# FDIC FIL-36-2022: Interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts > Federal · Agency guidance · Superseded URL: https://www.frixlaw.com/law-library/statutes/FDIC_FIL22036 ## Section - **Citation:** FDIC FIL-36-2022 - **Heading:** Interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts - **Jurisdiction:** Federal - **Kind:** Agency guidance - **Status:** Superseded - **Text as of:** August 14, 2026 - **Source:** Compiled text - **Location:** FDIC Financial Institution Letters / Interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts ## Text Page 1 of 99 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. Page 2 of 99 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 Page 3 of 99 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. Page 4 of 99  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): Page 5 of 99  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 Page 6 of 99 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). Page 7 of 99 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). Page 8 of 99 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 Page 9 of 99 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. Page 10 of 99 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). Page 11 of 99 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. Page 12 of 99 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. Page 13 of 99 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. Page 14 of 99 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. Page 16 of 99  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. Page 17 of 99 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 Page 18 of 99 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)). Page 19 of 99  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 Page 20 of 99 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. Page 21 of 99 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. Page 22 of 99 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 Page 23 of 99 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). Page 24 of 99 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. Page 25 of 99 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. Page 26 of 99  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 Page 27 of 99 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. Page 28 of 99 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 Page 29 of 99 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 Page 30 of 99 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 Page 31 of 99 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. Page 32 of 99 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 Page 33 of 99 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. Page 34 of 99 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 Page 35 of 99 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. Page 36 of 99 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. Page 37 of 99 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 Page 38 of 99 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 Page 39 of 99 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 Page 40 of 99 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. Page 41 of 99 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. Page 42 of 99 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 Page 43 of 99 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 Page 44 of 99 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 Page 45 of 99 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, Page 46 of 99 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 Page 47 of 99 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 Page 48 of 99 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. Page 49 of 99 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. Page 50 of 99 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. Page 51 of 99 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 Page 52 of 99 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 t [Text truncated at 120,000 characters. The full text is on the page linked above.] ## Nearby sections - [FDIC FIL-1-2002 FOREIGN ASSETS CONTROL ACT](https://www.frixlaw.com/law-library/statutes/FDIC_FIL02001.md) - [FDIC FIL-1-2010 Employee Compensation Advance Notice of Proposed Rulemaking](https://www.frixlaw.com/law-library/statutes/FDIC_FIL10001.md) - [FDIC FIL-1-2024 Consolidated Reports of Condition and Income for Fourth Quarter 2023](https://www.frixlaw.com/law-library/statutes/FDIC_FIL24001.md) - [FDIC FIL-2-2004 Foreign Assets Control Act](https://www.frixlaw.com/law-library/statutes/FDIC_FIL04002.md) - [FDIC FIL-2-2020 Consolidated Reports of Condition and Income for Fourth Quarter 2019](https://www.frixlaw.com/law-library/statutes/FDIC_FIL20002.md) - [FDIC FIL-3-2003 FILING PROCEDURES](https://www.frixlaw.com/law-library/statutes/FDIC_FIL03003.md) - [FDIC FIL-4-2006 Commercial Real Estate Lending Proposed Interagency Guidance](https://www.frixlaw.com/law-library/statutes/FDIC_FIL06004.md) - [FDIC FIL-4-2021 Revised Guidelines for Appeals of Material Supervisory Determinations](https://www.frixlaw.com/law-library/statutes/FDIC_FIL21004.md) - [FDIC FIL-4-2023 Guidance to Help Financial Institutions and Facilitate Recovery in Areas of California Affected by Severe Winter Storms, Flooding, Landslides and Mudslides](https://www.frixlaw.com/law-library/statutes/FDIC_FIL23004.md) - [FDIC FIL-4-2025 FDIC Statement of Policy on Bank Merger Transactions](https://www.frixlaw.com/law-library/statutes/FDIC_FIL25004.md) - [FDIC FIL-5-2000 Consumer Credit Reporting Practices](https://www.frixlaw.com/law-library/statutes/FDIC_FIL00005.md) - [FDIC FIL-5-2003 LETTER TO STAKEHOLDERS](https://www.frixlaw.com/law-library/statutes/FDIC_FIL03005.md) - [FDIC FIL-5-2021 Frequently Asked Questions Regarding Suspicious Activity Reporting and Other Anti-Money Laundering (AML) Considerations](https://www.frixlaw.com/law-library/statutes/FDIC_FIL21005.md) - [FDIC FIL-6-2000 Special Alert](https://www.frixlaw.com/law-library/statutes/FDIC_FIL00006.md) --- Source: Frix Law Library, https://www.frixlaw.com/law-library/statutes/FDIC_FIL22036. Check the current official text before relying on it. Not legal advice.