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It Figures Podcast: S4:E18 – Out with TDRs and in with Loan Mods

On this week’s episode of “It Figures,” join CRI Partners Hillary Collier and Doug Mims, as they look at ways for community banks to better help their customers, and formulate new processes with loan modifications.

Speaker 1:

From Carr, Riggs & Ingram, this is It Figures, the CRI podcast, an accounting, advisory, and industry-focused podcast for business and organization leaders, entrepreneurs, and anyone who is looking to go beyond the status quo.

Hillary Collier:

Thank you for tuning in into the It Figures podcast. My name is Hillary Collier and I’m an audit partner in the Atlanta office of CRI. I’m joined today by Doug Mims, who’s one of the CRI’s financial institution industry line leaders, who’s also based in Atlanta. Welcome, Doug.

Doug Mims:

Thanks, Hillary. It’s good to be here.

Hillary Collier:

So the topic for discussion today is out with the TDRs and in with loan modifications.

Doug Mims:

Well, that’s right, Hillary. We got rid of TDR accounting, essentially coming out of the CECL process. Of course, the CECL process from exposure draft to final issuance and implementation was a long process with a lot of feedback. In the post-implementation process, there was a lot of feedback about troubled debt restructurings, about the concept, the accounting, and so as a consequence, Audit Accounting Standards Update 2022-02 was issued and it addressed troubled debt restructurings and vintage disclosures, but essentially it, and all the headlines said it eliminated TDR recognition in accounting.

Hillary Collier:

So what have you been seeing in the community banking industry and your clients?

Doug Mims:

Well, I think at this point, and this is from just talking to my peers and talking to clients and we’re actually going out and doing some audit work and things, it’s kind of been a bit of a slow role for community banks, I would say. What we’re seeing, first of all, for the Q1… So TDRs were disclosed as part of the call reporting process. And that process, the instructions for the call report didn’t get updated for the first quarter. I actually didn’t look to see if they’re updated for the second quarter.

But that kind of drives some smaller community banks thought process around TDRs, plus in what is still a good economy, there’s not a lot of modifications being done at a lot of the banks that we work with, which is generally banks under five billion. So it hadn’t come on the radar for some folks. So it hadn’t come up. And I do think there’s some folks that really read the headline that said no more TDR accounting because of CECL, and they’re thinking somehow CECL’s taking care of the accounting or whatever. And it’s not happening.

So I think you basically have it’s not really on the radar and it’s either people don’t know what they need to be doing or it’s business as usual. They do know, but they hadn’t had any modifications.

Hillary Collier:

So if it’s no longer a business as usual, what is the scope of low modifications in the context of the updated standard?

Doug Mims:

Well, I think the first thing that community banks need to be doing, and the first question is do you have a modification? And so that the criteria are do you have a borrower? I guess I kind of got that out of order, but do you have a borrower that’s experiencing financial difficulty and do you have a modification? But it’s not just any modification. It would be, there’s really four things that fall under this standard. It’s principle forgiveness, interest rate reduction, other than insignificant payment delay, and term extension.

So a modification that falls under this standard and the disclosure requirements would need to be one of those four things. So things like adding or removing a guarantor, adding or removing collateral. Those types of things, those aren’t the modifications. Those are changes in the structure of the debt. But the four things that I mentioned are what need to be on the radar. And also you could have one of those four, but the bar needs to be experiencing financial difficulty as defined by the standard as well.

Hillary Collier:

Well, since the definition of financial difficulty can be subjective, how’s it defined by the update?

Doug Mims:

Well, so the guidance on that has not changed. GAAP has not changed in that regard. And so similar concept that the standard really gives you four things to consider, and they’re not the only things that you could consider, but they’re the four drivers. And one would be is the borrower in default? Is the borrower in bankruptcy? If there is substantial doubt about the entity’s ability to continue as a going concern, that would also represent potential financial difficulty. And then if you didn’t do the modification, now the fourth tier I guess would be if you didn’t do the modification, could that borrower go out in the marketplace and get similar financing? Given their credit risk profile, could they get similar financing, similar interest rate, duration from another institution?

Hillary Collier:

Well, it’s good that there’s at least one thing that hasn’t changed with this update. So another key subjective element is the other than insignificant payment delays. How has this been addressed in the update?

Doug Mims:

Well, that’s, again, no change from there. So it ought to be something that resonates with…

Hillary Collier:

It did.

Doug Mims:

… community banks. So an insignificant delay really has, I guess, four or five pieces to this. So if the amount of the restructured payments that’s subject to the delay is insignificant relative to the unpaid balance or collateral value, that would be insignificant. So if the restructured payment, I’ll say that again, if the restructured payment subject to the delay is insignificant related to the balance or the collateral, then that would be an indicator that it is insignificant.

As it relates to timing, the delay in timing of the restructured payment would be considered insignificant if it was insignificant relative to the frequency of the payment due, the loans original contractual maturity date, or the loans original expected duration. So if that restructured payment is insignificant relative to those three things, then it would be considered insignificant.

Now, there’s another component. If you had, the standard also requires if you had a borrower that you made a modification for, and let’s say that modification was considered to be insignificant, it was out of scope because it was insignificant, but in the same 12-month window, in the same reporting period, not necessarily just 12 months, but in a 12-month reporting period, if you had another modification, then you would have to assess the cumulative impact of those modifications in determining significance of the delay. So that’s a little bit of a twist on that if you had multiple deals.

Hillary Collier:

[inaudible 00:08:02].

Doug Mims:

But it’s really about the restructured payment as it relates to the balance and the collateral. And then the delay itself, how much does it deviate from what was the original agreement.

Hillary Collier:

So it seems pretty straightforward and there’s changes, but at least some of the subjective areas remain unchanged. But what are your biggest concerns with the update?

Doug Mims:

I think the biggest challenge is going to be the disclosures because ultimately what we’re talking about now is about disclosure. It’s actually not about accounting, right?

Hillary Collier:

Right.

Doug Mims:

So the disclosures will be challenging. They have changed. And so from a high level, for each balance sheet presented, you have to disclose the amount of additional funds committed to a borrower for which you have made a modification that’s in the scope. So if you’ve made a modification that’s within the scope of this disclosure requirement and you’ve committed a additional funds, then you have to disclose that as part of the process.

The second disclosure requirements are related to the income statement. So for every income statement presented, you have to present certain quantitative and qualitative information about the modifications that meet the requirements. So again, if it doesn’t meet the requirements we’ve been talking about, it wouldn’t be in the scope of the disclosure. But those disclosures, they’ll be done by loan type, by past due classification, by the nature of the modification.

Some other elements in there without going through the whole list, but at the end of the day, there’s quantitative and qualitative disclosures that are required that are different than what have… Some are the same, but some are different, and there’ll be a need to capture that data. And so that’s probably, it’s following the rules, but once you follow the rules and say, “Hey, there’s a modification that’s in scope,” it’s capturing the data and getting it into your note disclosure.

And that’s also, presumably, what would be reported in your call report at some level. Having not seen the call report instructions, I’m not exactly sure what the requirements would be, but I think there would be some reporting requirements there.

Hillary Collier:

Yeah. So yeah, you’re right, capturing that data and making sure that it’s complete and accurate is definitely going to be a concern.

Doug Mims:

Now, the good news is is that the update can be adopted prospectively. So you can start doing this on a prospective basis as of 1/1. And really what I don’t think I said earlier is this standard was issued in March of 2022, but it became effective 1/1 of this year, essentially. You could have early adopted, but for most folks, 1/1 of this year. But you can do it prospectively. You don’t have to go back. And in the first year, you don’t have to do comparatives. So if you’re a bank and you’ve got modifications in this reporting period that you’re going to need to disclose, you don’t have to go back and try to reinvent the wheel for last year.

You also don’t have to continue any TDR disclosures that you had. The ones that were in your report last year, those go away for last year. Now, if those loans are modified in this period and they need to be disclosed, and they’ll need to be disclosed, but TDR accounting is gone as well as the disclosures prospectively.

Hillary Collier:

So it sounds like community banks have some work to do as we enter a possible recessionary period. Is that it?

Doug Mims:

Well, unfortunately, no, that’s not it. That’s just the disclosure piece. So if you have modifications within the scope of the standard, then this discussion has been all about disclosure.

There’s also the element of whether or not the modification meets the criteria to be considered a new loan, and that has no bearing on the disclosure. If the disclosure is required, it’s required. If it’s not, it’s not. But the accounting for the loan might be different depending on whether it’s a new loan or not.

So a modification results in a new loan if the new terms are at least as favorable to the institution as comparable loans to other customers with similar risk profiles. So that’s the primary consideration. And from that, there’s really two prongs, if you will. The new loan’s effective yield is at least equal to the effective yield of the original loan. Again, these would qualify as new loans.

Hillary Collier:

New loans.

Doug Mims:

Or the modifications to the original loan are considered more than minor. So if they’re more than minor, then you’ve got a new loan. But here’s the two tests. If the present value of the cash flows of the new versus the old loan is 10% different, the modification’s considered more than minor. So there’s a 10% test. And then if, if you do that test and it’s not 10%, that doesn’t necessarily mean it’s not a new loan, there are other qualitative considerations that you can make to further evaluate and make sure. And that would… Again, whether or not it’s a new loan impacts the accounting. It actually doesn’t impact whether or not you need to make the disclosure.

Hillary Collier:

Okay. So given everything we’ve discussed today, what final thoughts would you like to leave our listeners?

Doug Mims:

Well, I think it’s really about people and process. So I think you need to make sure that you’ve identified all the people that need to be trained and educated on the subject matter, make sure they understand what a modification is, at least be able to identify if a loan is meeting one of the four criteria, make sure they understand what financial difficulty means. They may not be doing a test, if you will.

But basically, train everybody up that needs to be aware so if there’s a modification that might need to be evaluated further, somebody raises their hand, that the process would also include the systems. So are you capturing the data that you need to in the event you have a modification and you’ve got to make these evaluations? Are you capturing the data that you need to to make these modifications, particularly the quantitative ones?

And on a go-forward basis, then what that looks like, I think from process perspective is maybe a checklist or something like that where the people that touch these loans, the people that would be involved in the modification can document some of these things and move it along in the process so that it could be recognized in the organization. I think, depending on the size of the institution and the number and materiality of modifications, the larger the institution, the more formal the process probably needs to be.

Hillary Collier:

Right.

Doug Mims:

The larger the institution, the more people involved, so the more structure that you need around it. The smaller, they probably know each other, they may be sitting across from each other, and so it’s a little bit easier to communicate and say, “Hey, we’re making a modification here and raise your hand.”

So I think it just depends on the institution, but people do need to recognize that there is a new standard, that it is different than what’s in the past. There are similarities, but you want to make sure that when that time comes, that you comply so that your call reporting is accurate, as well as the financial reporting for when your auditors come in, because they’re not going to be able to go through or not going to want to go through and identify your loan modifications for you.

Hillary Collier:

That’s right.

Doug Mims:

That’s some process you need to have in place for the footnote disclosure and any accounting implications if it in fact is considered a new loan.

Hillary Collier:

That was very informative and helpful for our community banks. Thanks for your time today, Doug.

Doug Mims:

Thank you, Hillary.

Hillary Collier:

Thanks for listening to this week’s IT Figures podcast. Please follow CRI on all of our socials. If you have any questions or concerns, please visit cricpa.com and we will be glad to help.

Speaker 1:

If you want more CRI insights or are interested in learning about our firm, please visit our website at cricpa.com. Thanks for listening to this episode of It Figures, the CRI podcast. You can subscribe to It Figures on iTunes, Spotify, or wherever you prefer to listen to your podcasts. If you liked what you heard today, please leave us a review.

 

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