Federal Reserve Board Governor Elizabeth Duke favors the issuance of guidance clarifying the regulatory and accounting treatment of troubled debt restructuring, non-performing assets, and classified loans which, while they have different definitions, time frames, and regulatory consequences, often seem to be used interchangeably. In remarks before the California Bankers Association, the Fed official also sees a need to clarify expectations, improve transparency, and heighten consistency around accounting for loan losses.
With regard to troubled debt restructuring, Gov. Duke noted that some bankers are reluctant to offer modifications that would help struggling borrowers and enhance the potential for ultimate repayment because they are concerned that the loan would be classified as a TDR and remain classified even after performance under the modified terms is demonstrated.
She also noted that a factor contributing to uncertainty is the intersection of Generally Accepted Accounting Principles (GAAP) and regulatory requirements. In her view, nowhere is this more evident than in the accounting for the allowance for loan and lease losses. The current accounting standard requires provisions only to cover losses that have already been incurred.
The central banker observed that conflicting views of the range of likely losses sometimes leads to a perception that the regulatory evaluation of the adequacy of accounting for loan loss levels involves something of a black box. To further complicate things, the accounting standard generally requires estimation, using statistical analysis, of a bank's unique past loss patterns, but most community banks have neither the rich data nor the capability to perform such analysis.
Gov. Duke said that the Federal Reserve staff is currently investigating whether there is any way to use available supervisory data to publish loss rate ranges that could be used as a starting point for any bank to calculate allowance amounts in a way that is simple to understand and not inconsistent with GAAP. Even if development of such a tool does not turn out to be feasible, she continued, the staff is still working to amend its approach to clarify expectations, improve transparency, and heighten consistency.