Transcript Document

SHARING THE VISION™
SFAS 114
Accounting by Creditors for
Impairment of a Loan
Jaime Boone, CPA
Manager
August 28, 2008
SHARING THE VISION™
Discussion Topics
 2006 Interagency Policy Statement
 FAS 5, Accounting for Contingencies (1975)
 FAS 114, Accounting by Creditors for Impairment of a
Loan (1993)
 Interagency Q&A
 FAS 114 Example
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Allowance for Loan and Lease
Losses
2006 Interagency Policy Statement
“The purpose of the ALLL is not to
absorb all of the risk in the loan
portfolio, but to cover probable losses
that have already been incurred.”
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Current Supervisory Guidance
2006 Interagency Policy Statement
• Revision replaces 1993 policy statement to ensure consistency
with GAAP (FAS 5 and FAS 114).
• Applies to all depository institutions except U.S. branches of and
agencies of foreign banks
– “As of the end of each quarter, or more frequently if warranted,
each institution must analyze the collectability of its loans and
maintain an ALLL at a level that is appropriate and determined in
accordance with GAAP.”
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SFAS 5
• SFAS 5 defines a contingency as an existing condition,
situation, or set of circumstances involving uncertainty as to
possible gain or loss to an enterprise that will ultimately be
resolved when one or more future events occur or fail to
occur.
• SFAS 5 requires the accrual of a loss contingency when
information available prior to the issuance of the financial
statements indicates it is probable that an asset has been
impaired at the date of the financial statements and the
amount of the loss can be reasonably estimated.
• A reserve may be considered in relation to individual loans
or groups of similar types of loans.
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SFAS 5
• Paragraph 23 : Collectability of Receivables
• “If it is possible that the Company will not be able to collect all
amounts due (principal and interest) in accordance with the
contractual terms, then a loss contingency should be accrued.
Whether the amount of loss can be reasonably estimated (the
condition in paragraph 8(b)) will normally depend on, among
other things, the experience of the enterprise, information about
the ability of individual debtors to pay, and appraisal of the
receivables in light of the current economic environment. In the
case of an enterprise that has no experience of its own,
reference to the experience of other enterprises in the same
business may be appropriate.”
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Interagency Policy
Measurement of Estimated Credit Losses
When measuring estimated credit losses on groups
of loans with similar risk characteristics in accordance
with FAS 5, a widely used method is based on each
group’s historical charge off rate adjusted for the
effects of the qualitative and environmental factors.
Example FAS 5 Analysis
Loan type
Total loans
Impaired
loans
Net loans
Real estate
loans
$14,000,000
$2,000,000
$12,000,000
2%
$240,000
Consumer
loans
$ 3,000,000
$ 500,000
$ 2,500,000
2.5%
$ 62,500
Agricultural
loan
$ 4,000,000
$ 600,000
$ 3,400,000
1.35%
$ 45,900
Business loan
$20,000,000
$4,000,000
$16,000,000
2%
$320,000
Total
Loss rate
FAS 5
reserve
$668,400
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SFAS 114
• An individual loan is impaired when it is
probable that a creditor will be unable to
collect all amounts due according to the
contractual terms of the loan agreement.
• SFAS 114 does not specify how a creditor
should identify loan to be evaluated for
collectability.
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SFAS 114
• Measure the impairment based on the present value
of expected future cash flows discounted at the loan’s
effective interest rate.
– Loan’s observable market price; OR
– Fair value of the collateral less costs to sell if the loan is
collateral dependent
• All loans that have been restructured are impaired
since the original loan agreement has been modified
and principal and interest will not be fully collected.
• An insignificant delay (typically 90 days) does not
mean that a loan is impaired.
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Steps for determining FAS 114 component of the ALLL
1.
Establish criteria for loans that will be reviewed individually.
2.
Review loans to determine if any impairment.
3.
Categorize impaired loans as collateral dependent, saleable or cash
flow.
4.
Sum the 3 categories, omitting the loans whose fair value exceeds
their book value. The sum of the 3 categories less the outstanding
balance on the loans to derive the amount for the FAS 114
component.
FAS 114 Analysis
Loan
Classification
Reason
Loan
balance
Appraised
Value
Test for
Impairment?
Reason for
basis
Bob & Co
Substandard
Low
profitability
$500,000
$400,000
Yes
Appraised
value below
loan
balance
Julie Smith
Doubtful
Slow pay,
cash flow
$ 200,000
$150,000
Yes
Appraised
value below
loan
balance
John Doe
Watch
Bankruptcy
$ 100,000
$200,000
No
Borrower
pays on
time, high
appraised
value
Betsy
Johnson
Doubtful
Poor sales,
slow pay
$2,000,000
$1,500,000
Yes
Appraised
value below
loan
balance
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FAS 114 Disclosures
•
As of the date of each statement of financial position presented, the total recorded
investment in the impaired loans at the end of each period and (1) the amount of that
recorded investment for which there is a related allowance for credit losses determined in
accordance with this Statement and the amount of that allowance and (2) the amount of that
recorded investment for which there is no related allowance for credit losses determined in
accordance with this Statement
•
The creditor's policy for recognizing interest income on impaired loans, including how cash
receipts are recorded
•
For each period for which results of operations are presented, the average recorded
investment in the impaired loans during each period, the related amount of interest income
recognized during the time within that period that the loans were impaired, and, unless not
practicable, the amount of interest income recognized using a cash-basis method of
accounting during the time within that period that the loans were impaired.
FAS 114 Disclosure - Bank of America
The following table presents the recorded loan amounts, without consideration for the specific component of the allowance for loan and lease
losses, that were considered individually impaired in accordance with SFAS 114 at December 31, 2007 and 2006. SFAS 114 impairment
includes performing troubled debt restructurings and excludes all commercial leases.
December 31
2007
2006
Commercial – Domestic
$1.018
$ 586
Commercial – real estate
$1,099
$ 118
Commercial - foreign
$
$
Total impaired loans
19
$2,136
13
$ 717
The average recorded investment in certain impaired loans for 2007, 2006 and 2005 was approximately $1.2 billion, $722 million and $852
million, respectively. At December 31, 2007 and 2006, the recorded investment in impaired loans requiring an allowance for loan and lease
losses based on individual analysis per SFAS 114 guidelines was $1.2 billion and $567 million, and the related allowance for loan and lease
losses was $123 million and $43 million. For 2007, 2006 and 2005, interest income recognized on impaired loans totaled $130 million, $36
million and $17 million, respectively, all of which was recognized on a cash basis.
At December 31, 2007 and 2006, nonperforming loans and leases, including impaired and nonaccrual consumer loans, totaled $5.6 billion
and $1.8 billion. In addition, included in other assets were consumer and commercial nonperforming loans held-for-sale of $188 million and
$80 million at December 31, 2007 and 2006.
The Corporation has loan products with varying terms (e.g., interest-only mortgages, option adjustable rate mortgages, etc.) and loans with
high loan-to-value ratios. Exposure to any of these loan products does not result in a significant concentration of credit risk. Terms of loan
products, collateral coverage, the borrower’s credit history, and the amount of these loans that are retained on the Corporation’s balance
sheet are included in the Corporation’s assessment when establishing its allowance for loan and lease losses.
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Interagency Q&A
•
#2 How should an institution identify loans to be evaluated for
impairment under SFAS 114?
Answer: An institution should apply its normal review procedures including
watch list, past due report, overdraft listings, loans to insiders, historical loss
experience, loan files lacking current financial data related to borrowers and
guarantors, borrowers experiencing financial difficulty. Also, consider
examination reports and materiality.
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Interagency Q&A
•
#3 If an institution concludes that an individual loan specifically
identified for evaluation is NOT impaired under SFAS 114, should that
loan be included in the assessment of the ALLL under SFAS 5?
Answer: Yes, if the specific characteristics of the individually evaluated loan
that is not impaired indicate that it is probable that there would be an
incurred loss in a group of loans with those characteristics, then the loan
should be included in the assessment of the ALLL for that group of loans
under SFAS 5.
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Interagency Q&A
•
#4 If an institution assesses an individual loan under SFAS 114 and
determines that it is impaired, but it measures the amount of the
impairment as zero, may it include that loan in a group of loans
collectively assessed under SFAS 5 for estimation of the ALLL?
Answer: No, for an individual loan that is impaired, no additional loss is
appropriate under SFAS 5 even if the measurement of impairment results in
no allowance.
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Interagency Q&A
• #11 Are all substandard loans individually impaired loans that
should be evaluated under SFAS 114?
Answer: No, for an individual loan that is impaired, no additional
loss is appropriate under SFAS 5 even if the measurement of
impairment results in no allowance.
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FAS 114 Example
Hatz’s Hamburger Stand missed the last three payments on its loan to Small Bank. The original loan was
for $100,000, and the current balance is $90,000. Although the collateral for the loan, the restaurant
building itself, has an appraised value of $107,000, the management of Small Bank believes the bank will
be lucky to find a buyer who will pay $100,000. Management estimates that the building may take as long
as a year to sell. The utilities for the building are projected to be about $200 a month. To improve the
chances of a sale, the bank will have the building’s exterior repainted, for a cost of $6,000. The bank will
also have to pay a realtor a 10 percent commission to sell the building, the going rate for commercial
property sales. Finally, management believes that the bank would have earned an 8 percent return on the
money tied up in the building if it had been available to lend.
If the loan is impaired, how much should Small Bank increase its provision to cover the expected loss on
the loan? Assume the loan is categorized as collateral dependent for your analysis.
A. $8,400
B. $15,600
C. $6,000
D. $8,600
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FAS 114 Example
The correct answer is $8,400. This is the appraised value
$107,000; less $7,000 (the bank believes it can only get
$100,000 out of the building because it is the seller); less
$2,400 for utilities for a year; less $6,000 for a paint job; less
$10,000 sales commission = $81,600. With a loan balance of
$90,000, the amount of expected loss is thus $8,400 ($90,00081,600). The lost interest income is not used in the loss
calculation.