A new rule designed to assist federally insured credit unions (FICUs) to effectively balance appropriate loan workout programs with safety and soundness considerations goes into effect today, July 2, 2012.  However, certain portions of the rule have extended compliance dates as discussed below.

The rule was originally proposed in February and, following a comment period, it was issued as a final rule on May 24, 2012 by the National Credit Union Administration (NCUA).  Requirements under the new rule include:

• Adoption by FICUs of written policies addressing loan workouts and non-accrual practices.
• FICUs must cease to accrue interest on all loans at 90 days or more past due, subject to a few exceptions.
• FICU member business workout loans are to be maintained in a non-accrual status until the FICU receives 6 consecutive payments under the modified terms.
• FICUs should calculate and report delinquencies of troubled debt restructured loans (TDR loans or simply, TDRs) based on the restructured contract terms rather than the original loan terms.  To that end, the NCUA is modifying the Call Report to reduce data collection to TDRs as defined by generally accepted accounting principles (GAAP).

This alert addresses the rule’s requirement that FICUs (regardless of size) adopt written policies addressing loan workouts and non-accural status.

1.   Loan Workouts.

The rule requires each FICU to adopt and adhere to an explicit written policy and standards that control the use of loan workouts and establish controls to ensure that the policy is consistently applied.  The loan workout policy should be commensurate with each FICU’s size and complexity, and must be in line with the FICU’s broader risk mitigation strategies.  The policy must define eligibility for a loan workout and establish limits on the number of times a loan may be modified.  If a loan is restructured more than once a year or more than twice in five years, examiners will have higher expectations for the documentation of the borrower’s renewed willingness and ability to repay the loan.  Examiners will ask for evidence that an FICU’s policy of permitting multiple restructurings will actually improve collectability.  The policy must also prohibit any authorizations of additional advances to finance unpaid interest and credit union fees.  (However, advances may be allowed to cover third-party fees, such as force-placed insurance or property taxes, provided that the FICU does not receive any related commission from such third-parties.)

2.   Loan Nonaccrual Policy.

The rule codifies existing general industry practice to cease accruing interest on a loan when it becomes 90 days or more past due.  FICUs are now required to adopt written nonaccrual policies to that effect, as well as establishing the requirements for restoring such loans (including member business loan workouts) to accrual status.  Also, the rule discusses the criteria under GAAP for Cash or Cost Recovery basis of income recognition.

An FICU may not accrue interest on any loan upon which principal or interest has been in default for a period of 90 days or more unless the loan is both “well secured” and “in the process of collection.”  Both of these phrases are defined terms under the rule.  “Well secured” means the loan is collateralized by (i) a perfected security interest in, or pledges of, real or personal property, including securities with an estimable value, less cost to sell, sufficient to recover the recorded investment in the loan, as well as a reasonable  return on that amount, or (ii) by the guarantee of a financially responsible party.  “In the process of collection” means that collection of the loan is proceeding in due course either (i) through legal action, including, judgment enforcement procedures, or (ii) in appropriate circumstances, through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or in its restoration to a current status in the near future, i.e., generally within the next 90 days.

Although the rule becomes effective today, the compliance date is extended to October 1, 2012 for the requirement to adopt written policies addressing loan workouts and nonaccrual practices.  With our more than forty years experience in representing credit unions, we would be pleased to assist you and your Board of Directors in drafting appropriate policies to comply with this rule.  For more information, please contact David Kesler or any member of Miller & Martin's Financial Services Practice Group.