has stated that the duration of the short-term modification results in
an “insignificant delay” in payment.
Question 21: (October 2010)

Is the bank required to apply TDR accounting to these short-term modifications?
Staff Response:
Yes, TDR accounting should apply to such short-term modifications. If, however, the bank determines
the short-term modification meets the definition of a TDR but the impact (both quantitative and
qualitative) is immaterial, the TDR accounting need not be applied. A blanket, unsupported statement
that such short-term modifications are immaterial to a bank’s financial reporting without a
documented materiality analysis is inappropriate.
Facts:
A bank executes short-term modifications (i.e., 12 months or less) to troubled borrowers that meet
the definition of a TDR. The bank has stated that the duration of the short-term modification results
in an “insignificant delay” in payment.
Question 22: (October 2010)

How should Bank B account for the second lien mortgage under FAS 114 after the first lien mortgage
was modified?

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Troubled Debt Restructurings Job Aid: Workflow, Case Studies, and Q&As

Introduction and definitions ......................................................................... 2

Responsibilities of the institution:

2 © 2011 Conference of State Bank Supervisors

Insignificant delay in payment:

Is the debtor experiencing financial difficulties?

While not a concession, the following indicate a TDR:

4 © 2011 Conference of State Bank Supervisors

5 © 2011 Conference of State Bank Supervisors

6 © 2011 Conference of State Bank Supervisors

7 © 2011 Conference of State Bank Supervisors

8 © 2011 Conference of State Bank Supervisors

9 © 2011 Conference of State Bank Supervisors

Classification Nonaccrual Treatment TDR Treatment

10 © 2011 Conference of State Bank Supervisors

11 © 2011 Conference of State Bank Supervisors

12 © 2011 Conference of State Bank Supervisors

Questions and Answers Question 3:

13 © 2011 Conference of State Bank Supervisors

Staff Response: (December 2008)

14 © 2011 Conference of State Bank Supervisors

15 © 2011 Conference of State Bank Supervisors

16 © 2011 Conference of State Bank Supervisors

Question 21: (October 2010)

Question 22: (October 2010)

17 © 2011 Conference of State Bank Supervisors

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