Current Economic Conditions Bring Old Concepts Back to the Forefront:
A Reminder of Key Concepts in TDR and OREO Accounting
By: Lincoln C. McKinnon, CPA
Banking, as a profession, is one of the single-most rewarding careers a person can choose. Providing people with access to the capital needed to pursue their dreams and provide opportunity for themselves, and others, is one of the valiant missions tasked to you as a banker. I’ve been told the feeling of accomplishment when a customer is wildly successful in their goals, is one of the most fulfilling experiences a banker can have. But I was taught that how we handle the bad times is what defines us in life and in business. The Texas economy has benefitted greatly from the energy boom during the past few years, but has begun to fall in recent months due to depressed oil and gas prices. During these times of $45 oil, what was hoped to be short-lived news of rig shut-downs, budget cuts and, unfortunately, job losses, has not shown many signs of subsiding. All these issues may begin to rear their ugly head in your loan portfolio, if they have not done so already.
So, as we move into this next year-end, it is best to revisit such concepts as troubled debt restructurings (TDR) and the proper accounting for other real estate owned (OREO). Luckily, the concept of TDR’s has not changed in the past few years. The keys to remember are (1) is the borrower experiencing any type of financial difficulty and (2) is the financial institution making a concession for the borrower that it would not reasonably make if the borrower were not experiencing such difficulty. If the answer to both of these questions is yes, the lender should classify the modified loan as a TDR and follow the necessary regulatory guidance regarding reporting.
OREO accounting rules come into effect in cases where the Bank feels there is no better option than to cease the borrowing relationship, or is left no choice. As stated in a separate article, new guidance was issued in late 2014 stating the institution must have legal title to the property prior to the recording as OREO on the books. In addition, government guarantees on the subject loan should be considered (also discussed in separate article). However, when recording these infrequent transactions, accounting personnel may sometimes forget the nuances of recording OREO transactions. For instance, all write-downs to get the loan balance to fair value at the time of foreclosure are charged to the Provision for Loan Losses. After the loan is transferred to OREO, all subsequent write-offs are charged to the write up/down of OREO account, which should act as a valuation allowance. We have seen increased regulatory emphasis placed on property’s having an updated appraisal (usually within 6 months of foreclosure) to determine the lower of cost or market for the initial recording. The institution can have a qualified employee review a previously obtained appraisal in lieu of obtaining a new appraisal, but the conclusion must be documented in the file with supportable evidence. Also note, the cost basis includes principal and any interest accrued up to the point of foreclosure. Although the general rule is at no point in time can the book value of the property exceed the initial book value on transfer date, there are a few items which qualify for capitalization. This includes costs to get the property complete and ready for sale, and other betterments. Any items which are not considered to add to the sales price of the property should not be recorded, which includes items such as property taxes, general maintenance, HOA dues, etc.
Our intention was only to brush upon some of the common places where institutions run into trouble but know we are always available to discuss a particular situation. We always attempt to treat you, our customers, with the same level of accessibility and helpfulness that you strive to provide to your customers. But our real hope is that this article merely serves as a reminder of things we hope we don’t have to encounter in the near future.