Nonaccrual Loans and Restructured Debt …

1 Nonaccrual Loans and Restructured Debt( accounting , Reporting, and disclosure issues ) Section with borrowers who are experiencingfinancial difficulties may involve formallyrestructuring their Loans and taking other mea-sures to conform the repayment terms to theborrowers ability to repay. Such actions, ifdone in a way that is consistent with prudentlending principles and supervisory practices, canimprove the prospects for collection. Generallyaccepted accounting principles (GAAP) andregulatory reporting requirements provide aframework for reporting that may alleviate cer-tain concerns that lenders may have about work-ing constructively with borrowers who are hav-ing financial policy statements and guidance,issued on March 1, 1991; March 10, 1993.

2 AndJune 10, 1993, clarified supervisory policiesregarding Nonaccrual assets, Restructured Loans ,and collateral valuation (additional clarificationguidance may be found in SR-95-38 and in theglossary of the reporting instructions for thebank call report and the FR-Y-9C, the consoli-dated bank holding company report). When cer-tain criteria1are met, (1) interest payments onnonaccrual assets can be recognized as incomeon a cash basis without first recovering anyprior partial charge-offs; (2) Nonaccrual assetscan be restored to accrual status when subject toformal restructurings, according to FinancialAccounting Standards Board (FASB) StatementNos.

3 15 and 114, accounting by Debtors andCreditors for Troubled Debt Restructurings (FAS 15) and accounting by Creditors forImpairment of a Loan (FAS 114); and (3) re-structurings that specify a market rate of interestwould not have to be included in restructuredloan amounts reported in the years after the yearof the restructuring. These supervisory policiesapply to federally supervised financial institu-tions. The board of directors and managementof bank holding companies should therefore in-corporate these policies into the supervision oftheir federally supervised financial CASH-BASIS INCOMERECOGNITION ON NONACCRUALASSETSC urrent regulatory reporting requirements donot preclude the cash-basis recognition ofincome on Nonaccrual assets (including loansthat have been partially charged off), if theremaining book balance of the loan is deemedfully collectible.

4 Interest income recognized ona cash basis should be limited to that whichwould have been accrued on the recorded bal-ance at the contractual rate. Any cash interestreceived over this limit should be recorded asrecoveries of prior charge-offs until thesecharge-offs have been fully Nonaccrual ASSETSSUBJECT TO FAS 15 AND FAS 114 RESTRUCTURINGSA loan or other debt instrument that has beenformally Restructured to ensure repayment andperformance need not be maintained in non-accrual status. When the asset is returned toaccrual status, payment performance that hadbeen sustained for a reasonable time before therestructuring may be considered.

5 For example, aloan may have been Restructured , in part, toreduce the amount of the borrower s contractualpayments. It may be that the amount and fre-quency of payments under the restructuredterms do not exceed those of the payments thatthe borrower had made over a sustained period,within a reasonable time before the restruc-turing. In this situation, if the lender is reason-ably assured of repayment and performanceaccording to the modified terms, the loan can beimmediately restored to accrual , a period of sustained performance,whether before or after the date of the restructur-ing, is very important in determining whetherthere is reasonable assurance of repaymentand performance.

6 In certain circumstances, otherinformation may be sufficient to demonstrate animprovement in the borrower s condition or ineconomic conditions that may affect the bor-rower s ability to repay. Such information mayreduce the need to rely on the borrower s perfor-mance to date in assessing repayment example, if the borrower has obtained sub-stantial and reliable sales, lease, or rental con-tracts or if other important developments areexpected to significantly increase the borrow-er s cash flow and debt-service capacity andstrength, then the borrower s commitment torepay may be sufficient.

7 A preponderance ofsuch evidence may be sufficient to warrant1. A discussion of the criteria is found within the corre-sponding subsections that Supervision ManualDecember 2002 Page 1returning a Restructured loan to accrual Restructured terms must reasonably ensureperformance and full is imperative that the reasons for restoringrestructured debt to accrual status be docu-mented. A restoration should be supported bya current, well-documented evaluation of theborrower sfinancial condition and prospectsfor repayment. This documentation will bereviewed by formal restructuring of a loan or otherdebt instrument should be undertaken in waysthat will improve the likelihood that the creditwill be repaid in full in accordance with reason-ably Restructured repayment requirements and GAAP donotrequire a banking organization that restructuresa loan to grant excessive concessions, forgiveprincipal, or take other steps not commensuratewith the borrower s ability to repay in order touse the reporting treatment specified in FAS.

8 The Restructured terms may includeprudent contingent payment provisions that per-mit an institution to obtain appropriate recoveryof concessions granted in the restructuring, ifthe borrower s condition substantially RESTRUCTURINGSRESULTING IN A MARKETINTEREST RATEA FAS 114 restructuring that specifies an effec-tive interest rate that is equal to or greater thanthe rate the lending banking organization is will-ing to accept at the time of the restructuring, fora new loan with comparable risk (assuming theloan is not impaired by the restructuring agree-ment), does not have to be reported asa troubled-debt restructuring after the year Nonaccrual TREATMENTOF MULTIPLE Loans TO ONEBORROWERAs a general principle, whether to place an assetin Nonaccrual status should be determined by anassessment of the individual asset s collect-ibility.

9 One loan to a borrower being placedin Nonaccrual status does not automatically haveto result in all other extensions of credit to thatborrower being placed in Nonaccrual a single borrower has multiple extensionsof credit outstanding and one meets the criteriafor Nonaccrual status, the lender should evalu-ate the others to determine whether one or moreof them should also be placed in Troubled-DebtRestructuring Returning a Multiple-NoteStructure to Accrual StatusOn June 10, 1993, interagency guidance wasissued to clarify a March 10, 1993, interagencypolicy statement on credit availability.

10 The guid-ance addresses a troubled-debt restructuring(TDR) that involves multiple notes (some-times referred to as A/B note structures). Anexample of a multiple-note structure is whenthefirst, or A, note would represent the portionof the original-loan principal amount that wouldbe expected to be fully collected along withcontractual interest. The second part of therestructured loan, or B note, represents the por-tion of the original loan that has been TDRs generally may take any of threeforms: (1) In certain TDRs, the B note may be acontingent receivable that is payable only ifcertain conditions are met (for example, if thereis sufficient cashflow from the property).