We have been providing robust, statistically-based TDR impairment calculations on residential real estate and consumer loans for nearly a decade.
Why Choose Us
In our experience, many financial institutions incorrectly calculate TDR impairments because they only consider interest rate reductions and not the reduced present value of the modified cash flows. We believe the impairment reserve should be based on the cash flows expected to be received including prepayments and credit losses. We further believe the reserve estimate should be based on the timing of the cash flows.
Financial institutions often used modifications of loan terms to manage credit risk. Loan modifications must be accounted for as a TDR if:
- Prior to the restructuring the borrower was experiencing financial difficulty; and
- In response, the lender granted a concession to the borrower (reduction of interest rate, reduced payment amount, extension of loan term, etc.)
The impairment amount resulting from the TDR should be based on the present value of the cash flows a financial institution expects to collect, discounted at the loan’s original effective interest rate. Our TDR cash flow estimates are based on the contractual amounts of principal and interest to be received under the modified terms, adjusted for our estimates of prepayment, default and loss severity to be experienced prospectively. Our input assumptions are applied at the loan level based on our database of the past performance for TDR loans with similar attributes. It is very important to note that while we are applying our statistical inputs at the loan level to achieve a more accurate result for the aggregated cash flows, we do not for a moment believe our results are accurate for any given loan. In fact, we show a small percentage of each loan prepaying and defaulting each year – the latter, of course, being impossible. Our results are intended to be accurate and used only on a pooled basis. We therefore strongly recommend financial institutions account for relatively homogenous residential real estate and consumer loan TDRs at the pool level.