Sometimes Putting Members First Can Come At Significant Cost

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Over the past few years, virtually every American has been impacted in some way, shape or form by the economic downturn. And with unemployment at an alarmingly high rate, many Americans are facing situations in which they are unable to meet their financial obligations. As a result, financial institutions across the country are being overwhelmed by members and customers alike asking their institution to help restructure their debt.

Credit unions have been going the extra mile to help as many members as possible. But putting members first doesn't come without recourse-and credit unions now find themselves grappling with the issue of Troubled Debt Restructuring (TDR) and its impact on their institutions, both financially and operationally.

In almost every instance where a credit union restructures a loan for a member facing financial difficulty, a TDR is born-resulting in a significant increase in accounting and reporting requirements. This means increased scrutiny from regulators and external auditors alike. And if the issue is important enough to draw the attention of regulators and external auditors, it's guaranteed to be a high priority for credit union boards and senior management.

TDR accounting has some of the most difficult accounting rules to interpret, primarily because they are subjective in nature. It's also an issue that, until the Great Recession, many credit unions had not dealt with before. As a result, credit union management are now having to implement policies and procedures to properly identify, monitor, account for, and report troubled debt restructurings to their supervisory committees, boards, regulators, and auditors.

Spotlight Shining On Compliance
With the spotlight shining brightly on this issue, credit unions cannot risk noncompliance. Implementing these types of policies and procedures will require a well-trained professional who understands the nuances of accounting for TDRs, and is also knowledgeable about internal controls and how to analyze which controls to implement based on cost/benefit, risk, and impact on operations.

This is a delicate balance. Putting too many controls in place is not only costly but will bring operations to a crawl, negatively affecting efficiency and earnings. Conversely, implementing too few controls or the incorrect controls means the credit union runs the risk of noncompliance, potentially causing future deterioration in the loan portfolio, and sanctions from the NCUA - not to mention the negative public attention, which can seriously damage its reputation. With all of this in mind, here are some key points to consider when determining what policies and procedures should be implemented:

1) Identifying a TDR:

* Training: the accounting rules for what constitutes a TDR are very subjective, and not all loans that are modified will be TDRs, so properly training loan staff that deal with modification on how to identify a TDR is critical.

* Consider using a checklist with the TDR criteria (GAAP) and common examples for loan administrative staff to use in making changes to loans in the system.

* Segregation of duties: this is a fundamental concept of any control environment. All loan modifications should go through a formal process where more than one or two people are responsible for the modification process (authorizing, initiating, recording, reconciling and reporting).

* Implement a review process to go back and ensure all modified loans for potential TDRs.

A. Use information reports from the loan application system to report all loans modified during a specific time period (one or two quarters at most).

B. Then define a material dollar amount and review all modified loans over that amount to determine if it should be considered a TDR. In a perfect world this would be done on a quarterly basis before call reports and at Year-End to ensure all TDRs are properly identified. Each CU will have to evaluate and consider the frequency in which to have these reviews performed, which realistically often comes down to budget constraints.

C. The review should be done by a professional who is knowledgeable of TDR accounting and regulatory requirements (usually the Internal Auditor, Controller, or CFO).

D. It is imperative to have the reviewer and preparer sign and date when the review is performed.

* Document everything: the general rule is if you didn't document it, you didn't do it. The burden of proof lies with the credit union. Regulators and auditors will require adequate reasoning for decisions in which a loan was modified and determined not to be a TDR.

2) Monitoring and tracking:

* Use information reports from the loan application system. Due to the heightened attention on this issue, credit unions have been requesting from their vendors the ability to generate these reports. Most systems now have fields for notating if a loan is a TDR.

* If your loan systems do not have a way to track TDRs, then track them using some other form, such as Excel.

* Keep and maintain documentation of the reports that support amounts used to disclose and report TDRs for financial and regulatory purposes.

3) Accounting:

* Train key staff (CFO, CEO, Controller, other high level financial personnel) on accounting and regulatory requirements to stay current on accounting and regulatory changes.

* Have a process in place to ensure TDRs are reviewed for impairment at the time of restructuring, and properly disclosed in financial statements and call reports. All TDRs inherently are impaired and will have a negative impact on the credit union, resulting in lower earnings and additional regulatory and financial reporting disclosure requirements.

* Keep and maintain documentation of the reports that support amounts used to disclose and report TDRs for financial and regulatory purposes.

4) Report to the board on a monthly or quarterly basis:

* Use reports to make educated decisions on credit availability to the individual member and membership, as well as to provide support for regulators and auditors.

* Report to the board of directors and/or supervisory committee on a monthly or quarterly basis TDRs and their impact on the credit union's operations.

* Disclose TDRs in quarterly call report filings with NCUA, and on annual audited financial statements.

Final Thoughts
In terms of accounting for troubled debt restructuring, identification is key. A credit union can have all other proper controls in place but if a TDR isn't properly identified, it can't be properly monitored, accounted for, and reported.

The bottom line is that credit unions have been put in a difficult situation in recent years. While the core beliefs of credit unions are to put members first and help all members, credit unions also need to comply with the accounting and regulatory requirements. Helping members by restructuring debt will not only negatively affect the credit union (via lost income, and higher provision expense); it also increases their compliance burden. There may be times in which the credit union can't help every member. Credit unions in today's economic landscape need to evaluate the big picture and determine what's best for them and the majority of their members. 

Harvey L. Johnson, CPA is an Audit Manager and is an active member of the Financial Institution Services Team at Witt Mares, PLC, Newport News, Va. Mr. Johnson can be reached at or:  

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