LOANS Section 3.2
RMS Manual of Examination Policies 3.2-59 Loans (07-24)
Federal Deposit Insurance Corporation
an institution will be unable to collect all amounts due
according to the contractual terms of the loan agreement
(i.e., principal and interest). Impaired loans encompass all
loans that are restructured in a troubled debt restructuring,
including smaller balance homogenous loans that are
typically exempt from ASC Subtopic 310-10. However, the
standard does not include loans that are measured at fair
value or the lower of cost or fair value.
When a loan is impaired under ASC Subtopic 310-10, the
amount of impairment should be measured based on the
present value of expected future cash flows discounted at
the loan’s effective interest rate (i.e., the contractual interest
rate adjusted for any net deferred loan fees or costs and
premium or discount existing at the origination or
acquisition of the loan). As a practical expedient,
impairment may also be measured based on a loan’s
observable market price. The fair value of the collateral
must be used if the loan is collateral dependent. An
impaired loan is collateral dependent if repayment would be
expected to be provided solely by the sale or continued
operation of the underlying collateral.
If the measure of a loan calculated in accordance with ASC
Subtopic 310-10 is less than the recorded investment in the
loan (typically the face amount of the loan, plus accrued
interest, adjusted for any premium or discount, deferred fee
or cost, less any charge-offs), impairment on that loan
should be recognized as a part of the ALLL. In general,
when the amount of the recorded investment in the loan
exceeds the amount calculated under ASC Subtopic 310-10
and that amount is determined to be uncollectible, this
excess amount should be promptly charged-off against the
ALLL. In all cases, when an impaired loan is collateral
dependent and the repayment of the loan is expected from
the sale of the collateral, any portion of the recorded
investment in the loan in excess of the fair value less cost to
sell of the collateral should be charged-off.
Troubled Debt Restructuring - The accounting for TDRs
is set forth in ASC Subtopic 310-40, Receivables-Troubled
Debt Restructurings by Creditors. A restructuring
constitutes a troubled debt restructuring if the institution for
economic or legal reasons related to the borrower’s
financial difficulties grants a concession to the borrower
that it would not otherwise consider. A troubled debt
restructuring takes place when an institution grants a
concession to a debtor in financial difficulty. Examiners are
expected to reflect all TDRs in examination reports in
accordance with this accounting guidance and institutions
are expected to follow these principles when filing the Call
Report.
TDRs may be divided into two broad groups: those where
the borrower transfers assets to the creditor in full or partial
satisfaction of the debt, which would include foreclosures;
and those in which the terms of a debtor’s obligation are
modified, which may include reduction in the stated interest
rate to an interest rate that is less than the current market
rate for new obligations with similar risk, extension of the
maturity date, or forgiveness of principal or interest. A third
type of restructuring combines a receipt of assets and a
modification of loan terms. A loan extended or renewed at
an interest rate equal to the current market interest rate for
new debt with similar risk is not reported as a restructured
loan for examination purposes.
Transfer of Assets to the Creditor - An institution that
receives assets (except long-lived assets that will be sold)
from a borrower in full satisfaction of the recorded
investment in the loan should record those assets at fair
value. If the fair value of the assets received is less than the
institution’s recorded investment in the loan, a loss is
charged to the ALLL. When property is received in full
satisfaction of an asset other than a loan (e.g., a debt
security), the loss should be reflected in a manner consistent
with the balance sheet classification of the asset satisfied.
When long-lived assets that will be sold, such as real estate,
are received in full satisfaction of a loan, the real estate is
recorded at its fair value less cost to sell. This fair value
(less cost to sell) becomes the “cost” of the foreclosed asset.
To illustrate, assume an institution forecloses on a defaulted
mortgage loan of $100,000 and takes title to the property. If
the fair value of the property at the time of foreclosure is
$90,000 and costs to sell are estimated at $10,000, a $20,000
loss should be immediately recognized by a charge to the
ALLL. The cost of the foreclosed asset becomes $80,000.
If the institution is on an accrual basis of accounting, there
may also be adjusting entries necessary to reduce both the
accrued interest receivable and loan interest income
accounts. Assume further that in order to effect sale of the
realty to a third party, the institution is willing to offer a new
mortgage loan (e.g., of $100,000) at a concessionary rate of
interest (e.g., 10 percent while the market interest rate for
new loans with similar risk is 20 percent). Before booking
this new transaction, the institution must establish its
"economic value" or what would be the cash price paid.
Pursuant to ASC Subtopic 835-30, Interest – Imputation of
Interest, the value is represented by the sum of the present
value of the income stream to be received from the new
loan, discounted at the current market interest rate for this
type of credit, and the present value of the principal to be
received, also discounted at the current market interest rate.
This economic value (calculated by discounting the cash
flows at the current market interest rate) becomes the proper
carrying value for the property at its sale date. Since the
sales price of $78,000 is less than the property’s carrying
amount of $80,000), an additional loss has been incurred
and should be immediately recognized. This additional loss
should be reflected in the allowance if a relatively brief
period has elapsed between foreclosure and subsequent