Fitch: New Accounting Guidelines Could Push Up Q3 U.S. Bank TDRs

CHICAGO--(BUSINESS WIRE)-- New guidelines for the treatment of restructured loans on banks' financial statements will likely drive third-quarter net chargeoffs (NCOs) and nonperforming assets (NPAs) higher. While reporting changes may increase troubled debt restructuring (TDR) balances for some U.S. banks, Fitch believes banks have already boosted reserves to a level where the overall impact will be manageable.

In its most recent bank accounting standards publication, the Office of the Comptroller of the Currency (OCC) indicated that banks should classify mortgages and other loans discharged by troubled borrowers in bankruptcy as TDRs. The OCC staff guidelines state that affected banks should charge off "the excess of the loan's carrying amount over the fair value of the collateral as uncollectible." The remaining balance of the loan would then be placed into non-accrual status.

The OCC document makes clear that loans discharged in bankruptcy should continue to be reported as loans, rather than other real estate owned (OREO), since physical possession of the collateral would not be taken after the borrower's obligation has been discharged by the court. Such a loan would be considered a TDR, since a restructuring in the form of a concession to the borrower has taken place.

As a result of these changes, we expect some U.S. banks to boost NCOs and NPAs related to TDRs when third-quarter results are released. This guidance is applicable to national banks regulated by the OCC. Further, as accruing TDRs are included in Fitch-calculated nonperforming asset ratios, this could lead to some distortions in comparability between asset quality ratios among banks.

Investors should be careful not to view increases in TDR-related chargeoffs as fundamentally at odds with the broader pattern of asset quality improvement in U.S. banks' mortgage books. We view these prospective losses as reflections of accounting clarifications rather than economically significant changes. Loan loss reserves will likely be adequate to cover increases in NCOs. Based on the most recent industry data, there is $106.8 billion of TDRs outstanding as of June 30, 2012.

We believe this change affects a relatively small segment of loans, as it pertains to borrowers in bankruptcy. Furthermore, Fitch has attempted to build appropriate forecasts of TDR growth into our bank analysis. These views stems from research presented in two previous special reports: "Troubled Debt Restructurings: First Look at New Re-Default Rates and Disclosures," dated Dec. 9, 2011; and "Troubled Debt Restructurings Expected to Rise in New Accounting Guidance," dated May 16, 2011. We would not expect the new charges to represent a significant credit quality or ratings driver. To the extent that some banks may report unusually large TDR-related charges, we may adjust our views of risk and asset quality.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

Applicable Criteria and Related Research:
Troubled Debt Restructurings
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=657516
Troubled Debt Restructurings (Accounting Standards Update Set to Increase TDR Recognition)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=628437

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