Interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts
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DEPARTMENT OF TREASURY
Office of the Comptroller of the Currency
[Docket ID OCC-2022-0017]
FEDERAL DEPOSIT INSURANCE CORPORATION
RIN 3064-ZA33
NATIONAL CREDIT UNION ADMINISTRATION
[Docket ID NCUA-2022-0123]
Policy Statement on Prudent Commercial Real Estate Loan Accommodations and
Workouts
AGENCY: Office of the Comptroller of the Currency, Treasury; Federal Deposit
Insurance Corporation; and National Credit Union Administration.
ACTION: Proposed policy statement with request for comment.
SUMMARY: The Office of the Comptroller of the Currency (OCC), Federal Deposit
Insurance Corporation (FDIC), and National Credit Union Administration (NCUA) (the
agencies), in consultation with state bank and credit union regulators, are inviting
comment on an updated policy statement for prudent commercial real estate loan
accommodations and workouts, which would be relevant to all financial institutions
supervised by the agencies. This updated policy statement would build on existing
guidance on the need for financial institutions to work prudently and constructively with
creditworthy borrowers during times of financial stress, update existing interagency
guidance on commercial real estate loan workouts, and add a new section on short-term
loan accommodations. The updated statement also would address relevant accounting
changes on estimating loan losses and provide updated examples of how to classify and
account for loans modified or affected by loan accommodations or loan workout activity.
es of financial stress, update existing interagency
guidance on commercial real estate loan workouts, and add a new section on short-term
loan accommodations. The updated statement also would address relevant accounting
changes on estimating loan losses and provide updated examples of how to classify and
account for loans modified or affected by loan accommodations or loan workout activity.
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DATES: Comments must be received by [INSERT DATE 60 DAYS AFTER DATE OF
PUBLICATION IN THE FEDERAL REGISTER].
ADDRESSES: Interested parties are encouraged to submit written comments to any or
all of the agencies listed below. The agencies will share comments with each other.
Comments should be directed to:
OCC: You may submit comments to the OCC by any of the methods set forth below.
Commenters are encouraged to submit comments through the Federal eRulemaking
Portal, if possible. Please use the title “Interagency Policy Statement on Prudent
Commercial Real Estate Loan Workouts” to facilitate the organization and distribution of
the comments. Federal eRulemaking Portal— “Regulations.gov”: Go to
www.regulations.gov. Enter “Docket ID OCC-2022-0017” in the Search Box and click
“Search.” Click on “Comment Now” to submit public comments. For help with
submitting effective comments please click on “View Commenter’s Checklist.” Click on
the “Help” tab on the Regulations.gov home page to get information on using
Regulations.gov, including instructions for submitting public comments.
Mail: Chief Counsel’s Office, Attention: Comment Processing, Office of the
Comptroller of the Currency, 400 7th Street, SW., Suite 3E-218, Washington, DC 20219.
Hand Delivery/Courier: 400 7th Street, SW., Suite 3E-218, Washington, DC
20219.
Instructions: You must include “OCC” as the agency name and “Docket ID
OCC-2022-0017” in your comment
structions for submitting public comments.
Mail: Chief Counsel’s Office, Attention: Comment Processing, Office of the
Comptroller of the Currency, 400 7th Street, SW., Suite 3E-218, Washington, DC 20219.
Hand Delivery/Courier: 400 7th Street, SW., Suite 3E-218, Washington, DC
20219.
Instructions: You must include “OCC” as the agency name and “Docket ID
OCC-2022-0017” in your comment.
In general, the OCC will enter all comments received into the docket and publish
the comments on the Regulations.gov website without change, including any business or
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personal information provided such as name and address information, e-mail addresses,
or phone numbers. Comments received, including attachments and other supporting
materials, are part of the public record and subject to public disclosure. Do not include
any information in your comment or supporting materials that you consider confidential
or inappropriate for public disclosure.
You may review comments and other related materials that pertain to this action
by the following method:
Viewing Comments Electronically: Go to www.regulations.gov. Enter “Docket
ID OCC-2022-0017” in the Search box and click “Search.” Click on “Open
Docket Folder” on the right side of the screen. Comments and supporting
materials can be viewed and filtered by clicking on “View all documents and
comments in this docket” and then using the filtering tools on the left side of the
screen. Click on the “Help” tab on the Regulations.gov home page to get
information on using Regulations.gov. The docket may be viewed after the close
of the comment period in the same manner as during the comment period.
FDIC: You may submit comments, identified by FDIC RIN 3064-ZA33, by any of the
following methods:
Agency Website: https://www.fdic.gov/resources/regulations/federal-
register-publications/. Follow the instructions for submitting comments on
the Agency website.
Mail: James P
he docket may be viewed after the close
of the comment period in the same manner as during the comment period.
FDIC: You may submit comments, identified by FDIC RIN 3064-ZA33, by any of the
following methods:
Agency Website: https://www.fdic.gov/resources/regulations/federal-
register-publications/. Follow the instructions for submitting comments on
the Agency website.
Mail: James P. Sheesley, Assistant Executive Secretary, Attention:
Comments RIN 3064-ZA33, Federal Deposit Insurance Corporation, 550
17th Street NW, Washington, DC 20429.
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Hand Delivery/Courier: Comments may be hand-delivered to the guard
station at the rear of the 550 17th Street NW building (located on F Street
NW) on business days between 7:00 a.m. and 5:00 p.m., ET.
Email: comments@fdic.gov. Include the RIN 3064-ZA33 in the subject line
of the message.
Public Inspection: Comments received, including any personal information
provided, may be posted without change to
https://www.fdic.gov/resources/regulations/federal-register-publications/.
Commenters should submit only information that the commenter wishes to
make available publicly. The FDIC may review, redact, or refrain from
posting all or any portion of any comment that it may deem to be
inappropriate for publication, such as irrelevant or obscene material. The
FDIC may post only a single representative example of identical or
substantially identical comments, and in such cases will generally identify
the number of identical or substantially identical comments represented by
the posted example. All comments that have been redacted, as well as those
that have not been posted, that contain comments on the merits of this notice
will be retained in the public comment file and will be considered as required
under all applicable laws. All comments may be accessible under the
Freedom of Information Act.
NCUA: You may submit comments by any one of the following methods (please send
comments by one method only):
been redacted, as well as those
that have not been posted, that contain comments on the merits of this notice
will be retained in the public comment file and will be considered as required
under all applicable laws. All comments may be accessible under the
Freedom of Information Act.
NCUA: You may submit comments by any one of the following methods (please send
comments by one method only):
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Federal rulemaking Portal: http://www.regulations.gov. Follow the instructions
for submitting comments.
Mail: Address to Melane Conyers-Ausbrooks, Secretary of the Board, National
Credit Union Administration, 1775 Duke Street, Alexandria, Virginia 22314-
3428.
Hand Delivery/Courier: Same as mail address.
Public Inspection: You can view all public comments on the Federal eRulemaking Portal
at http://www.regulations.gov as submitted, except for those we cannot post for technical
reasons. NCUA will not edit or remove any identifying or contact information from the
public comments submitted. Due to social distancing measures in effect, the usual
opportunity to inspect paper copies of comments in the NCUA’s law library is not
currently available. After social distancing measures are relaxed, visitors may make an
appointment to review paper copies by calling (703) 518-6540 or e-mailing
OGCMail@ncua.gov.
FOR FURTHER INFORMATION CONTACT:
OCC: Beth Nalyvayko, Credit Risk Specialist, Bank Supervision Policy, (202) 649-
6670; or Kevin Korzeniewski, Counsel, Chief Counsel’s Office, (202) 649-5490. If you
are deaf, hard of hearing, or have a speech disability, please dial 7-1-1 to access
telecommunications relay services.
FDIC: Thomas F. Lyons, Associate Director, Risk Management Policy,
tlyons@fdic.gov, (202) 898-6850; Peter A. Martino, Senior Examination Specialist, Risk
Management Policy, pmartino@fdic.gov, (813) 973-7046 x8113, Division of Risk
Management Supervision; Gregory Feder, Counsel, gfeder@fdic.gov, (202) 898-8724; or
ech disability, please dial 7-1-1 to access
telecommunications relay services.
FDIC: Thomas F. Lyons, Associate Director, Risk Management Policy,
tlyons@fdic.gov, (202) 898-6850; Peter A. Martino, Senior Examination Specialist, Risk
Management Policy, pmartino@fdic.gov, (813) 973-7046 x8113, Division of Risk
Management Supervision; Gregory Feder, Counsel, gfeder@fdic.gov, (202) 898-8724; or
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Kate Marks, Counsel, kmarks@fdic.gov, (202) 898-3896, Supervision and Legislation
Branch, Legal Division, Federal Deposit Insurance Corporation; 550 17th Street NW,
Washington, DC 20429.
NCUA: Simon Hermann, Senior Credit Specialist, Naghi H. Khaled, Director of Credit
Markets, Office of Examination and Insurance, (703) 518-6360; Ian Marenna, Associate
General Counsel, Ariel Pereira, Senior Staff Attorney, Office of General Counsel, (703)
518-6540; or by mail at National Credit Union Administration, 1775 Duke Street,
Alexandria, VA 22314.
SUPPLEMENTARY INFORMATION:
I. Background
On October 30, 2009, the agencies, along with the Board of Governors of the
Federal Reserve System (Board), the Federal Financial Institutions Examination Council
(FFIEC) State Liaison Committee, and the former Office of Thrift Supervision, adopted
the Policy Statement on Prudent Commercial Real Estate Loan Workouts, which was
issued by the FFIEC (2009 Statement).1 The agencies view the 2009 Statement as being
useful for both agency staff and financial institutions in understanding risk management
and accounting practices for commercial real estate (CRE) loan workouts.
The agencies are proposing to update and expand the 2009 Statement by
incorporating recent policy guidance on loan accommodations and accounting
developments for estimating loan losses (proposed Statement)
e 2009 Statement as being
useful for both agency staff and financial institutions in understanding risk management
and accounting practices for commercial real estate (CRE) loan workouts.
The agencies are proposing to update and expand the 2009 Statement by
incorporating recent policy guidance on loan accommodations and accounting
developments for estimating loan losses (proposed Statement). In developing the
1 See FFIEC Press Release, October 30, 2009, available at: https://www.ffiec.gov/press/pr103009.htm; See
OCC Bulletin 2009-32 (October 30, 2009); FDIC Financial Institution Letter FIL-61-2009 (October 30,
2009); Federal Reserve Supervision and Regulation (SR) letter 09-7 (October 30, 2009); NCUA Letter to
Credit Unions 10-CU-07 (June 2010).
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proposed Statement, the agencies consulted with state bank and credit union regulators.
If finalized, the proposed Statement would supersede the 2009 Statement for all
supervised financial institutions.2
II. Overview of the Proposed Statement
The proposed Statement discusses the importance of working constructively with
CRE borrowers who are experiencing financial difficulty and would be appropriate for all
supervised financial institutions engaged in CRE lending that apply U.S. generally
accepted accounting principles (GAAP).3 The proposed Statement addresses supervisory
expectations with respect to a financial institution’s handling of loan accommodations
and loan workouts on matters including (1) risk management elements, (2) classification
of loans, (3) regulatory reporting, and (4) accounting considerations. While focused on
CRE loans, the proposed Statement includes general principles that are relevant to a
financial institution’s commercial loans that are collateralized by either real property or
other business assets (e.g., furniture, fixtures, or equipment) of a borrower
ing (1) risk management elements, (2) classification
of loans, (3) regulatory reporting, and (4) accounting considerations. While focused on
CRE loans, the proposed Statement includes general principles that are relevant to a
financial institution’s commercial loans that are collateralized by either real property or
other business assets (e.g., furniture, fixtures, or equipment) of a borrower. Additionally,
the proposed Statement would include updated references to supervisory guidance,4 and
would revise language to incorporate current industry terminology.
Prudent CRE loan accommodations and workouts are often in the best interest of
both the financial institution and the borrower. As such, and consistent with safety and
soundness standards, the proposed Statement reaffirms two key principles from the 2009
2 For purposes of this guidance, financial institutions are those supervised by the FDIC, NCUA, or OCC.
3 Federally insured credit unions with less than $10 million in assets are not required to comply with
GAAP, unless the credit union is state-chartered and GAAP compliance is mandated by state law (86 FR
34924, July 1, 2021).
4 Supervisory guidance outlines the agencies’ supervisory practices or priorities and articulates the
agencies’ general views regarding appropriate practices for a given subject area. The agencies have each
adopted regulations setting forth Statements Clarifying the Role of Supervisory Guidance. See 12 CFR 4,
subpart F (OCC); 12 CFR 302, appendix A (FDIC); and 12 CFR 791, subpart D (NCUA).
4 Supervisory guidance outlines the agencies’ supervisory practices or priorities and articulates the
agencies’ general views regarding appropriate practices for a given subject area. The agencies have each
adopted regulations setting forth Statements Clarifying the Role of Supervisory Guidance. See 12 CFR 4,
subpart F (OCC); 12 CFR 302, appendix A (FDIC); and 12 CFR 791, subpart D (NCUA).
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Statement: (1) financial institutions that implement prudent CRE loan accommodation
and workout arrangements after performing a comprehensive review of a borrower’s
financial condition will not be subject to criticism for engaging in these efforts, even if
these arrangements result in modified loans that have weaknesses that result in adverse
credit classification; and (2) modified loans to borrowers who have the ability to repay
their debts according to reasonable terms will not be subject to adverse classification
solely because the value of the underlying collateral has declined to an amount that is less
than the loan balance.
The proposed Statement includes the following changes: (1) a new section on
short-term loan accommodations; (2) information about changes in accounting principles
since 2009; and (3) revisions and additions to examples of CRE loan workouts.
Short-Term Loan Accommodations
The agencies recognize that financial institutions may benefit from the proposed
Statement’s inclusion of a discussion on the use of short-term and less complex CRE loan
accommodations before a loan requires a longer term or more complex workout scenario.
The proposed Statement would identify short-term loan accommodations as a tool that
can be used to mitigate adverse effects on borrowers and would encourage financial
institutions to work prudently with borrowers who are or may be unable to meet their
contractual payment obligations during periods of financial stress
tions before a loan requires a longer term or more complex workout scenario.
The proposed Statement would identify short-term loan accommodations as a tool that
can be used to mitigate adverse effects on borrowers and would encourage financial
institutions to work prudently with borrowers who are or may be unable to meet their
contractual payment obligations during periods of financial stress. This section of the
proposed Statement would incorporate principles consistent with existing interagency
guidance on accommodations.5
5 See Joint Statement on Additional Loan Accommodations Related to COVID-19. FIL-74-2020 (FDIC),
and Bulletin 2020-72 (OCC). See also Interagency Statement on Loan Modifications and Reporting for
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Accounting Changes
The proposed Statement also would reflect changes in GAAP since 2009,
including those in relation to current expected credit losses (CECL).6 The discussion
would align with existing regulatory reporting guidance and instructions that have also
been updated to reflect current accounting requirements under GAAP.7 In particular, the
section for Regulatory Reporting and Accounting Considerations would be modified to
include CECL references. Appendices 5 and 6 of the proposed Statement would address
the relevant accounting and regulatory guidance on estimating loan losses for financial
institutions that use the CECL methodology, or incurred loss methodology, respectively.
The agencies also note that the Financial Accounting Standards Board (FASB)
has issued ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled
Debt Restructurings and Vintage Disclosures,” which amended ASC Topic 326,
Financial Instruments – Credit Losses
mating loan losses for financial
institutions that use the CECL methodology, or incurred loss methodology, respectively.
The agencies also note that the Financial Accounting Standards Board (FASB)
has issued ASU 2022-02, “Financial Instruments - Credit Losses (Topic 326): Troubled
Debt Restructurings and Vintage Disclosures,” which amended ASC Topic 326,
Financial Instruments – Credit Losses. Once adopted, ASU 2022-02 will eliminate the
need for financial institutions to identify and account for loan modifications as troubled
debt restructuring (TDR) and will enhance disclosure requirements for certain
modifications by creditors when a borrower is experiencing financial difficulty.8 The
agencies plan to remove the TDR determination from the examples once all financial
Financial Institutions Working With Customers Affected by the Coronavirus (Revised); FIL-36-2020
(FDIC); Bulletin 2020-35 (OCC); and Joint Press Release April 7, 2020 (NCUA).
6 The Financial Accounting Standards Board’s (FASB’s) Accounting Standards Update 2016-13, Financial
Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and
subsequent amendments issued since June 2016 are codified in Accounting Standards Codification (ASC)
Topic 326, Financial Instruments – Credit Losses (FASB ASC Topic 326). FASB ASC Topic 326 revises
the accounting for the allowances for credit losses (ACLs) and introduces CECL.
7 For FDIC-insured depository institutions, the FFIEC Consolidated Reports of Condition and Income
(FFIEC Call Report); and for credit unions, the NCUA 5300 Call Report.
8 Financial institutions may only early adopt ASU 2022-02 if ASC Topic 326 is adopted. Financial
institutions that have not adopted ASC Topic 326 will continue to report TDRs and will only report in
accordance with ASU 2022-02 concurrently with the adoption of ASC Topic 326.
EC Consolidated Reports of Condition and Income
(FFIEC Call Report); and for credit unions, the NCUA 5300 Call Report.
8 Financial institutions may only early adopt ASU 2022-02 if ASC Topic 326 is adopted. Financial
institutions that have not adopted ASC Topic 326 will continue to report TDRs and will only report in
accordance with ASU 2022-02 concurrently with the adoption of ASC Topic 326.
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institutions are required to report in accordance with ASU 2022-02 and ASC Topic 326
by year-end 2023. In the interim, the agencies have modified sections of the proposed
Statement to reflect updates that have occurred pertaining to TDR accounting since 2009,
for financial institutions that are still required to report TDRs.
CRE Workout Examples
The proposed Statement would include updated information about current
industry loan workout practices and revisions to examples of CRE loan workouts. The
examples in the proposed Statement are intended to illustrate the application of existing
guidance on (1) credit classification, (2) determination of nonaccrual status, and (3)
determination of TDR status. The proposed Statement also would revise the 2009
Statement to provide Appendix 2, which contains an updated summary of selected
references to relevant supervisory guidance and accounting standards for real estate
lending, appraisals, restructured loans, fair value measurement, and regulatory reporting
matters such as a loan’s nonaccrual status.
The proposed Statement would retain information in Appendix 3 about valuation
concepts for income-producing real property included in the 2009 Statement. Further,
Appendix 4 of the proposed Statement restates the agencies’ long-standing special
mention and classification definitions that are referenced and applied in the examples in
Appendix 1
g
matters such as a loan’s nonaccrual status.
The proposed Statement would retain information in Appendix 3 about valuation
concepts for income-producing real property included in the 2009 Statement. Further,
Appendix 4 of the proposed Statement restates the agencies’ long-standing special
mention and classification definitions that are referenced and applied in the examples in
Appendix 1.
The proposed Statement would be consistent with the Interagency Guidelines
Establishing Standards for Safety and Soundness issued by the FDIC and OCC,9 which
articulate safety and soundness standards for insured depository institutions to establish
9 12 CFR part 30, appendix A (OCC); and 12 CFR part 364 appendix A (FDIC).
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and maintain prudent credit underwriting practices and to establish and maintain systems
to identify problem assets and manage deterioration in those assets commensurate with a
financial institution’s size and the nature and scope of its operations. The NCUA is
issuing this proposed Statement pursuant to its regulation in 12 CFR part 723, governing
member business loans and commercial lending, 12 CFR 741.3(b)(2) on written lending
policies that cover loan workout arrangements and nonaccrual standards, and appendix B
to 12 CFR part 741, regarding nonaccrual policy, and regulatory reporting of TDRs.10
III. Request for Comment
The agencies request comments on all aspects of the proposed Statement and
responses to the questions set forth below:
Question 1: To what extent does the proposed Statement reflect safe and sound practices
currently incorporated in a financial institution’s CRE loan accommodation and workout
activities? Should the agencies add, modify, or remove any elements, and, if so, which
and why?
Question 2: What additional information, if any, should be included to optimize the
guidance for managing CRE loan portfolios during all business cycles and why?
Question 3: Some of the principl
nd practices
currently incorporated in a financial institution’s CRE loan accommodation and workout
activities? Should the agencies add, modify, or remove any elements, and, if so, which
and why?
Question 2: What additional information, if any, should be included to optimize the
guidance for managing CRE loan portfolios during all business cycles and why?
Question 3: Some of the principles discussed in the proposed Statement are appropriate
for Commercial & Industrial (C&I) lending secured by personal property or other
business assets. Should the agencies further address C&I lending more explicitly, and if
so, how?
10 Additional guidance is available in NCUA letter to credit unions 10-CU-02 “Current Risks in Business
Lending and Sound Risk Management Practices,” issued January 2010, and in the Commercial and
Member Business Loans section of the NCUA Examiner’s Guide.
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Question 4: What additional loan workout examples or scenarios should the agencies
include or discuss? Are there examples in Appendix 1 of the proposed statement that are
not needed, and if so, why not? Should any of the examples in the proposed Statement be
revised to better reflect current practices, and if so, how?
Question 5: To what extent do the TDR examples continue to be relevant in 2023 given
that ASU 2022-02 eliminates the need for a financial institution to identify and account
for a new loan modification as a TDR?
IV. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (44 U.S.C. 3501–3521) states that no
agency may conduct or sponsor, nor is the respondent required to respond to, an
information collection unless it displays a currently valid Office of Management and
Budget (OMB) control number. The Agencies have determined that this proposed Policy
Statement does not create any new, or revise any existing, collections of information
pursuant to the Paperwork Reduction Act
521) states that no
agency may conduct or sponsor, nor is the respondent required to respond to, an
information collection unless it displays a currently valid Office of Management and
Budget (OMB) control number. The Agencies have determined that this proposed Policy
Statement does not create any new, or revise any existing, collections of information
pursuant to the Paperwork Reduction Act. Consequently, no information collection
request will be submitted to the OMB for review.
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V. Proposed Guidance
The text of the proposed Statement is as follows:
Policy Statement on Prudent Commercial Real Estate Loan Accommodations
and Workouts
The agencies1 recognize that financial institutions2 face significant challenges
when working with commercial real estate (CRE)3 borrowers who are experiencing
diminished operating cash flows, depreciated collateral values, prolonged sales and rental
absorption periods, or other issues that may hinder repayment. While borrowers may
experience deterioration in their financial condition, many continue to be creditworthy
and have the willingness and capacity to repay their debts. In such cases, financial
institutions may find it beneficial to work constructively with borrowers. Such
constructive efforts may involve loan accommodations4 or more extensive loan workout
arrangements.5
1 The Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA),
and the Office of the Comptroller of the Currency (OCC) (collectively, the agencies). This Policy
Statement was developed in consultation with state bank and credit union regulators.
2 For the purposes of this statement, financial institutions are those supervised by the FDIC, NCUA, or
OCC
1 The Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA),
and the Office of the Comptroller of the Currency (OCC) (collectively, the agencies). This Policy
Statement was developed in consultation with state bank and credit union regulators.
2 For the purposes of this statement, financial institutions are those supervised by the FDIC, NCUA, or
OCC.
3 Consistent with the FDIC and OCC joint guidance on Concentrations in Commercial Real Estate
Lending, Sound Risk Management Practices (December 2006), CRE loans include loans secured by
multifamily property, and nonfarm nonresidential property where the primary source of repayment is
derived from rental income associated with the property (that is, loans for which 50 percent or more of the
source of repayment comes from third party, nonaffiliated, rental income) or the proceeds of the sale,
refinancing, or permanent financing of the property. CRE loans also include land development and
construction loans (including 1- to 4-family residential and commercial construction loans), other land
loans, loans to real estate investment trusts (REITs), and unsecured loans to developers. For credit unions,
“commercial real estate loans” refers to “commercial loans,” as defined in Section 723.2 of the NCUA
Rules and Regulations, secured by real estate.
4 For the purposes of this statement, an accommodation includes any agreement to defer one or more
payments, make a partial payment, forbear any delinquent amounts, modify a loan or contract or provide
other assistance or relief to a borrower who is experiencing a financial challenge.
5 Workouts can take many forms, including a renewal or extension of loan terms, extension of additional
credit, or a restructuring with or without concessions.
tion includes any agreement to defer one or more
payments, make a partial payment, forbear any delinquent amounts, modify a loan or contract or provide
other assistance or relief to a borrower who is experiencing a financial challenge.
5 Workouts can take many forms, including a renewal or extension of loan terms, extension of additional
credit, or a restructuring with or without concessions.
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This statement provides a broad set of principles relevant to CRE loan
accommodations and workouts in all business cycles, particularly in challenging
economic environments. A variety of factors can drive challenging economic
environments, including economic downturns, natural disasters, and local, national, and
international events. This statement also describes how examiners will review CRE loan
accommodation and workout arrangements and provides examples of CRE workout
arrangements as well as useful references in the appendices.
The agencies have found that prudent CRE loan accommodations and workouts
are often in the best interest of the financial institution and the borrower. Examiners are
expected to take a balanced approach in assessing the adequacy of a financial institution’s
risk management practices for loan accommodation and workout activities. Consistent
with the Interagency Guidelines Establishing Standards for Safety and Soundness,6
(safety and soundness standards), financial institutions that implement prudent CRE loan
accommodation and workout arrangements after performing a comprehensive review of a
borrower’s financial condition will not be subject to criticism for engaging in these
efforts, even if these arrangements result in modified loans that have weaknesses that
result in adverse classification
and Soundness,6
(safety and soundness standards), financial institutions that implement prudent CRE loan
accommodation and workout arrangements after performing a comprehensive review of a
borrower’s financial condition will not be subject to criticism for engaging in these
efforts, even if these arrangements result in modified loans that have weaknesses that
result in adverse classification. In addition, modified loans to borrowers who have the
ability to repay their debts according to reasonable terms will not be subject to adverse
classification solely because the value of the underlying collateral has declined to an
amount that is less than the outstanding loan balance.
I. Purpose
6 12 CFR part 30, appendix A (OCC); 12 CFR part 364 appendix A (FDIC); and 12 CFR part 741.3(b)(2),
12 CFR 741, appendix B, 12 CFR 723, and NCUA letters to credit unions 10-CU-02 “Current Risks in
Business Lending and Sound Risk Management Practices” issued January 2010. Credit unions should also
refer to the Commercial and Member Business Loans section of the NCUA Examiner’s Guide.
Page 15 of 99
Consistent with the safety and soundness standards, this statement updates and
supersedes existing supervisory guidance to assist financial institutions’ efforts to modify
CRE loans to borrowers who are, or may be, unable to meet a loan’s current contractual
payment obligations or fully repay the debt.7 This statement is intended to promote
supervisory consistency among examiners, enhance the transparency of CRE loan
accommodation and workout arrangements, and ensure that supervisory policies and
actions do not inadvertently curtail the availability of credit to sound borrowers
owers who are, or may be, unable to meet a loan’s current contractual
payment obligations or fully repay the debt.7 This statement is intended to promote
supervisory consistency among examiners, enhance the transparency of CRE loan
accommodation and workout arrangements, and ensure that supervisory policies and
actions do not inadvertently curtail the availability of credit to sound borrowers.
This statement addresses prudent risk management practices regarding short-term
accommodations, risk management elements for loan workout programs, long-term loan
workout arrangements, classification of loans, and regulatory reporting and accounting
requirements and considerations. The statement also includes selected references and
materials related to regulatory reporting.8 The statement does not, however, affect
existing regulatory reporting requirements or guidance provided in relevant interagency
statements issued by the agencies or accounting requirements under U.S. generally
accepted accounting principles (GAAP). Certain principles in this statement are also
generally applicable to commercial loans that are secured by either real property or other
business assets of a commercial borrower.
Six appendices are incorporated into this statement:
Appendix 1 contains examples of CRE loan workout arrangements
illustrating the application of this statement to classification of loans, and
determination of accrual treatment.
7 This statement replaces the interagency Policy Statement on Prudent Commercial Real Estate Loan
Workouts (October 2009).
8 For banks, the FFIEC Consolidated Reports of Condition and Income (FFIEC Call Report), and for credit
unions, the NCUA 5300 Call Report.
ment to classification of loans, and
determination of accrual treatment.
7 This statement replaces the interagency Policy Statement on Prudent Commercial Real Estate Loan
Workouts (October 2009).
8 For banks, the FFIEC Consolidated Reports of Condition and Income (FFIEC Call Report), and for credit
unions, the NCUA 5300 Call Report.
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Appendix 2 lists selected relevant rules as well as supervisory and
accounting guidance for real estate lending, appraisals, allowance
methodologies,9 restructured loans, fair value measurement, and
regulatory reporting matters such as nonaccrual status. This statement is
intended to be used in conjunction with materials identified in Appendix 2
to reach appropriate conclusions regarding loan classification and
regulatory reporting.
Appendix 3 discusses valuation concepts for income-producing real
property.10
Appendix 4 provides the classification definitions used by the FDIC and
OCC.11
Appendices 5 and 6 address the relevant accounting and supervisory
guidance on estimating loan losses for financial institutions that use the
current expected credit losses (CECL) methodology, or incurred loss
methodology, respectively.
II. Short-Term Loan Accommodations
The agencies encourage financial institutions to work prudently with borrowers
who are, or may be, unable to meet their contractual payment obligations during periods
9 The allowance methodology refers to the allowance for credit losses (ACL) under Financial Accounting
Standards Board (FASB) Accounting Standards Codification (ASC) Topic 326, Financial Instruments –
Credit Losses; or allowance for loan and lease losses (ALLL) under ASC 310, Receivables and ASC
Subtopic 450-20, Contingencies – Loss Contingencies, as applicable.
10 Valuation concepts applied to regulatory reporting processes also should be consistent with ASC Topic
820, Fair Value Measurement
Standards Board (FASB) Accounting Standards Codification (ASC) Topic 326, Financial Instruments –
Credit Losses; or allowance for loan and lease losses (ALLL) under ASC 310, Receivables and ASC
Subtopic 450-20, Contingencies – Loss Contingencies, as applicable.
10 Valuation concepts applied to regulatory reporting processes also should be consistent with ASC Topic
820, Fair Value Measurement.
11 Credit unions must apply a relative credit risk score (i.e., credit risk rating) to each commercial loan as
required by 12 CFR part 723 Member Business Loans; Commercial Lending (see Section 723.4(g)(3)) or
the equivalent state regulation as applicable.
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of financial stress. Such actions may entail loan accommodations that are generally
short-term or temporary in nature but occur before a loan reaches a workout scenario.
These actions can mitigate long-term adverse effects on borrowers by allowing them to
address the issues affecting repayment capacity and are often in the best interest of
financial institutions and their borrowers.
When entering into an accommodation with a borrower, it is prudent for the
financial institution to provide clear, accurate, and timely information about the
arrangement to the borrower and any guarantor. Any such accommodation must be
consistent with applicable laws and regulations. Further, a financial institution should
employ prudent risk management practices and appropriate internal controls over such
accommodations. Failed or imprudent risk management practices and internal controls
can adversely affect borrowers, and expose a financial institution to increases in credit,
compliance, operational, or other risks. Imprudent practices that are widespread at a
financial institution may also pose risk to its capital adequacy.
Prudent risk management practices and internal controls will enable financial
institutions to identify, measure, monitor, and manage the credit risk of accommodated
loans
borrowers, and expose a financial institution to increases in credit,
compliance, operational, or other risks. Imprudent practices that are widespread at a
financial institution may also pose risk to its capital adequacy.
Prudent risk management practices and internal controls will enable financial
institutions to identify, measure, monitor, and manage the credit risk of accommodated
loans. Prudent risk management practices include developing appropriate policies and
procedures, updating and assessing financial and collateral information, maintaining
appropriate risk grading, and ensuring proper tracking and accounting for loan
accommodations. Prudent internal controls related to loan accommodations include
comprehensive policies and practices, proper management approvals, and timely and
accurate reporting and communication.
III. Loan Workout Programs
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When short-term accommodation measures are not sufficient or have not been
successful to address credit problems, the financial institutions could proceed into longer-
term or more complex loan arrangements with borrowers under a formal workout
program. Loan workout arrangements can take many forms, including, but not limited to:
Renewing or extending loan terms;
Granting additional credit to improve prospects for overall repayment; or
Restructuring12 with or without concessions.
A financial institution’s risk management practices for implementing workout
arrangements should be appropriate for the scope, complexity, and nature of the financial
institution’s lending activity. Further, these practices should be consistent with safe-and-
sound lending policies and guidance, real estate lending standards,13 and relevant
regulatory reporting requirements
thout concessions.
A financial institution’s risk management practices for implementing workout
arrangements should be appropriate for the scope, complexity, and nature of the financial
institution’s lending activity. Further, these practices should be consistent with safe-and-
sound lending policies and guidance, real estate lending standards,13 and relevant
regulatory reporting requirements. Examiners will evaluate the effectiveness of practices,
which typically address:
A prudent workout policy that establishes appropriate loan terms and
amortization schedules and that permits the financial institution to reasonably
adjust the workout plan if sustained repayment performance is not
demonstrated or if collateral values do not stabilize;14
Management infrastructure to identify, measure, and monitor the volume and
complexity of workout activity;
12 A restructuring involves a formal, legally enforceable modification in the loan’s terms.
13 12 CFR part 34, subpart D (OCC); and 12 CFR part 365 (FDIC). For NCUA, refer to 12 CFR part 723
for member business loan and commercial loan regulations which addresses commercial real estate lending
and 12 CFR part 741, Appendix B, which addresses loan workouts, nonaccrual policy, and regulatory
reporting of troubled debt restructurings.
14 Federal credit unions are reminded that in making decisions related to loan workout arrangements, they
must take into consideration any applicable maturity limits (12 CFR 701.21(c)(4)).
l loan regulations which addresses commercial real estate lending
and 12 CFR part 741, Appendix B, which addresses loan workouts, nonaccrual policy, and regulatory
reporting of troubled debt restructurings.
14 Federal credit unions are reminded that in making decisions related to loan workout arrangements, they
must take into consideration any applicable maturity limits (12 CFR 701.21(c)(4)).
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Documentation standards to verify a borrower’s creditworthiness, including
financial condition, repayment capacity, and collateral values;
Management information systems and internal controls to identify and track
loan performance and risk, including impact on concentration risk and the
allowance;
Processes designed to ensure that the financial institution’s regulatory reports
are consistent with regulatory reporting requirements;
Loan collection procedures;
Adherence to statutory, regulatory, and internal lending limits;
Collateral administration to ensure proper lien perfection of the financial
institution’s collateral interests for both real and personal property; and
An ongoing credit risk review function.
IV. Long-Term Loan Workout Arrangements
An effective loan workout arrangement should improve the lender’s prospects for
repayment of principal and interest, be consistent with sound banking and accounting
practices, and comply with applicable laws and regulations. Typically, financial
institutions consider loan workout arrangements after analyzing a borrower’s repayment
capacity, evaluating the support provided by guarantors, and assessing the value of any
collateral pledged.
Consistent with safety and soundness standards, while loans in workout
arrangements may be adversely classified, a financial institution will not be criticized for
engaging in loan workout arrangements so long as management has:
For each loan, developed a well-conceived and prudent workout plan that
ng the support provided by guarantors, and assessing the value of any
collateral pledged.
Consistent with safety and soundness standards, while loans in workout
arrangements may be adversely classified, a financial institution will not be criticized for
engaging in loan workout arrangements so long as management has:
For each loan, developed a well-conceived and prudent workout plan that
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supports the ultimate collection of principal and interest and that is based on
key elements such as:
Updated and comprehensive financial information on the borrower,
real estate project, and all guarantors and sponsors;
Current valuations of the collateral supporting the loan and the
workout plan;
Appropriate loan structure (e.g., term and amortization schedule),
covenants, and requirements for curtailment or re-margining; and
Appropriate legal analyses and agreements, including those for
changes to loan terms;
Analyzed the borrower’s global debt15 service coverage that reflects a realistic
projection of the borrower’s available cash flow;
Analyzed the available cash flow of guarantors;
Demonstrated the willingness and ability to monitor the ongoing performance
of the borrower and guarantor under the terms of the workout arrangement;
Maintained an internal risk rating or loan grading system that accurately and
consistently reflects the risk in the workout arrangement; and
Maintained an allowance methodology that calculates (or measures) an
allowance in accordance with GAAP for loans that have undergone a workout
arrangement and recognizes loan losses in a timely manner through provision
15 Global debt represents the aggregate of a borrower’s or guarantor’s financial obligations, including
contingent obligations.
an allowance methodology that calculates (or measures) an
allowance in accordance with GAAP for loans that have undergone a workout
arrangement and recognizes loan losses in a timely manner through provision
15 Global debt represents the aggregate of a borrower’s or guarantor’s financial obligations, including
contingent obligations.
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expense and enacting appropriate charge-offs.16
A. Supervisory Assessment of Repayment Capacity of Commercial Borrowers
The primary focus of an examiner’s review of a CRE loan, including binding
commitments, is an assessment of the borrower’s ability to repay the loan. The major
factors that influence this analysis are the borrower’s willingness and capacity to repay
the loan under reasonable terms and the cash flow potential of the underlying collateral or
business. When analyzing a commercial borrower’s repayment ability, examiners should
consider the following factors:
The borrower’s character, overall financial condition, resources, and payment
history;
The nature and degree of protection provided by the cash flow from business
operations or the collateral on a global basis that considers the borrower’s
total debt obligations;
Market conditions that may influence repayment prospects and the cash flow
potential of the business operations or underlying collateral; and
The prospects for repayment support from guarantors.
B. Supervisory Assessment of Guarantees and Sponsorships
Examiners should review the financial attributes of guarantees and sponsorships
in considering the loan classification
bt obligations;
Market conditions that may influence repayment prospects and the cash flow
potential of the business operations or underlying collateral; and
The prospects for repayment support from guarantors.
B. Supervisory Assessment of Guarantees and Sponsorships
Examiners should review the financial attributes of guarantees and sponsorships
in considering the loan classification. The presence of a legally enforceable guarantee
from a financially responsible guarantor may improve the prospects for repayment of the
debt obligation and may be sufficient to preclude classification or reduce the severity of
16 Additionally, if applicable, financial institutions should recognize in other liabilities an allowance for
estimated credit losses on off-balance sheet credit exposures related to restructured loans (e.g., loan
commitments) and should reverse interest accruals on loans that are deemed uncollectible.
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classification. A financially responsible guarantor possesses the financial capacity, the
demonstrated willingness, and the incentive to provide support for the loan through
ongoing payments, curtailments, or re-margining.
Examiners also review the financial attributes and economic incentives of
sponsors that support a loan. Even if not legally obligated, financially responsible
sponsors are similar to guarantors in that they may also possess the financial capacity, the
demonstrated willingness, and may have an incentive to provide support for the loan
through ongoing payments, curtailments, or re-margining.
Financial institutions that have sufficient information on the guarantor’s global
financial condition, income, liquidity, cash flow, contingent liabilities, and other relevant
factors (including credit ratings, when available) are better able to determine the
guarantor’s financial capacity to fulfill the obligation
support for the loan
through ongoing payments, curtailments, or re-margining.
Financial institutions that have sufficient information on the guarantor’s global
financial condition, income, liquidity, cash flow, contingent liabilities, and other relevant
factors (including credit ratings, when available) are better able to determine the
guarantor’s financial capacity to fulfill the obligation. An effective assessment includes
consideration of whether the guarantor has the financial capacity to fulfill the total
number and amount of guarantees currently extended by the guarantor. A similar
analysis should be made for any material sponsors that support the loan.
Examiners should consider whether a guarantor has demonstrated the willingness
to fulfill all current and previous obligations, has sufficient economic incentive, and has a
significant investment in the project. An important consideration is whether any previous
performance under its guarantee(s) was voluntary or the result of legal or other actions by
the lender to enforce the guarantee(s).
C. Supervisory Assessment of Collateral Values
As the primary sources of loan repayment decline, the importance of collateral
value as another repayment source increases when analyzing credit risk and developing
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an appropriate workout plan. Examiners will analyze real estate collateral values based
on the financial institution’s original appraisal or evaluation, any subsequent updates,
additional pertinent information (e.g., recent inspection results), and relevant market
conditions. An examiner will assess the major facts, assumptions, and valuation
approaches in the collateral valuation and their influence in the financial institution’s
credit and allowance analyses
eral values based
on the financial institution’s original appraisal or evaluation, any subsequent updates,
additional pertinent information (e.g., recent inspection results), and relevant market
conditions. An examiner will assess the major facts, assumptions, and valuation
approaches in the collateral valuation and their influence in the financial institution’s
credit and allowance analyses.
The appraisal regulations of the Federal financial institution supervisory
agencies17 require financial institutions to review appraisals for compliance with the
Uniform Standards of Professional Appraisal Practice.18 As part of that process, and
when reviewing evaluations, financial institutions should ensure that assumptions and
conclusions used are reasonable. Further, financial institutions typically have policies19
and procedures that dictate when collateral valuations should be updated as part of their
ongoing credit monitoring processes, as market conditions change, or as a borrower’s
financial condition deteriorates.20
CRE loans in workout arrangements consider current project plans and market
conditions in a new or updated appraisal or evaluation, as appropriate. In determining
whether to obtain a new appraisal or evaluation, a prudent financial institution considers
whether there has been material deterioration in the following factors: the performance of
the project; conditions for the geographic market and property type; variances between
17 The Board of Governors of the Federal Reserve System (Board), FDIC, NCUA, and OCC.
18 See 12 CFR part 34, subpart C (OCC); 12 CFR part 323 (FDIC); and 12 CFR part 722 (NCUA).
19 See 12 CFR 34.62(a) (OCC); and 12 CFR 365.2(a) (FDIC)
performance of
the project; conditions for the geographic market and property type; variances between
17 The Board of Governors of the Federal Reserve System (Board), FDIC, NCUA, and OCC.
18 See 12 CFR part 34, subpart C (OCC); 12 CFR part 323 (FDIC); and 12 CFR part 722 (NCUA).
19 See 12 CFR 34.62(a) (OCC); and 12 CFR 365.2(a) (FDIC). For NCUA, refer to 12 CFR part 723 for
member business loan and commercial loan regulations that address commercial real estate lending and 12
CFR part 741, appendix B, which addresses loan workouts, nonaccrual policy, and regulatory reporting of
troubled debt restructurings.
20 For further reference, see Interagency Appraisal and Evaluation Guidelines, 75 FR 77450 (December 10,
2010).
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actual conditions and original appraisal assumptions; changes in project specifications
(e.g., changing a planned condominium project to an apartment building); loss of a
significant lease or a take-out commitment; or increases in pre-sale fallout. A new
appraisal may not be necessary when an evaluation prepared by the financial institution
appropriately updates the original appraisal assumptions to reflect current market
conditions and provides a reasonable estimate of the collateral’s fair value.21 If new
money is advanced, financial institutions should refer to the Federal financial institution
supervisory agencies’ appraisal regulations to determine whether a new appraisal is
required.22
The market value provided by an appraisal and the fair value for accounting
purposes are based on similar valuation concepts.23 The analysis of the collateral’s
market value reflects the financial institution’s understanding of the property’s current
“as is” condition (considering the property’s highest and best use) and other relevant risk
factors affecting value
w appraisal is
required.22
The market value provided by an appraisal and the fair value for accounting
purposes are based on similar valuation concepts.23 The analysis of the collateral’s
market value reflects the financial institution’s understanding of the property’s current
“as is” condition (considering the property’s highest and best use) and other relevant risk
factors affecting value. Valuations of commercial properties may contain more than one
value conclusion and could include an “as is” market value, a prospective “as complete”
market value, and a prospective “as stabilized” market value.
Financial institutions typically use the market value conclusion (and not the fair
21 According to the FASB ASC Master Glossary, “fair value” is “the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market participants at the measurement
date.”
22 See footnote 18.
23 The term “market value” as used in an appraisal is based on similar valuation concepts as “fair value” for
accounting purposes under GAAP. For both terms, these valuation concepts about the real property and the
real estate transaction contemplate that the property has been exposed to the market before the valuation
date, the buyer and seller are well informed and acting in their own best interest (that is, the transaction is
not a forced liquidation or distressed sale), and marketing activities are usual and customary (that is, the
value of the property is unaffected by special financing or sales concessions). The market value in an
appraisal may differ from the collateral’s fair value if the values are determined as of different dates or the
fair value estimate reflects different assumptions from those in the appraisal. This may occur as a result of
changes in market conditions and property use since the “as of” date of the appraisal.
erty is unaffected by special financing or sales concessions). The market value in an
appraisal may differ from the collateral’s fair value if the values are determined as of different dates or the
fair value estimate reflects different assumptions from those in the appraisal. This may occur as a result of
changes in market conditions and property use since the “as of” date of the appraisal.
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value) that corresponds to the workout plan objective and the loan commitment. For
example, if the financial institution intends to work with the borrower so that a project
will achieve stabilized occupancy, then the financial institution can consider the “as
stabilized” market value in its collateral assessment for credit risk grading after
confirming that the appraisal’s assumptions and conclusions are reasonable. Conversely,
if the financial institution intends to foreclose, then it is more appropriate for the financial
institution to use the fair value (less costs to sell)24 of the property in its current “as is”
condition in its collateral assessment.
If weaknesses are noted in the financial institution’s supporting documentation or
appraisal or evaluation review process, examiners should direct the financial institution to
address the weaknesses, which may require the financial institution to obtain a new
collateral valuation. However, if the financial institution is unable or unwilling to
address deficiencies in a timely manner, examiners will have to assess the degree of
protection that the collateral affords when analyzing and classifying the loan. In
performing this assessment of collateral support, examiners may adjust the collateral’s
value to reflect current market conditions and events
ollateral valuation. However, if the financial institution is unable or unwilling to
address deficiencies in a timely manner, examiners will have to assess the degree of
protection that the collateral affords when analyzing and classifying the loan. In
performing this assessment of collateral support, examiners may adjust the collateral’s
value to reflect current market conditions and events. When reviewing the
reasonableness of the facts and assumptions associated with the value of an income-
producing property, examiners evaluate:
Current and projected vacancy and absorption rates;
Lease renewal trends and anticipated rents;
Effective rental rates or sale prices, considering sales and financing
concessions;
24 Costs to sell are used when the loan is dependent on the sale of the collateral. Costs to sell are not used
when the collateral-dependent loan is dependent on the operation of the collateral.
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Time frame for achieving stabilized occupancy or sellout;
Volume and trends in past due leases;
Net operating income of the property as compared with budget projections,
reflecting reasonable operating and maintenance costs; and
Discount rates and direct capitalization rates (refer to Appendix 3 for more
information).
Assumptions, when recently made by qualified appraisers (and, as appropriate, by
the financial institution) and when consistent with the discussion above, should be given
reasonable deference by examiners. Examiners should also use the appropriate market
value conclusion in their collateral assessments. For example, when the financial
institution plans to provide the resources to complete a project, examiners can consider
the project’s prospective market value and the committed loan amount in their analysis
onsistent with the discussion above, should be given
reasonable deference by examiners. Examiners should also use the appropriate market
value conclusion in their collateral assessments. For example, when the financial
institution plans to provide the resources to complete a project, examiners can consider
the project’s prospective market value and the committed loan amount in their analysis.
Examiners generally are not expected to challenge the underlying assumptions,
including discount rates and capitalization rates, used in appraisals or evaluations when
these assumptions differ only marginally from norms generally associated with the
collateral under review. The estimated value of the collateral may be adjusted for credit
analysis purposes when the examiner can establish that any underlying facts or
assumptions are inappropriate and when the examiner can support alternative
assumptions.
Many CRE borrowers may have their commercial loans secured by owner
occupied real estate or other business assets, such as inventory and accounts receivable,
or may have CRE loans also secured by furniture, fixtures, and equipment. For these
loans, the financial institution should have appropriate policies and practices for
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quantifying the value of such collateral, determining the acceptability of the assets as
collateral, and perfecting its security interests. The financial institution also should have
appropriate procedures for ongoing monitoring of this type of collateral and the financial
institution’s interests and security protection.
V. Classification of Loans
Loans that are adequately protected by the current sound worth and debt service
capacity of the borrower, guarantor, or the underlying collateral generally are not
adversely classified.25 Similarly, loans to sound borrowers that are modified in
accordance with prudent underwriting standards should not be adversely classified unless
well-defined weaknesses exist that jeopardize repayment
oans
Loans that are adequately protected by the current sound worth and debt service
capacity of the borrower, guarantor, or the underlying collateral generally are not
adversely classified.25 Similarly, loans to sound borrowers that are modified in
accordance with prudent underwriting standards should not be adversely classified unless
well-defined weaknesses exist that jeopardize repayment. However, such loans could be
flagged for management’s attention or other designated ‘‘watch lists’’ of loans that
management is more closely monitoring.
Further, examiners should not adversely classify loans solely because the
borrower is associated with a particular industry that is experiencing financial difficulties.
When a financial institution’s loan modifications are not supported by adequate analysis
and documentation, examiners are expected to exercise reasonable judgment in reviewing
and determining loan classifications until such time as the financial institution is able to
provide information to support management’s conclusions and internal loan grades.
Refer to Appendix 4 for the classification definitions.
A. Loan Performance Assessment for Classification Purposes
25 The NCUA does not require credit unions to adopt a uniform regulatory classification schematic of loss,
doubtful, or substandard. A credit union must apply a relative credit risk score (i.e., credit risk rating) to
each commercial loan as required by 12 CFR part 723, Member Business Loans; Commercial Lending, or
the equivalent state regulation as applicable (see Section 723.4(g)(3)). Adversely classified refers to loans
more severely graded under the credit union’s credit risk rating system. Adversely classified loans
generally require enhanced monitoring and present a higher risk of loss. Refer to the NCUA’s Examiner’s
Guide for further information on credit risk rating systems.
rcial Lending, or
the equivalent state regulation as applicable (see Section 723.4(g)(3)). Adversely classified refers to loans
more severely graded under the credit union’s credit risk rating system. Adversely classified loans
generally require enhanced monitoring and present a higher risk of loss. Refer to the NCUA’s Examiner’s
Guide for further information on credit risk rating systems.
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The loan’s record of performance to date should be one of several considerations
when determining whether a loan should be adversely classified. As a general principle,
examiners should not adversely classify or require the recognition of a partial charge-off
on a performing commercial loan solely because the value of the underlying collateral
has declined to an amount that is less than the loan balance. However, it is appropriate to
classify a performing loan when well-defined weaknesses exist that jeopardize
repayment.
One perspective of loan performance is based upon an assessment as to whether
the borrower is contractually current on principal or interest payments. For many loans,
this definition is sufficient and accurately portrays the status of the loan. In other cases,
being contractually current on payments can be misleading as to the credit risk embedded
in the loan. This may occur when the loan’s underwriting structure or the liberal use of
extensions and renewals masks credit weaknesses and obscures a borrower’s inability to
meet reasonable repayment terms.
For example, for many acquisition, development, and construction projects, the
loan is structured with an “interest reserve” for the construction phase of the project. At
the time the loan is originated, the lender establishes the interest reserve as a portion of
the initial loan commitment. During the construction phase, the lender recognizes
interest income from the interest reserve and capitalizes the interest into the loan balance
nt, and construction projects, the
loan is structured with an “interest reserve” for the construction phase of the project. At
the time the loan is originated, the lender establishes the interest reserve as a portion of
the initial loan commitment. During the construction phase, the lender recognizes
interest income from the interest reserve and capitalizes the interest into the loan balance.
After completion of the construction, the lender recognizes the proceeds from the sale of
lots, homes, or buildings for the repayment of principal, including any of the capitalized
interest. For a commercial construction loan where the property has achieved stabilized
occupancy, the lender uses the proceeds from permanent financing for repayment of the
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construction loan or converts the construction loan to an amortizing loan.
However, if the development project stalls and management fails to evaluate the
collectability of the loan, interest income may continue to be recognized from the interest
reserve and capitalized into the loan balance, even though the project is not generating
sufficient cash flows to repay the loan. In such cases, the loan will be contractually
current due to the interest payments being funded from the reserve, but the repayment of
principal may be in jeopardy, especially when leases or sales have not occurred as
projected and property values have dropped below the market value reported in the
original collateral valuation. In these situations, adverse classification of the loan may be
appropriate.
A second perspective for assessing a loan’s classification is to consider the
borrower’s expected performance and ability to meet its obligations in accordance with
the modified terms over the loan’s tenure. Therefore, the loan classification is meant to
measure risk over the term of the loan rather than just reflecting the loan’s payment
history
assification of the loan may be
appropriate.
A second perspective for assessing a loan’s classification is to consider the
borrower’s expected performance and ability to meet its obligations in accordance with
the modified terms over the loan’s tenure. Therefore, the loan classification is meant to
measure risk over the term of the loan rather than just reflecting the loan’s payment
history. As a borrower’s expected performance is dependent upon future events,
examiners’ credit analyses should focus on:
The borrower’s financial strength as reflected by its historical and projected
balance sheet and income statement outcomes; and
The prospects for a CRE property in light of events and market conditions that
reasonably may occur during the term of the loan.
B. Classification of Renewals or Restructurings of Maturing Loans
Loans to commercial borrowers can have short maturities, including short-term
working capital loans to businesses, financing for CRE construction projects, or loans to
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finance recently completed CRE projects for the period to achieve stabilized occupancy.
When there has been deterioration in collateral values, a borrower with a maturing loan
amid an economic downturn may have difficulty obtaining short-term financing or
adequate sources of long-term credit, despite their demonstrated and continued ability to
service the debt. In such cases, financial institutions may determine that the most
appropriate course is to restructure or renew the loans. Such actions, when done
prudently, are often in the best interest of both the financial institution and the borrower.
A restructured loan typically reflects an elevated level of credit risk, as the
borrower may not be, or has not been, able to perform according to the original
contractual terms. The assessment of each loan should be based upon the fundamental
characteristics affecting the collectability of that loan
prudently, are often in the best interest of both the financial institution and the borrower.
A restructured loan typically reflects an elevated level of credit risk, as the
borrower may not be, or has not been, able to perform according to the original
contractual terms. The assessment of each loan should be based upon the fundamental
characteristics affecting the collectability of that loan. In general, renewals or
restructurings of maturing loans to commercial borrowers who have the ability to repay
on reasonable terms will not automatically be subject to adverse classification by
examiners. However, consistent with safety and soundness standards, such loans are
identified in the financial institution’s internal credit grading system and may warrant
close monitoring. Adverse classification of a renewed or restructured loan would be
appropriate, if, despite the renewal or restructuring, well-defined weaknesses exist that
jeopardize the orderly repayment of the loan pursuant to reasonable modified terms.
C. Classification of Troubled CRE Loans Dependent on the Sale of Collateral for
Repayment
As a general classification principle for a troubled CRE loan that is dependent on
the sale of the collateral for repayment, any portion of the loan balance that exceeds the
amount that is adequately secured by the fair value of the real estate collateral less the
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costs to sell should be classified “loss.” This principle applies to loans that are collateral
dependent based on the sale of the collateral in accordance with GAAP and there are no
other available reliable sources of repayment such as a financially capable guarantor.26
The portion of the loan balance that is adequately secured by the fair value of the
real estate collateral less the costs to sell generally should be adversely classified no
worse than “substandard.” The amount of the loan balance in excess of the fair value of
the real estate collateral, or portions thereof, should be adversely classified “doubtful
such as a financially capable guarantor.26
The portion of the loan balance that is adequately secured by the fair value of the
real estate collateral less the costs to sell generally should be adversely classified no
worse than “substandard.” The amount of the loan balance in excess of the fair value of
the real estate collateral, or portions thereof, should be adversely classified “doubtful”
when the potential for full loss may be mitigated by the outcomes of certain pending
events, or when loss is expected but the amount of the loss cannot be reasonably
determined. If warranted by the underlying circumstances, an examiner may use a
“doubtful” classification on the entire loan balance. However, examiners should use a
“doubtful” classification infrequently and for a limited time period to permit the pending
events to be resolved.
D. Classification and Accrual Treatment of Restructured Loans with a Partial Charge-
off
Based on consideration of all relevant factors, an assessment may indicate that a
loan has well-defined weaknesses that jeopardize collection in full of all amounts
contractually due and may result in a partial charge-off as part of a restructuring. When
well-defined weaknesses exist and a partial charge-off has been taken, the remaining
recorded balance for the restructured loan generally should be classified no more severely
26 Under ASC Topic 310, applicable for financial institutions reporting an ALLL, a loan is collateral
dependent if repayment of the loan is expected to be provided solely by sale or operation of the collateral.
Under ASC Topic 326, applicable for financial institutions reporting an ACL, a loan is collateral dependent
when the repayment is expected to be provided substantially through the operation or sale of the collateral
when the borrower is experiencing financial difficulty based on the entity’s assessment as of the reporting
date.
ed to be provided solely by sale or operation of the collateral.
Under ASC Topic 326, applicable for financial institutions reporting an ACL, a loan is collateral dependent
when the repayment is expected to be provided substantially through the operation or sale of the collateral
when the borrower is experiencing financial difficulty based on the entity’s assessment as of the reporting
date.
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than “substandard.” A more severe classification than “substandard” for the remaining
recorded balance would be appropriate if the loss exposure cannot be reasonably
determined. Such situations may occur where significant remaining risk exposures are
identified but are not quantified, such as bankruptcy or a loan collateralized by a property
with potential environmental concerns.
A restructuring may involve a multiple note structure in which, for example, a
troubled loan is restructured into two notes. Lenders may separate a portion of the
current outstanding debt into a new, legally enforceable note (i.e., Note A) that is
reasonably assured of repayment and performance according to prudently modified
terms. This note may be placed back on accrual status in certain situations. In returning
the loan to accrual status, sustained historical payment performance for a reasonable time
prior to the restructuring may be taken into account. Additionally, a properly structured
and performing “Note A” generally would not be adversely classified by examiners. The
portion of the debt that is not reasonably assured of repayment (i.e., Note B) must be
adversely classified and charged-off.
In contrast, the loan should remain on, or be placed on, nonaccrual status if the
lender does not split the loan into separate notes, but internally recognizes a partial
charge-off. A partial charge-off would indicate that the financial institution does not
expect full repayment of the amounts contractually due
assured of repayment (i.e., Note B) must be
adversely classified and charged-off.
In contrast, the loan should remain on, or be placed on, nonaccrual status if the
lender does not split the loan into separate notes, but internally recognizes a partial
charge-off. A partial charge-off would indicate that the financial institution does not
expect full repayment of the amounts contractually due. If facts change after the charge-
off is taken such that the full amounts contractually due, including the amount charged
off, are expected to be collected and the loan has been brought contractually current, the
remaining balance of the loan may be returned to accrual status without having to first
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receive payment of the charged-off amount.27 In these cases, examiners should assess
whether the financial institution has well-documented support for its credit assessment of
the borrower’s financial condition and the prospects for full repayment.
VI. Regulatory Reporting and Accounting Considerations
Financial institution management is responsible for preparing regulatory reports
in accordance with GAAP and regulatory reporting requirements. Management also is
responsible for establishing and maintaining an appropriate governance and internal
control structure over the preparation of regulatory reports. The agencies have observed
this governance and control structure commonly includes policies and procedures that
provide clear guidelines on accounting matters. Accurate regulatory reports are critical to
the transparency of a financial institution’s financial position and risk profile and
imperative for effective supervision. Decisions related to loan workout arrangements
may affect regulatory reporting, particularly interest accruals, and loan loss estimates
only includes policies and procedures that
provide clear guidelines on accounting matters. Accurate regulatory reports are critical to
the transparency of a financial institution’s financial position and risk profile and
imperative for effective supervision. Decisions related to loan workout arrangements
may affect regulatory reporting, particularly interest accruals, and loan loss estimates.
Therefore, it is important that loan workout staff appropriately communicate with the
accounting and regulatory reporting staff concerning the financial institution’s loan
restructurings and that the reporting consequences of restructurings are presented
accurately in regulatory reports.
In addition to evaluating credit risk management processes and validating the
accuracy of internal loan grades, examiners are responsible for reviewing management’s
processes related to accounting and regulatory reporting. While similar data are used for
27 The charged-off amount should not be reversed or re-booked, under any condition, to increase the
recorded investment in the loan or its amortized costs, as applicable, when the loan is returned to accrual
status. However, expected recoveries, prior to collection, are a component of management’s estimate of the
net amount expected to be collected for a loan under ASC Topic 326. Refer to relevant regulatory
reporting instructions for guidance on returning a loan to accrual status.
se the
recorded investment in the loan or its amortized costs, as applicable, when the loan is returned to accrual
status. However, expected recoveries, prior to collection, are a component of management’s estimate of the
net amount expected to be collected for a loan under ASC Topic 326. Refer to relevant regulatory
reporting instructions for guidance on returning a loan to accrual status.
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loan risk monitoring, accounting, and reporting systems, this information does not
necessarily produce identical outcomes. For example, loss classifications may not be
equivalent to the associated allowance measurements.
A. Allowance for Credit Losses
Examiners need to have a clear understanding of the differences between credit
risk management and accounting and regulatory reporting concepts (such as accrual
status, restructurings, and the allowance) when assessing the adequacy of the financial
institution’s reporting practices for on- and off-balance sheet credit exposures. Refer to
the appropriate Appendix that provides a summary of the allowance standards under the
incurred loss methodology (Appendix 6) or the CECL methodology for institutions that
have adopted ASC Topic 326, Financial Instruments – Credit Losses (Appendix 5).
Examiners should also refer to regulatory reporting instructions in the FFIEC Call Report
and the NCUA 5300 Call Report guidance and applicable GAAP for further information.
B. Implications for Interest Accrual
A financial institution needs to consider whether a loan that was accruing interest
prior to the loan restructuring should be placed in nonaccrual status at the time of
modification to ensure that income is not materially overstated. Consistent with Call
Report Instructions, a loan that has been restructured so as to be reasonably assured of
repayment and performance according to prudent modified terms need not be placed in
nonaccrual status
loan that was accruing interest
prior to the loan restructuring should be placed in nonaccrual status at the time of
modification to ensure that income is not materially overstated. Consistent with Call
Report Instructions, a loan that has been restructured so as to be reasonably assured of
repayment and performance according to prudent modified terms need not be placed in
nonaccrual status. Therefore, for a loan to remain on accrual status, the restructuring and
any charge-off taken on the loan have to be supported by a current, well-documented
credit assessment of the borrower’s financial condition and prospects for repayment
under the revised terms. Otherwise, in accordance with outstanding Call Report
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instructions, the restructured loan must be placed in nonaccrual status.
A restructured loan placed in nonaccrual status should not be returned to accrual
status until the borrower demonstrates a period of sustained repayment performance for a
reasonable period prior to the date on which the loan is returned to accrual status. A
sustained period of repayment performance generally would be a minimum of six months
and would involve payments of cash or cash equivalents. It may also include historical
periods prior to the date of the loan restructuring. While an appropriately designed
restructuring should improve the collectability of the loan in accordance with a
reasonable repayment schedule, it does not relieve the financial institution from the
responsibility to promptly charge off all identified losses. For more detailed instructions
about placing a loan in nonaccrual status and returning a nonaccrual loan to accrual
status, refer to the instructions for the FFIEC Call Report and the NCUA 5300 Call
Report.
ility of the loan in accordance with a
reasonable repayment schedule, it does not relieve the financial institution from the
responsibility to promptly charge off all identified losses. For more detailed instructions
about placing a loan in nonaccrual status and returning a nonaccrual loan to accrual
status, refer to the instructions for the FFIEC Call Report and the NCUA 5300 Call
Report.
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Appendix 1
Examples of CRE Loan Workout Arrangements
The examples in this Appendix are provided for illustrative purposes only and are
designed to demonstrate an examiner’s analytical thought process to derive an
appropriate classification and evaluate implications for interest accrual and appropriate
regulatory reporting, such as whether a loan should be reported as a troubled debt
restructuring (TDR).28 Although not discussed in the examples below, examiners
consider the adequacy of a lender’s supporting documentation, internal analysis, and
business decision to enter into a loan workout arrangement. The examples also do not
address the effect of the loan workout arrangement on the allowance and subsequent
reporting requirements.
Examiners should use caution when applying these examples to “real-life”
situations, consider all facts and circumstances of the loan being evaluated, and exercise
judgment before reaching conclusions related to loan classifications, accrual treatment,
and TDR reporting.29
The TDR determination requires consideration of all of the facts and
circumstances surrounding the modification. No single factor, by itself, is determinative
of whether a modification is a TDR. To make this determination, the lender assesses
whether (a) the borrower is experiencing financial difficulties and (b) the lender has
granted a concession
accrual treatment,
and TDR reporting.29
The TDR determination requires consideration of all of the facts and
circumstances surrounding the modification. No single factor, by itself, is determinative
of whether a modification is a TDR. To make this determination, the lender assesses
whether (a) the borrower is experiencing financial difficulties and (b) the lender has
granted a concession. For purposes of these examples, if the borrower was not
28 The agencies view that the accrual treatments in these examples as falling within the range of acceptable
practices under regulatory reporting instructions.
29 In addition, estimates of the fair value of collateral require the use of assumptions requiring judgment and
should be consistent with measurement of fair value in ASC Topic 820, Fair Value Measurement; see
Appendix 2.
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experiencing financial difficulties, the example does not assess whether a concession was
granted. However, in distressed situations, lenders may make concessions because
borrowers are experiencing financial difficulties. Accordingly, lenders and examiners
should exercise judgment in evaluating whether a restructuring is a TDR. In addition,
some examples refer to disclosures of TDRs, which pertain only to the reporting in
Schedules RC-C or RC-N of the Call Report or Schedule A, Section 2 of NCUA Form
5300 and not the applicable measurement in determining an appropriate allowance
pursuant to the accounting standards.
A. Income Producing Property – Office Building
BASE CASE: A lender originated a $15 million loan for the purchase of an office
building with monthly payments based on an amortization of 20 years and a balloon
payment of $13.6 million at the end of year five
n 2 of NCUA Form
5300 and not the applicable measurement in determining an appropriate allowance
pursuant to the accounting standards.
A. Income Producing Property – Office Building
BASE CASE: A lender originated a $15 million loan for the purchase of an office
building with monthly payments based on an amortization of 20 years and a balloon
payment of $13.6 million at the end of year five. At origination, the loan had a 75
percent loan-to-value (LTV) based on an appraisal reflecting a $20 million market value
on an “as stabilized” basis, a debt service coverage (DSC) ratio of 1.30x, and a market
interest rate. The lender expected to renew the loan when the balloon payment became
due at the end of year five. Due to technological advancements and a workplace culture
change since the inception of the loan, many businesses switched to hybrid work-from-
home arrangements to reduce longer-term costs and improve employee retention. As a
result, the property’s cash flow declined as the borrower has had to grant rental
concessions to either retain its existing tenants or attract new tenants, since the demand
for office space has decreased.
SCENARIO 1: At maturity, the lender renewed the $13.6 million loan for one year at a
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market interest rate that provides for the incremental risk and payments based on
amortizing the principal over the remaining 15 years. The borrower had not been
delinquent on prior payments and has sufficient cash flow to service the loan at the
market interest rate terms with a DSC ratio of 1.12x, based on updated financial
information.
A review of the leases reflects that most tenants are stable occupants, with long-term
leases and sufficient cash flow to pay their rent. The major tenants have not adopted
hybrid work-from-home arrangements for their employees given the nature of the
businesses. A recent appraisal reported an “as stabilized” market value of $13.3 million
for the property for an LTV of 102 percent
ormation.
A review of the leases reflects that most tenants are stable occupants, with long-term
leases and sufficient cash flow to pay their rent. The major tenants have not adopted
hybrid work-from-home arrangements for their employees given the nature of the
businesses. A recent appraisal reported an “as stabilized” market value of $13.3 million
for the property for an LTV of 102 percent. This reflects current market conditions and
the resulting decline in cash flow.
Classification: The lender internally graded the loan pass and is monitoring the
credit. The examiner agreed, because the borrower has the ability to continue making
loan payments based on reasonable terms, despite a decline in cash flow and in the
market value of the collateral.
Nonaccrual Treatment: The lender maintained the loan on accrual status. The
borrower has demonstrated the ability to make the regularly scheduled payments and,
even with the decline in the borrower’s creditworthiness, cash flow appears sufficient
to make these payments, and full repayment of principal and interest is expected. The
examiner concurred with the lender’s accrual treatment.
TDR Treatment: The lender determined that the renewed loan should not be reported
as a TDR. While the borrower is experiencing some financial deterioration, the
borrower has sufficient cash flow to service the debt and has no record of payment
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default; therefore, the borrower is not experiencing financial difficulties. The
examiner concurred with the lender’s TDR treatment.
SCENARIO 2: At maturity, the lender renewed the $13.6 million loan at a market
interest rate that provides for the incremental risk and payments based on amortizing the
principal over the remaining 15 years. The borrower had not been delinquent on prior
payments. Current projections indicate the DSC ratio will not drop below 1.12x based on
leases in place and letters of intent for vacant space
NARIO 2: At maturity, the lender renewed the $13.6 million loan at a market
interest rate that provides for the incremental risk and payments based on amortizing the
principal over the remaining 15 years. The borrower had not been delinquent on prior
payments. Current projections indicate the DSC ratio will not drop below 1.12x based on
leases in place and letters of intent for vacant space. However, some leases are coming
up for renewal, and additional rental concessions may be necessary to either retain those
existing tenants or attract new tenants. The lender estimates the property’s current “as
stabilized” market value is $14.5 million, which results in a 94 percent LTV, but a current
valuation has not been ordered. In addition, the lender has not asked the borrower or
guarantors to provide current financial statements to assess their ability to support any
cash flow shortfall.
Classification: The lender internally graded the loan pass and is monitoring the
credit. The examiner disagreed with the internal grade and listed the credit as special
mention. While the borrower has the ability to continue to make payments based on
leases currently in place and letters of intent for vacant space, there has been a
declining trend in the property’s revenue stream, and there is most likely a reduced
collateral margin. In addition, there is potential for further deterioration in the cash
flow as more leases will expire in the upcoming months, while absorption for office
space in this market has slowed. Lastly, the examiner noted that the lender failed to
ters of intent for vacant space, there has been a
declining trend in the property’s revenue stream, and there is most likely a reduced
collateral margin. In addition, there is potential for further deterioration in the cash
flow as more leases will expire in the upcoming months, while absorption for office
space in this market has slowed. Lastly, the examiner noted that the lender failed to
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request current financial information and to obtain an updated collateral valuation,30
representing administrative weaknesses.
Nonaccrual Treatment: The lender maintained the loan on accrual status. The
borrower has demonstrated the ability to make regularly scheduled payments and,
even with the decline in the borrower’s creditworthiness, cash flow is sufficient at this
time to make payments, and full repayment of principal and interest is expected. The
examiner concurred with the lender’s accrual treatment.
TDR Treatment: The lender determined that the renewed loan should not be reported
as a TDR. While the borrower is experiencing some financial deterioration, the
borrower is not experiencing financial difficulties as the borrower has sufficient cash
flow to service the debt, and there is no history of default. The examiner concurred
with the lender’s TDR treatment.
SCENARIO 3: At maturity, the lender restructured the $13.6 million loan on a 12-
month interest-only basis at a below market interest rate. The borrower has been
sporadically delinquent on prior principal and interest payments. The borrower projects a
DSC ratio of 1.10x based on the restructured interest-only terms. A review of the rent
roll, which was available to the lender at the time of the restructuring, reflects the
majority of tenants have short-term leases, with three leases expected to expire within the
next three months. According to the lender, leasing has not improved since the
restructuring as market conditions remain soft
a
DSC ratio of 1.10x based on the restructured interest-only terms. A review of the rent
roll, which was available to the lender at the time of the restructuring, reflects the
majority of tenants have short-term leases, with three leases expected to expire within the
next three months. According to the lender, leasing has not improved since the
restructuring as market conditions remain soft. Further, the borrower does not have an
update as to whether the three expiring leases will renew at maturity; two of the tenants
30 In relation to comments on valuations within these examples, refer to the appraisal regulations of the
applicable Federal financial institution supervisory agency to determine whether there is a regulatory
requirement for either an evaluation or appraisal. See footnote 18.
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have moved to hybrid work-from-home arrangements. A recent appraisal provided a
$14.5 million “as stabilized” market value for the property, resulting in a 94 percent
LTV.
Classification: The lender internally graded the loan pass and is monitoring the
credit. The examiner disagreed with the internal grade and classified the loan
substandard due to the borrower’s limited ability to service a below market interest
rate loan on an interest-only basis, sporadic delinquencies, and an increase in the LTV
based on an updated appraisal. In addition, there is lease rollover risk because three
of the leases are expiring soon, which could further limit cash flow.
Nonaccrual Treatment: The lender maintained the loan on accrual status due to the
positive cash flow and collateral margin. The examiner did not concur with this
treatment as the loan was not restructured with reasonable repayment terms, and the
borrower has not demonstrated the ability to amortize the loan and has limited
capacity to service a below market interest rate on an interest-only basis
crual Treatment: The lender maintained the loan on accrual status due to the
positive cash flow and collateral margin. The examiner did not concur with this
treatment as the loan was not restructured with reasonable repayment terms, and the
borrower has not demonstrated the ability to amortize the loan and has limited
capacity to service a below market interest rate on an interest-only basis. After a
discussion with the examiner on regulatory reporting requirements, the lender placed
the loan on nonaccrual.
TDR Treatment: The lender reported the restructured loan as a TDR because the
borrower is experiencing financial difficulties (the project’s ongoing ability to
generate sufficient cash flow to service the debt is questionable as lease income is
declining, loan payments have been sporadic, leases are expiring with uncertainty as
to renewal or replacement, and collateral values have declined) and the lender granted
a concession by reducing the interest rate to a below market level and deferring
principal payments. The examiner concurred with the lender’s TDR treatment.
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B. Income Producing Property – Retail Properties
BASE CASE: A lender originated a 36-month, $10 million loan for the construction of a
shopping mall. The construction period was 24 months with a 12-month lease-up period
to allow the borrower time to achieve stabilized occupancy before obtaining permanent
financing. The loan had an interest reserve to cover interest payments over the three-year
term. At the end of the third year, there is $10 million outstanding on the loan, as the
shopping mall has been built and the interest reserve, which has been covering interest
payments, has been fully drawn.
At the time of origination, the appraisal reported an “as stabilized” market value of $13.5
million for the property. In addition, the borrower had a take-out commitment that would
provide permanent financing at maturity
there is $10 million outstanding on the loan, as the
shopping mall has been built and the interest reserve, which has been covering interest
payments, has been fully drawn.
At the time of origination, the appraisal reported an “as stabilized” market value of $13.5
million for the property. In addition, the borrower had a take-out commitment that would
provide permanent financing at maturity. A condition of the take-out lender was that the
shopping mall had to achieve a 75 percent occupancy level.
Due to weak economic conditions and a shift in consumer behavior to a greater reliance
on e-commerce, the property only reached a 55 percent occupancy level at the end of the
12-month lease up period. As a result, the original takeout commitment became void. In
addition, there has been a considerable tightening of credit for these types of loans, and
the borrower has been unable to obtain permanent financing elsewhere since the loan
matured. To date, the few interested lenders are demanding significant equity
contributions and much higher pricing.
SCENARIO 1: The lender renewed the loan for an additional 12 months to provide the
borrower time for higher lease-up and to obtain permanent financing. The extension was
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made at a market interest rate that provides for the incremental risk and is on an interest-
only basis. While the property’s historical cash flow was insufficient at a 0.92x debt
service ratio, recent improvements in the occupancy level now provide adequate coverage
based on the interest-only payments. Recent events include the signing of several new
leases with additional leases under negotiation; however, takeout financing continues to
be tight in the market.
In addition, current financial statements reflect that the builder, who personally
guarantees the debt, has cash on deposit at the lender plus other unencumbered liquid
assets
adequate coverage
based on the interest-only payments. Recent events include the signing of several new
leases with additional leases under negotiation; however, takeout financing continues to
be tight in the market.
In addition, current financial statements reflect that the builder, who personally
guarantees the debt, has cash on deposit at the lender plus other unencumbered liquid
assets. These assets provide sufficient cash flow to service the borrower’s global debt
service requirements on a principal and interest basis, if necessary, for the next 12
months. The guarantor covered the initial cash flow shortfalls from the project and
provided a good faith principal curtailment of $200,000 at renewal, reducing the loan
balance to $9.8 million. A recent appraisal on the shopping mall reports an “as is”
market value of $10 million and an “as stabilized” market value of $11 million, resulting
in LTVs of 98 percent and 89 percent, respectively.
Classification: The lender internally graded the loan as a pass and is monitoring the
credit. The examiner disagreed with the lender’s internal loan grade and listed it as
special mention. While the project continues to lease up, cash flows cover only the
interest payments. The guarantor has the ability, and has demonstrated the
willingness, to cover cash flow shortfalls; however, there remains considerable
uncertainty surrounding the takeout financing for this type of loan.
Nonaccrual Treatment: The lender maintained the loan on accrual status as the
guarantor has sufficient funds to cover the borrower’s global debt service
cover only the
interest payments. The guarantor has the ability, and has demonstrated the
willingness, to cover cash flow shortfalls; however, there remains considerable
uncertainty surrounding the takeout financing for this type of loan.
Nonaccrual Treatment: The lender maintained the loan on accrual status as the
guarantor has sufficient funds to cover the borrower’s global debt service
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requirements over the one-year period of the renewed loan. Full repayment of
principal and interest is reasonably assured from the project’s and guarantor’s cash
resources, despite a decline in the collateral margin. The examiner concurred with
the lender’s accrual treatment.
TDR Treatment: The lender concluded that while the borrower has been affected by
declining economic conditions and a shift to e-commerce, the deterioration has not
led to financial difficulties. The borrower was not experiencing financial difficulties
because the borrower and guarantor have the ability to service the renewed loan,
which was underwritten at a market interest rate, plus the borrower’s other
obligations on a timely basis. In addition, the lender expects to collect the full
amount of principal and interest from the borrower’s or guarantor’s cash sources (i.e.,
not from interest reserves). Therefore, the lender is not treating the loan renewal as a
TDR. The examiner concurred with the lender’s rationale that the loan renewal is not
a TDR.
SCENARIO 2: The lender restructured the loan on an interest-only basis at a below
market interest rate for one year to provide additional time to increase the occupancy
level and, thereby, enable the borrower to arrange permanent financing. The level of
lease-up remains relatively unchanged at 55 percent, and the shopping mall projects a
DSC ratio of 1.02x based on the preferential loan terms. At the time of the restructuring,
the lender used outdated financial information, which resulted in a positive cash flow
projection
al time to increase the occupancy
level and, thereby, enable the borrower to arrange permanent financing. The level of
lease-up remains relatively unchanged at 55 percent, and the shopping mall projects a
DSC ratio of 1.02x based on the preferential loan terms. At the time of the restructuring,
the lender used outdated financial information, which resulted in a positive cash flow
projection. However, other file documentation available at the time of the restructuring
reflected that the borrower anticipates the shopping mall’s revenue stream will further
decline due to rent concessions, the loss of a tenant, and limited prospects for finding new
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tenants.
Current financial statements indicate the builder, who personally guarantees the debt,
cannot cover any cash flow shortfall. The builder is highly leveraged, has limited cash or
unencumbered liquid assets, and has other projects with delinquent payments. A recent
appraisal on the shopping mall reports an “as is” market value of $9 million, which
results in an LTV ratio of 111 percent.
Classification: The lender internally classified the loan as substandard. The
examiner disagreed with the internal grade and classified the amount not protected by
the collateral value, $1 million, as loss and required the lender to charge-off this
amount. The examiner did not factor costs to sell into the loss classification analysis,
as the current source of repayment is not reliant on the sale of the collateral. The
examiner classified the remaining loan balance, based on the property’s “as is”
market value of $9 million, as substandard given the borrower’s uncertain repayment
capacity and weak financial support.
Nonaccrual Treatment: The lender determined the loan did not warrant being placed
in nonaccrual status
s,
as the current source of repayment is not reliant on the sale of the collateral. The
examiner classified the remaining loan balance, based on the property’s “as is”
market value of $9 million, as substandard given the borrower’s uncertain repayment
capacity and weak financial support.
Nonaccrual Treatment: The lender determined the loan did not warrant being placed
in nonaccrual status. The examiner did not concur with this treatment because the
partial charge-off is indicative that full collection of principal is not anticipated, and
the lender has continued exposure to additional loss due to the project’s insufficient
cash flow and reduced collateral margin and the guarantor’s inability to provide
further support. After a discussion with the examiner on regulatory reporting
requirements, the lender placed the loan on nonaccrual.
TDR Treatment: The lender reported the restructured loan as a TDR because (a) the
borrower is experiencing financial difficulties as evidenced by the high leverage,
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delinquent payments on other projects, and inability to meet the proposed exit
strategy because of the inability to lease the property in a reasonable timeframe; and
(b) the lender granted a concession as evidenced by the reduction in the interest rate
to a below market interest rate. The examiner concurred with the lender’s TDR
treatment.
SCENARIO 3: The loan has become delinquent. Recent financial statements indicate
the borrower and the guarantor have minimal other resources available to support this
loan. The lender chose not to restructure the $10 million loan into a new single
amortizing note of $10 million at a market interest rate because the project’s projected
cash flow would only provide a 0.88x DSC ratio as the borrower has been unable to lease
space. A recent appraisal on the shopping mall reported an “as is” market value of $7
million, which results in an LTV of 143 percent
s
loan. The lender chose not to restructure the $10 million loan into a new single
amortizing note of $10 million at a market interest rate because the project’s projected
cash flow would only provide a 0.88x DSC ratio as the borrower has been unable to lease
space. A recent appraisal on the shopping mall reported an “as is” market value of $7
million, which results in an LTV of 143 percent.
At the original loan’s maturity, the lender restructured the $10 million debt into two
notes. The lender placed the first note of $7 million (i.e., the Note A) on monthly
payments that amortize the debt over 20 years at a market interest rate that provides for
the incremental risk. The project’s DSC ratio equals 1.20x for the $7 million loan based
on the shopping mall’s projected net operating income. The lender then charged-off the
$3 million note due to the project’s lack of repayment capacity and to provide reasonable
collateral protection for the remaining on-book loan of $7 million. The lender also
reversed accrued but unpaid interest. The lender placed the second note (i.e., the Note B)
consisting of the charged-off principal balance of $3 million into a 2 percent interest-only
loan that resets in five years into an amortizing payment. Since the restructuring, the
borrower has made payments on both loans for more than six consecutive months and an
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updated financial analysis shows continued ability to repay under the new terms.
Classification: The lender internally graded the on-book loan of $7 million as a pass
loan due to the borrower’s demonstrated ability to perform under the modified terms.
The examiner agreed with the lender’s grade as the lender restructured the original
obligation into Notes A and B, the lender charged off Note B, and the borrower has
demonstrated the ability to repay Note A
the new terms.
Classification: The lender internally graded the on-book loan of $7 million as a pass
loan due to the borrower’s demonstrated ability to perform under the modified terms.
The examiner agreed with the lender’s grade as the lender restructured the original
obligation into Notes A and B, the lender charged off Note B, and the borrower has
demonstrated the ability to repay Note A. Using this multiple note structure with
charge-off of the Note B enables the lender to recognize interest income and limit the
amount reported as a TDR in future periods.
Nonaccrual Treatment: The lender placed the on-book loan (Note A) of $7 million
loan in nonaccrual status at the time of the restructure. The lender later restored the
$7 million to accrual status as the borrower has the ability to repay the loan, has a
record of performing at the revised terms for more than six months, and full
repayment of principal and interest is expected. The examiner concurred with the
lender’s accrual treatment. Interest payments received on the off-book loan have
been recorded as recoveries because full recovery of principal and interest on this
loan (Note B) was not reasonably assured.
TDR Treatment: The lender considered both Note A and Note B as TDRs because
the borrower is experiencing financial difficulties and the lender granted a concession.
The lender reported the restructured on-book loan (Note A) of $7 million as a TDR,
while the second loan (Note B) was charged off. The financial difficulties are
evidenced by the borrower’s high leverage, delinquent payments on other projects,
inability to lease the property in a reasonable timeframe, and the unlikely
collectability of the charged-off loan (Note B). The concessions on Note A include
r reported the restructured on-book loan (Note A) of $7 million as a TDR,
while the second loan (Note B) was charged off. The financial difficulties are
evidenced by the borrower’s high leverage, delinquent payments on other projects,
inability to lease the property in a reasonable timeframe, and the unlikely
collectability of the charged-off loan (Note B). The concessions on Note A include
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extending the on-book loan beyond expected timeframes.
The lender plans to stop disclosing the on-book loan as a TDR after the regulatory
reporting defined time period expires because the loan was restructured with a market
interest rate and is in compliance with its modified terms.31 The examiner agreed
with the lender’s TDR treatment.
SCENARIO 4: Current financial statements indicate the borrower and the guarantor
have minimal other resources available to support this loan. The lender restructured the
$10 million loan into a new single note of $10 million at a market interest rate that
provides for the incremental risk and is on an amortizing basis. The project’s projected
cash flow reflects a 0.88x DSC ratio as the borrower has been unable to lease space. A
recent appraisal on the shopping mall reports an “as is” market value of $9 million, which
results in an LTV of 111 percent. Based on the property’s current market value of $9
million, the lender charged-off $1 million immediately after the renewal.
Classification: The lender internally graded the remaining $9 million on-book
portion of the loan as a pass loan because the lender’s analysis of the project’s cash
flow indicated a 1.05x DSC ratio when just considering the on-book balance. The
examiner disagreed with the internal grade and classified the $9 million on-book
balance as substandard due to the borrower’s marginal financial condition, lack of
guarantor support, and uncertainty over the source of repayment. The DSC ratio
remains at 0.88x due to the single note restructure, and other resources are scant
ted a 1.05x DSC ratio when just considering the on-book balance. The
examiner disagreed with the internal grade and classified the $9 million on-book
balance as substandard due to the borrower’s marginal financial condition, lack of
guarantor support, and uncertainty over the source of repayment. The DSC ratio
remains at 0.88x due to the single note restructure, and other resources are scant.
Nonaccrual Treatment: The lender maintained the remaining $9 million on-book
portion of the loan on accrual, as the borrower has the ability to repay the principal
31 Refer to the guidance on “Troubled debt restructurings” in the FFIEC Call Report and NCUA 5300 Call
Report instructions.
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and interest on this balance. The examiner did not concur with this treatment.
Because the lender restructured the debt into a single note and had charged-off a
portion of the restructured loan, the repayment of the principal and interest
contractually due on the entire debt is not reasonably assured given the DSC ratio of
0.88x and nominal other resources. After a discussion with the examiner on
regulatory reporting requirements, the lender placed the loan on nonaccrual.
The loan can be returned to accrual status32 if the lender can document that
subsequent improvement in the borrower’s financial condition has enabled the loan to
be brought fully current with respect to principal and interest and the lender expects
the contractual balance of the loan (including the partial charge-off) will be fully
collected. In addition, interest income may be recognized on a cash basis for the
partially charged-off portion of the loan when the remaining recorded balance is
considered fully collectible. However, the partial charge-off cannot be reversed
ent with respect to principal and interest and the lender expects
the contractual balance of the loan (including the partial charge-off) will be fully
collected. In addition, interest income may be recognized on a cash basis for the
partially charged-off portion of the loan when the remaining recorded balance is
considered fully collectible. However, the partial charge-off cannot be reversed.
TDR Treatment: The lender reported the restructured loan as a TDR according to the
requirements of its regulatory reports because (a) the borrower is experiencing
financial difficulties as evidenced by the high leverage, delinquent payments on other
projects, and inability to meet the original exit strategy because the borrower was
unable to lease the property in a reasonable timeframe; and (b) the lender granted a
concession as evidenced by deferring payment beyond the repayment ability of the
borrower. The charge-off indicates that the lender does not expect full repayment of
principal and interest, yet the borrower remains obligated for the full amount of the
debt and payments, which is at a level that is not consistent with the borrower’s
32 Refer to the guidance on “nonaccrual status” in the FFIEC Call Report and NCUA 5300 Call Report
instructions.
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repayment capacity. Because the borrower is not expected to be able to comply with
the loan’s restructured terms, the lender would likely continue to disclose the loan as
a TDR. The examiner concurs with reporting the renewed loan as a TDR.
C. Income Producing Property – Hotel
BASE CASE: A lender originated a $7.9 million loan to provide permanent financing
for the acquisition of a stabilized 3-star hotel property. The borrower is a limited liability
company with underlying ownership by two families who guarantee the loan. The loan
term is five years, with payments based on a 25-year amortization and with a market
interest rate
Income Producing Property – Hotel
BASE CASE: A lender originated a $7.9 million loan to provide permanent financing
for the acquisition of a stabilized 3-star hotel property. The borrower is a limited liability
company with underlying ownership by two families who guarantee the loan. The loan
term is five years, with payments based on a 25-year amortization and with a market
interest rate. The LTV was 79 percent based on the hotel’s appraised value of $10
million.
At the end of the five-year term, the borrower’s annualized DSC ratio was 0.95x. Due to
competition from a well-known 4-star hotel that recently opened within one mile of the
property, occupancy rates have declined. The borrower progressively reduced room rates
to maintain occupancy rates, but continued to lose daily bookings. Both occupancy and
Revenue per Available Room (RevPAR)33 declined significantly over the past year. The
borrower then began working on an initiative to make improvements to the property (i.e.,
automated key cards, carpeting, bedding, and lobby renovations) to increase
competitiveness, and a marketing campaign is planned to announce the improvements
and new price structure.
The borrower had paid principal and interest as agreed throughout the first five years, and
the principal balance had reduced to $7 million at the end of the five-year term.
33 Total guest room revenue divided by room count and number of days in the period.
ing campaign is planned to announce the improvements
and new price structure.
The borrower had paid principal and interest as agreed throughout the first five years, and
the principal balance had reduced to $7 million at the end of the five-year term.
33 Total guest room revenue divided by room count and number of days in the period.
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SCENARIO 1: At maturity, the lender renewed the loan for 12 months on an interest-
only basis at a market interest rate that provides for the incremental risk. The extension
was granted to enable the borrower to complete the planned renovations, launch the
marketing campaign, and achieve the borrower’s updated projections for sufficient cash
flow to service the debt once the improvements are completed. (If the initiative is
successful, the loan officer expects the loan to either be renewed on an amortizing basis
or refinanced through another lending entity.) The borrower has a verified, pledged
reserve account to cover the improvement expenses. Additionally, the guarantors’
updated financial statements indicate that they have sufficient unencumbered liquid
assets. Further, the guarantors expressed the willingness to cover any estimated cash
flow shortfall through maturity. Based on this information, the lender’s analysis indicates
that, after deductions for personal obligations and realistic living expenses and
verification that there are no contingent liabilities, the guarantors should be able to make
interest payments. To date, interest payments have been timely. The lender estimates the
property’s current “as stabilized” market value at $9 million, which results in a 78
percent LTV.
Classification: The lender internally graded the loan as a pass and is monitoring the
credit. The examiner agreed with the lender’s internal loan grade
t liabilities, the guarantors should be able to make
interest payments. To date, interest payments have been timely. The lender estimates the
property’s current “as stabilized” market value at $9 million, which results in a 78
percent LTV.
Classification: The lender internally graded the loan as a pass and is monitoring the
credit. The examiner agreed with the lender’s internal loan grade. The examiner
concluded that the borrower and guarantors have sufficient resources to support the
interest payments; additionally, the borrower’s reserve account is sufficient to
complete the renovations as planned.
Nonaccrual Treatment: The lender maintained the loan on accrual status as full
repayment of principal and interest is reasonably assured from the hotel’s and
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guarantors cash flows, despite a decline in the borrower’s cash flow due to
competition. The examiner concurred with the lender’s accrual treatment.
TDR Treatment: The lender concluded that while the borrower has been affected by
competition, the level of deterioration does not warrant TDR treatment. The
borrower was not experiencing financial difficulties because the combined cash flow
generated by the borrower and the liquidity provided by the guarantors should be
sufficient to service the debt. Further, there was no history of default by the borrower
or guarantors. The examiner concurred with the lender that the loan renewal is not a
TDR.
SCENARIO 2: At maturity of the original loan, the lender restructured the loan on an
interest-only basis at a below market interest rate for 12 months to provide the borrower
time to complete its renovation and marketing efforts and increase occupancy levels. At
the end of the 12-month period, the hotel’s renovation and marketing efforts were
completed but unsuccessful. The hotel continued to experience a decline in occupancy
levels, resulting in a DSC ratio of 0.60x
on an
interest-only basis at a below market interest rate for 12 months to provide the borrower
time to complete its renovation and marketing efforts and increase occupancy levels. At
the end of the 12-month period, the hotel’s renovation and marketing efforts were
completed but unsuccessful. The hotel continued to experience a decline in occupancy
levels, resulting in a DSC ratio of 0.60x. The borrower does not have capacity to offer
additional incentives to lure customers from the competition. RevPAR has also declined.
Current financial information indicates the borrower has limited ability to continue to
make interest payments, and updated projections indicate that the borrower will be below
break-even performance for the next 12 months. The borrower has been sporadically
delinquent on prior interest payments. The guarantors are unable to support the loan as
they have unencumbered limited liquid assets and are highly leveraged. The lender is in
the process of renewing the loan again.
The most recent hotel appraisal, dated as of the time of the first restructuring, reports an
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“as stabilized” appraised value of $7.2 million ($6.7 million for the real estate and
$500,000 for the tangible personal property of furniture, fixtures, and equipment),
resulting in an LTV of 97 percent. The appraisal does not account for the diminished
occupancy, and its assumptions significantly differ from current projections. A new
valuation is needed to ascertain the current value of the property.
Classification: The lender internally classified the loan as substandard and is
monitoring the credit. The examiner agreed with the lender’s treatment due to the
borrower’s diminished ongoing ability to make payments, guarantors’ limited ability
to support the loan, and the reduced collateral position. The lender is obtaining a new
valuation and will adjust the internal classification, if necessary, based on the updated
value
y classified the loan as substandard and is
monitoring the credit. The examiner agreed with the lender’s treatment due to the
borrower’s diminished ongoing ability to make payments, guarantors’ limited ability
to support the loan, and the reduced collateral position. The lender is obtaining a new
valuation and will adjust the internal classification, if necessary, based on the updated
value.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because
the borrower demonstrated an ability to make interest payments. The examiner did
not concur with this treatment as the loan was not restructured on reasonable
repayment terms, the borrower has insufficient cash resources to service the below
market interest rate on an interest-only basis, and the collateral margin has narrowed
and may be narrowed further with a new valuation, which collectively indicate that
full repayment of principal and interest is in doubt. After a discussion with the
examiner on regulatory reporting requirements, the lender placed the loan on
nonaccrual.
TDR Treatment: The lender reported the restructured loan as a TDR because the
borrower is experiencing financial difficulties: the hotel’s ability to generate sufficient
cash flows to service the debt is questionable as the occupancy levels and resultant
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net operating income (NOI) continue to decline, the borrower has been delinquent,
and collateral value has declined. The lender made a concession by extending the
loan on an interest-only basis at a below market interest rate. The examiner
concurred with the lender’s TDR treatment.
SCENARIO 3: At maturity of the original loan, the lender restructured the debt for one
year on an interest-only basis at a below market interest rate to give the borrower
additional time to complete renovations and increase marketing efforts
e a concession by extending the
loan on an interest-only basis at a below market interest rate. The examiner
concurred with the lender’s TDR treatment.
SCENARIO 3: At maturity of the original loan, the lender restructured the debt for one
year on an interest-only basis at a below market interest rate to give the borrower
additional time to complete renovations and increase marketing efforts. While the
combined borrower/guarantors’ liquidity indicated they could cover any cash flow
shortfall until maturity of the restructured note, the borrower only had 50 percent of the
funds to complete its renovations in reserve. Subsequently, the borrower attracted a
sponsor to obtain the remaining funds necessary to complete the renovation plan and
marketing campaign.
Eight months later, the hotel experienced an increase in its occupancy and achieved a
DSC ratio of 1.20x on an amortizing basis. Updated projections indicated the borrower
would be at or above the 1.20x DSC ratio for the next 12 months, based on market terms
and rate. The borrower and the lender then agreed to restructure the loan again with
monthly payments that amortize the debt over 20 years, consistent with the current
market terms and rates. Since the date of the second restructuring, the borrower has
made all principal and interest payments as agreed for six consecutive months.
Classification: The lender internally classified the most recent restructured loan
substandard. The examiner agreed with the lender’s initial substandard grade at the
time of the subject restructuring, but now considers the loan as a pass as the borrower
was no longer having financial difficulty and has demonstrated the ability to make
interest payments as agreed for six consecutive months.
Classification: The lender internally classified the most recent restructured loan
substandard. The examiner agreed with the lender’s initial substandard grade at the
time of the subject restructuring, but now considers the loan as a pass as the borrower
was no longer having financial difficulty and has demonstrated the ability to make
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payments according to the modified principal and interest terms for more than six
consecutive months.
Nonaccrual Treatment: The original restructured loan was placed in nonaccrual
status. The lender initially maintained the most recent restructured loan in nonaccrual
status as well, but returned it to an accruing status after the borrower made six
consecutive monthly principal and interest payments. The lender expects full
repayment of principal and interest. The examiner concurred with the lender’s
accrual treatment.
TDR Treatment: The lender reported the first restructuring as a TDR. With the first
restructuring, the lender determined that the borrower was experiencing financial
difficulties as indicated by depleted cash resources and deteriorating financial
condition. The lender granted a concession on the first restructuring by providing a
below market interest rate. At the time of the second restructuring, the borrower’s
financial condition had improved, and the borrower was no longer experiencing
financial difficulty; the lender did not grant a concession on the second restructuring
as the renewal was granted at a market interest rate and amortizing terms, thus the
latest restructuring is no longer classified as a TDR. The examiner concurred with
the lender.
SCENARIO 4: The lender extended the original amortizing loan for 12 months at a
market interest rate. The borrower is now experiencing a six-month delay in completing
the renovations due to a conflict with the contractor hired to complete the renovation
work, and the current DSC ratio is 0.85x
e
latest restructuring is no longer classified as a TDR. The examiner concurred with
the lender.
SCENARIO 4: The lender extended the original amortizing loan for 12 months at a
market interest rate. The borrower is now experiencing a six-month delay in completing
the renovations due to a conflict with the contractor hired to complete the renovation
work, and the current DSC ratio is 0.85x. A current valuation has not been ordered. The
lender estimates the property’s current “as stabilized” market value is $7.8 million, which
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results in an estimated 90 percent LTV. The lender did receive updated projections, but
the borrower is now unlikely to achieve break-even cash flow within the 12-month
extension timeframe due to the renovation delays. At the time of the extension, the
borrower and guarantors had sufficient liquidity to cover the debt service during the
twelve-month period. The guarantors also demonstrated a willingness to support the loan
by making payments when necessary, and the loan has not gone delinquent. With the
guarantors’ support, there is sufficient liquidity to make payments to maturity, though
such resources are declining rapidly
Classification: The lender internally graded the loan as pass and is monitoring the
credit. The examiner disagreed with the lender’s grading and listed the loan as
special mention. While the borrower and guarantor can cover the debt service
shortfall in the near-term, the duration of their support may not extend long enough to
replace lost cash flow from operations due to delays in the renovation work. The
primary source of repayment does not fully cover the loan as evidenced by a DSC
ratio of 0.85x. It appears that competition from the new hotel will continue to
adversely affect the borrower's cash flow until the renovations are complete, and if
cash flow deteriorates further, the borrower and guarantors may be required to use
more liquidity to support loan payments and ongoing business operations
ary source of repayment does not fully cover the loan as evidenced by a DSC
ratio of 0.85x. It appears that competition from the new hotel will continue to
adversely affect the borrower's cash flow until the renovations are complete, and if
cash flow deteriorates further, the borrower and guarantors may be required to use
more liquidity to support loan payments and ongoing business operations. The
examiner also recommended the lender obtain a new valuation.
Nonaccrual Treatment: The lender maintained the loan on accrual status. The
borrower and legally obligated guarantors have demonstrated the ability and
willingness to make the regularly scheduled payments and, even with the decline in
the borrower’s creditworthiness, global cash resources appear sufficient to make these
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payments, and the ultimate full repayment of principal and interest is expected. The
examiner concurred with the lender’s accrual treatment.
TDR Treatment: While the borrower is experiencing some financial deterioration,
the borrower is not experiencing financial difficulties as the borrower and guarantors
have sufficient cash resources to service the debt. The lender expects full collection
of principal and interest from the borrower’s operating income and global cash
resources. The examiner concurred with the lender’s rationale that the loan is not a
TDR.
D. Acquisition, Development and Construction – Residential
BASE CASE: The lender originated a $4.8 million acquisition and development (A&D)
loan and a $2.4 million construction revolving line of credit (revolver) for the
development and construction of a 48-lot single-family project. The maturity for both
loans is three years, and both are priced at a market interest rate; both loans also have an
interest reserve. The LTV on the A&D loan is 75 percent based on an “as complete”
value of $6.4 million. Up to 12 units at a time will be funded under the construction
revolver at the lesser of 80 percent LTV or 100 percent of costs
nstruction of a 48-lot single-family project. The maturity for both
loans is three years, and both are priced at a market interest rate; both loans also have an
interest reserve. The LTV on the A&D loan is 75 percent based on an “as complete”
value of $6.4 million. Up to 12 units at a time will be funded under the construction
revolver at the lesser of 80 percent LTV or 100 percent of costs. The builder is allowed
two speculative (“spec”) units (including one model). The remaining units must be pre-
sold with an acceptable deposit and a pre-qualified mortgage. As units are settled, the
construction revolver will be repaid at 100 percent (or par); the A&D loan will be repaid
at 120 percent, or $120,000 ($4.8 million/48 units x 120 percent). The average sales
price is projected to be $500,000, and total construction cost to build each unit is
estimated to be $200,000. Assuming total cost is lower than value, the average release
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price will be $320,000 ($120,000 A&D release price plus $200,000 construction costs).
Estimated time for development is 12 months; the appraiser estimated absorption of two
lots per month for total sell-out to occur within three years (thus, the loan would be
repaid upon settlement of the 40th unit, or the 32nd month of the loan term). The
borrower is required to curtail the A&D loan by six lots, or $720,000, at the 24th month,
and another six lots, or $720,000, by the 30th month.
SCENARIO 1: Due to issues with the permitting and approval process by the county,
the borrower’s development was delayed by 18 months. Further delays occurred because
the borrower was unable to pave the necessary roadways due to excessive snow and
freezing temperatures. The lender waived both $720,000 curtailment requirements due to
the delays. Demand for the housing remains unchanged
th.
SCENARIO 1: Due to issues with the permitting and approval process by the county,
the borrower’s development was delayed by 18 months. Further delays occurred because
the borrower was unable to pave the necessary roadways due to excessive snow and
freezing temperatures. The lender waived both $720,000 curtailment requirements due to
the delays. Demand for the housing remains unchanged.
At maturity, the lender renewed the $4.8 million outstanding A&D loan balance and the
$2.4 million construction revolver for 24 months at a market interest rate that provides
for the incremental risk. The interest reserve for the A&D loan has been depleted as the
lender had continued to advance funds to pay the interest charges despite the delays in
development. Since depletion of the interest reserve, the borrower has made the last
several payments out-of-pocket.
Development is now complete, and construction has commenced on eight units (two
“spec” units and six pre-sold units). Combined borrower and guarantor liquidity show
they can cover any debt service shortfall until the units begin to settle and the project is
cash flowing. The lender estimates that the property’s current “as complete” value is $6
million, resulting in an 80 percent LTV. The curtailment schedule was re-set to eight
lots, or $960,000, by month 12, and another eight lots, or $960,000, by month 18. A new
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appraisal has not been ordered; however, the lender noted in the file that, if the borrower
does not meet the absorption projections of six lots/quarter within six months of booking
the renewed loan, the lender will obtain a new appraisal.
Classification: The lender internally graded the restructured loans as pass and is
monitoring the credits. The examiner agreed, as the borrower and guarantor can
continue making payments on reasonable terms and the project is moving forward
supported by housing demand and is consistent with the builder’s development plans
of booking
the renewed loan, the lender will obtain a new appraisal.
Classification: The lender internally graded the restructured loans as pass and is
monitoring the credits. The examiner agreed, as the borrower and guarantor can
continue making payments on reasonable terms and the project is moving forward
supported by housing demand and is consistent with the builder’s development plans.
However, the examiner noted weaknesses in the lender’s loan administrative practices
as the financial institution did not (1) suspend the interest reserve during the
development delay and (2) obtain an updated collateral valuation.
Nonaccrual Treatment: The lender maintained the loans on accrual status. The
project is moving forward, the borrower has demonstrated the ability to make the
regularly scheduled payments after depletion of the interest reserve, global cash
resources from the borrower and guarantor appears sufficient to make these
payments, and full repayment of principal and interest is expected. The examiner
concurred with the lender’s accrual treatment.
TDR Treatment: The borrower is not experiencing financial difficulties as the
borrower and guarantor have sufficient means to service the debt, and there is no
history of default. With the continued supportive housing market conditions, the
lender expects full collection of principal and interest from sales of the lots. The
examiner concurred with the lender’s rationale that the renewal is not a TDR.
SCENARIO 2: Due to weather and contractor issues, development was not completed
until month 24, a year behind the original schedule. The borrower began pre-marketing,
With the continued supportive housing market conditions, the
lender expects full collection of principal and interest from sales of the lots. The
examiner concurred with the lender’s rationale that the renewal is not a TDR.
SCENARIO 2: Due to weather and contractor issues, development was not completed
until month 24, a year behind the original schedule. The borrower began pre-marketing,
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but sales have been slow due to deteriorating market conditions in the region. The
borrower has achieved only eight pre-sales during the past six months. The borrower
recently commenced construction on the pre-sold units.
At maturity, the lender renewed the $4.8 million A&D loan balance and $2.4 million
construction revolver on a 12-month interest-only basis at a market interest rate, with
another 12-month option predicated upon $1 million in curtailments having occurred
during the first renewal term (the lender had waived the initial term curtailment
requirements). The lender also renewed the construction revolver for a one-year term and
reduced the number of “spec” units to just one, which also will serve as the model. A
recent appraisal estimates that absorption has dropped to four lots per quarter for the first
two years and assigns an “as complete” value of $5.3 million, for an LTV of 91 percent.
The interest reserve is depleted, and the borrower has been paying interest out-of-pocket
for the past few months. Updated borrower and guarantor financial statements indicate
the continued ability to cover interest-only payments for the next 12 to 18 months.
Classification: The lender internally classified the loan as substandard and is
monitoring the credit. The examiner agreed with the lender’s treatment due to the
deterioration and uncertainty surrounding the market (as evidenced by slower than
anticipated sales on the project), the lack of principal reduction, and the reduced
collateral margin
est-only payments for the next 12 to 18 months.
Classification: The lender internally classified the loan as substandard and is
monitoring the credit. The examiner agreed with the lender’s treatment due to the
deterioration and uncertainty surrounding the market (as evidenced by slower than
anticipated sales on the project), the lack of principal reduction, and the reduced
collateral margin.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because
the development is complete, the borrower has pre-sales and construction has
commenced, and the borrower and guarantor have sufficient means to make interest
payments at a market interest rate until the earlier of maturity or the project begins to
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cash flow. The examiner concurred with the lender’s accrual treatment.
TDR Treatment: While the borrower is experiencing some financial deterioration,
the borrower is not experiencing financial difficulties as the borrower and guarantor
have sufficient means to service the debt. The lender expects full collection of
principal and interest from the sale of the units. The examiner concurred with the
lender’s rationale that the renewal is not a TDR.
SCENARIO 3: Lot development was completed on schedule, and the borrower quickly
sold and settled the first 10 units. At maturity, the lender renewed the $3.6 million A&D
loan balance ($4.8 million reduced by the sale and settlement of the 10 units ($120,000
release price x 10) to arrive at $3.6 million) and $2.4 million construction revolver on a
12-month interest-only basis at a below market interest rate.
The borrower then sold an additional 10 units to an investor; the loan officer (new to the
financial institution) mistakenly marked these units as pre-sold and allowed construction
to commence on all 10 units. Market conditions then deteriorated quickly, and the
investor defaulted under the terms of the bulk contract
revolver on a
12-month interest-only basis at a below market interest rate.
The borrower then sold an additional 10 units to an investor; the loan officer (new to the
financial institution) mistakenly marked these units as pre-sold and allowed construction
to commence on all 10 units. Market conditions then deteriorated quickly, and the
investor defaulted under the terms of the bulk contract. The units were completed, but
the builder has been unable to re-sell any of the units, recently dropping the sales price by
10 percent and engaging a new marketing firm, which is working with several potential
buyers.
A recent appraisal estimates that absorption has dropped to three lots per quarter and
assigns an “as complete” value of $2.3 million for the remaining 28 lots, resulting in an
LTV of 156 percent. A bulk appraisal of the 10 units assigns an “as-is” value of the units
of $4.0 million ($400,000/unit). The loans are cross-defaulted and cross-collateralized;
the LTV on a combined basis is 95 percent ($6 million outstanding debt (A&D plus
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revolver) divided by $6.3 million in combined collateral value). Updated borrower and
guarantor financial statements indicate a continued ability to cover interest-only
payments for the next 12 months at the reduced rate; however, this may be limited in the
future given other troubled projects in the borrower’s portfolio that have been affected by
market conditions.
The lender modified the release price for each unit to net proceeds; any additional
proceeds as units are sold will go towards repayment of the A&D loan. Assuming the
units sell at a 10 percent reduction, the lender calculates the average sales price would be
$450,000. The financial institution’s prior release price was $320,000 ($120,000 for the
A&D loan and $200,000 for the construction revolver)
der modified the release price for each unit to net proceeds; any additional
proceeds as units are sold will go towards repayment of the A&D loan. Assuming the
units sell at a 10 percent reduction, the lender calculates the average sales price would be
$450,000. The financial institution’s prior release price was $320,000 ($120,000 for the
A&D loan and $200,000 for the construction revolver). As such (by requiring net
proceeds), the financial institution will be receiving an additional $130,000 per lot, or
$1.3 million for the completed units, to repay the A&D loan ($450,000 average sales
price less $320,000 bank’s release price equals $130,000). Assuming the borrower will
have to pay $30,000 in related sales/settlement costs leaves approximately $100,000
remaining per unit to apply towards the A&D loan, or $1 million total for the remaining
10 units ($100,000 times 10).
Classification: The lender internally classified the loan as substandard and is
monitoring the credit. The examiner agreed with the lender’s treatment due to the
borrower and guarantor’s diminished ability to make interest payments (even at the
reduced rate), the stalled status of the project, and the reduced collateral protection.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because
the borrower had previously demonstrated an ability to make interest payments. The
examiner disagreed as the loan was not restructured on reasonable repayment terms.
minished ability to make interest payments (even at the
reduced rate), the stalled status of the project, and the reduced collateral protection.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because
the borrower had previously demonstrated an ability to make interest payments. The
examiner disagreed as the loan was not restructured on reasonable repayment terms.
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While the borrower and guarantor may be able to service the debt at a below market
interest rate in the near term using other unencumbered liquid assets, other projects in
their portfolio are also affected by poor market conditions and may require significant
liquidity contributions, which could affect their ability to support the loan. After a
discussion with the examiner on regulatory reporting requirements, the lender placed
the loan on nonaccrual.
TDR Treatment: The lender reported the restructured loan as a TDR because the
borrower is experiencing financial difficulties as evidenced by the borrower’s
inability to re-sell the units, their diminished ability to make interest payments (even
at a reduced rate), and other troubled projects in the borrower’s portfolio. The lender
granted a concession with the interest-only terms at a below market interest rate. The
examiner concurred with the lender’s TDR treatment.
E. Construction Loan – Single Family Residence
BASE CASE: The lender originated a $1.2 million construction loan on a single-family
“spec” residence with a 15-month maturity to allow for completion and sale of the
property. The loan required monthly interest-only payments at a market interest rate and
was based on an “as completed” LTV of 70 percent at origination. During the original
loan construction phase, the borrower was able to make all interest payments from
personal funds. At maturity, the home had been completed, but not sold, and the
borrower was unable to find another lender willing to finance this property under similar
terms
terest-only payments at a market interest rate and
was based on an “as completed” LTV of 70 percent at origination. During the original
loan construction phase, the borrower was able to make all interest payments from
personal funds. At maturity, the home had been completed, but not sold, and the
borrower was unable to find another lender willing to finance this property under similar
terms.
SCENARIO 1: At maturity, the lender restructured the loan for one year on an interest-
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only basis at a below market interest rate to give the borrower more time to sell the
“spec” home. Current financial information indicates the borrower has limited ability to
continue to make interest-only payments from personal funds. If the residence does not
sell by the revised maturity date, the borrower plans to rent the home. In this event, the
lender will consider modifying the debt into an amortizing loan with a 20-year maturity,
which would be consistent with this type of income-producing investment property. Any
shortfall between the net rental income and loan payments would be paid by the
borrower. Due to declining home values, the LTV at the renewal date was 90 percent.
Classification: The lender internally classified the loan substandard and is
monitoring the credit. The examiner agreed with the lender’s treatment due to the
borrower’s diminished ongoing ability to make payments and the reduced collateral
position.
Nonaccrual Treatment: The lender maintained the loan on an accrual basis because
the borrower demonstrated an ability to make interest payments during the
construction phase. The examiner did not concur with this treatment because the loan
was not restructured on reasonable repayment terms. The borrower had limited
capacity to continue to service the debt, even on an interest-only basis at a below
market interest rate, and the deteriorating collateral margin indicated that full
repayment of principal and interest was not reasonably assured
he
construction phase. The examiner did not concur with this treatment because the loan
was not restructured on reasonable repayment terms. The borrower had limited
capacity to continue to service the debt, even on an interest-only basis at a below
market interest rate, and the deteriorating collateral margin indicated that full
repayment of principal and interest was not reasonably assured. The examiner
instructed the lender to place the loan in nonaccrual status.
TDR Treatment: The lender reported the restructured loan as a TDR. The borrower
was experiencing financial difficulties as indicated by depleted cash reserves,
inability to refinance this debt from other sources with similar terms, and the inability
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to repay the loan at maturity in a manner consistent with the original exit strategy. A
concession was provided by renewing the loan with a deferral of principal payments,
at a below market interest rate (compared to the rate charged on an investment
property) for an additional year when the loan was no longer in the construction
phase. The examiner concurred with the lender’s TDR treatment.
SCENARIO 2: At maturity of the original loan, the lender restructured the debt for one
year on an interest-only basis at a below market interest rate to give the borrower more
time to sell the “spec” home. Eight months later, the borrower rented the property. At
that time, the borrower and the lender agreed to restructure the loan again with monthly
payments that amortize the debt over 20 years at a market interest rate for a residential
investment property. Since the date of the second restructuring, the borrower had made
all payments for over six consecutive months.
Classification: The lender internally classified the restructured loan substandard
hat time, the borrower and the lender agreed to restructure the loan again with monthly
payments that amortize the debt over 20 years at a market interest rate for a residential
investment property. Since the date of the second restructuring, the borrower had made
all payments for over six consecutive months.
Classification: The lender internally classified the restructured loan substandard.
The examiner agreed with the lender’s initial substandard grade at the time of the
restructuring, but now considered the loan as a pass due to the borrower’s
demonstrated ability to make payments according to the reasonably modified terms
for more than six consecutive months.
Nonaccrual Treatment: The lender initially placed the restructured loan in
nonaccrual status but returned it to accrual after the borrower made six consecutive
monthly payments. The lender expects full repayment of principal and interest from
the rental income. The examiner concurred with the lender’s accrual treatment.
TDR Treatment: The lender reported the first restructuring as a TDR. At the time of
the first restructure, the lender determined that the borrower was experiencing
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financial difficulties as indicated by depleted cash resources and a weak financial
condition. The lender granted a concession on the first restructuring as evidenced by
the below market rate.
At the second restructuring, the lender determined that the borrower was not
experiencing financial difficulties due to the borrower's improved financial condition.
Further, the lender did not grant a concession on the second restructuring as that loan
is at market interest rate and terms. Therefore, the lender determined that the second
restructuring is no longer a TDR. The examiner concurred with the lender.
SCENARIO 3: The lender restructured the loan for one year on an interest-only basis at
a below market interest rate to give the borrower more time to sell the “spec” home
grant a concession on the second restructuring as that loan
is at market interest rate and terms. Therefore, the lender determined that the second
restructuring is no longer a TDR. The examiner concurred with the lender.
SCENARIO 3: The lender restructured the loan for one year on an interest-only basis at
a below market interest rate to give the borrower more time to sell the “spec” home. The
restructured loan has become more than 90 days past due, and the borrower has not been
able to rent the property. Based on current financial information, the borrower does not
have the capacity to service the debt. The lender considers repayment to be contingent
upon the sale of the property. Current market data reflects few sales, and similar new
homes in this property’s neighborhood are selling within a range of $750,000 to $900,000
with selling costs equaling 10 percent, resulting in anticipated net sales proceeds between
$675,000 and $810,000.
Classification: The lender graded $390,000 loss ($1.2 million loan balance less the
maximum estimated net sales proceeds of $810,000), $135,000 doubtful based on the
range in the anticipated net sales proceeds, and the remaining balance of $675,000
substandard. The examiner agreed, as this classification treatment results in the
recognition of the credit risk in the collateral-dependent loan based on the property’s
value less costs to sell. The examiner instructed management to obtain information
les proceeds of $810,000), $135,000 doubtful based on the
range in the anticipated net sales proceeds, and the remaining balance of $675,000
substandard. The examiner agreed, as this classification treatment results in the
recognition of the credit risk in the collateral-dependent loan based on the property’s
value less costs to sell. The examiner instructed management to obtain information
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on the current valuation on the property.
Nonaccrual Treatment: The lender placed the loan in nonaccrual status when it
became 60 days past due (reversing all accrued but unpaid interest) because the
lender determined that full repayment of principal and interest was not reasonably
assured. The examiner concurred with the lender’s nonaccrual treatment.
TDR Treatment: The lender reported the loan as a TDR until foreclosure of the
property and its transfer to other real estate owned. The lender determined that the
borrower was continuing to experience financial difficulties as indicated by depleted
cash reserves, inability to refinance this debt from other sources with similar terms,
and the inability to repay the loan at maturity in a manner consistent with the original
exit strategy. In addition, the lender granted a concession by reducing the interest rate
to a below market level. The examiner concurred with the lender’s TDR treatment.
SCENARIO 4: The lender committed an additional $48,000 for an interest reserve and
extended the $1.2 million loan for 12 months at a below market interest rate with monthly
interest-only payments. At the time of the examination, $18,000 of the interest reserve
had been added to the loan balance. Current financial information obtained during the
examination reflects the borrower has no other repayment sources and has not been able
to sell or rent the property. An updated appraisal supports an “as is” value of $952,950.
Selling costs are estimated at 15 percent, resulting in anticipated net sales proceeds of
$810,000
18,000 of the interest reserve
had been added to the loan balance. Current financial information obtained during the
examination reflects the borrower has no other repayment sources and has not been able
to sell or rent the property. An updated appraisal supports an “as is” value of $952
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