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Troubled debt restructuring (TDR) has been a critical financial reporting concern for the financial services industry the past several years, and the issues stemming from it are expected to continue well into the future. Because TDRs result from concessions made by a creditor to a debtor who is facing financial difficulties, they create concern for bankers and interested stakeholders who monitor the financial condition of banks. To illustrate some of the adverse effects for creditors, a TDR requires public disclosure of the nature and amount of the modified loans, loan impairment measurement, increased loan loss reserves, and, in all likelihood, a more comprehensive loan review by government agencies during regulatory examinations.
During the recent financial crisis, many borrowers faced economic hardship and needed help to restructure their debts to more favorable terms. Those with mort- gages were hit especially hard. Figure 1 illustrates the ris- ing level of residential real estate TDRs outstanding for all U.S. Federal Deposit Insurance Corporation (FDIC)- insured banking institutions since 2008. In addition to the rising volumes of real estate TDRs, the number of institutions has decreased significantly as the financial services industry continues to consolidate. The FDIC reported a large number of bank failures during the financial crisis period, and failures continue to be re- ported. There already have been 14 bank closures in 2014.
Creditors need to carefully monitor the status of the new loan terms and continue to communicate with cus- tomers when payment difficulties persist, especially because they want to maximize their investment recovery. Figure 2 shows the delinquency status of the residential real estate TDRs as of December 31, 2013. As you can see, approximately 40% of the restructured loans are either 90 days or more past due or are no longer accruing interest, a leading indicator that borrowers are continuing to struggle to make timely loan payments under the modi- fied loan terms. Banks generally stop accruing interest on loans when they significantly doubt they will collect the full loan investment. Loans no longer accruing interest are the most concerning and may require even higher lev- els of loan loss reserves going forward, which will result in lower levels of earnings and capital for the banks.
Although most reported TDR loans originate with individuals,...