Lenders have been vilified for not modifying the mortgages of financially strapped homeowners, when in fact they've restructured hundreds of billions of dollars in residential loans over the past several quarters.
The problem is, it's been difficult to know if the modifications are really working.
New accounting rules will soon require banks to disclose just how successful those modifications have, or haven't, been. Starting with third-quarter reports, banks will have to disclose redefault rates for the first time. Banks also will have to reclassify a larger number of loans as troubled debt restructurings.
In basic terms, a troubled debt restructuring occurs when a lender makes a concession by reducing the interest rate or giving a payment extension or forbearance to make it easier for a struggling borrower to afford his or her payments. But there has been much confusion around how they should be classified.
Restructured loans also carry a stigma and a cost. Most analysts say restructurings are generally indicative of trouble in a bank's loan portfolio and, along with other metrics, are an indication of a bank's overall asset quality. A huge volume of modified loans also means that a bank's servicing department is operationally under stress. Some would argue that the cost-benefit of working out a modification is not worth the effort.
While restructuring loans allows banks to avoid taking chargeoffs in the short term, some analysts say the danger in restructuring loans is that many of them fail to perform and become delinquent again, so the banks are just prolonging the problem to satisfy regulators, who have pushed for more workouts.
Because disclosures around troubled loans have been minimal, it has been difficult to assess the credit quality of billions of dollars in both performing and nonperforming loans, including commercial and credit card assets, experts say.
"Once you start to believe the balance sheets of these banks, then you can get comfortable that there are not going to be more surprises," said Kip Weissman, a partner at Luse, Gorman, Pomerenk & Schick, PC in Washington.
A review of call reports filed with the Federal Deposit Insurance Corp., compiled by BankRegData.com, shows that the top 100 banks and thrifts restructured $102 billion of residential mortgages in the first quarter, with some of the largest banks, including Citigroup Inc. and JPMorgan Chase & Co., restructuring as many as one in 12 mortgage loans.
Analysts say banks are on track to report an equal or larger number of residential loans as TDRs in the second quarter.
"These are sizable figures," said Brandon Bajema, an associate director at Fitch Ratings.
"Once we have the enhanced disclosures in the third quarter, we'll have a sense of whether management is doing the right thing and restructuring loans in such a way that allows them to be current."
Banks have varied widely in how they account for loan modifications and restructurings. Most TDRs are classified as nonperforming and can only be returned to performing status after a borrower has repaid under revised payment terms for a reasonable period, generally six months.
"Restructured debt is massive but all the work by banks to restructure these loans means they're just delaying the inevitable, which is a redefault," said Bill Moreland, the founder of BankRegData.com in Dallas.
Some banks have raised the white flag under pressure from regulators and have been reclassifying an ever-larger number of nonperforming loans as TDRs. Others are pouring over the guidance issued last year from the Financial Accounting Standards Board and coming up with their own interpretations.
Rick Weiss, an analyst at Janney Montgomery Scott LLC, said banks with strong balance sheets and a lot of capital are more inclined to "take the hit," and charge off a loan when it has been delinquent for 180 days, which is standard practice. But banks on the cusp may be less willing to do so and might classify a loan as a TDR.
"If it's a bank that you thought was healthy and pays a dividend and then there's an increase in TDRs, it's not positive," Weiss said.
Part of the continuing dispute between banks, accounting authorities and regulators involves whether offering a lower interest rate to a borrower that is underwater (and owes more than the value of the loan) should be classified as a restructuring.
Banks have been targeting borrowers who have interest rates about to reset on hybrid adjustable-rate mortgages, said Tim O'Brien, an analyst with Sandler O'Neill & Partners LP.
Many workouts are being done on currently performing loans and borrowers with good credit. But because the interest rate is lowered, the loan has to be classified as a troubled debt restructuring.
"This is all part of the cleanup process," O'Brien said.
In 2009, regulators issued a policy statement that enabled banks to use TDR accounting rules in working out certain problem loans. It provided banks with "the regulatory latitude" to revive loans that were essentially in default not because they were not current, but rather because of the collapse of real estate values, O'Brien said. In many cases, previous regulatory rules would have forced banks to take massive chargeoffs on such loans even when borrowers had the financial means to continue to make debt payments.
He said that policy was essential in bringing stability back to the real estate markets by allowing banks to address their credit problems in a more ordered fashion.
"Wall Street is well aware how TDRs work, and most investors appreciate a balanced approach between prompt loss recognition and the drive to recoup the maximum amount of principal and interest from a distressed loan," O'Brien said.
There's also the issue of how banks account for the impairment of a troubled debt, which is no small task for banks' finance departments. Troubled debt restructurings do not involve additional loss reserves because the loan is typically written down to its market value. Analysts also are in some disagreement as to whether the impairment taken on a troubled debt would be smaller, equal to or greater than a chargeoff.
Weissman said that in some ways, the accounting treatment puts banks at a disadvantage when considering whether to make a loan modification.
An impairment analysis "tends to be more punitive than loss reserves," and typically results in a larger loss or a mark-to-market accounting of the loan, he said.
Because regulators and investors are looking for banks to have large reserves, if a loan is classified as a TDR and is impaired there is no reserve against it.
"Banks may feel the market or regulators will force them to add reserves," Weissman said.
Christopher Wolfe, a managing director at Fitch, said he thinks banks are doing a better job of restructuring loans so their performance should show some improvement.
"We do think the transparency that will come about will be beneficial," Wolfe said.