Restoring Nonaccrual Loans to Accrual Status

3/31/2011

By Robert L. Hamby, CPA

In accordance with the call report instructions, loans must be placed in a nonaccrual status if the financial condition of the borrower causes the asset to be maintained on a cash basis, if full payment of principal or interest is not expected or if the principal or interest has been in default for more than 90 days unless the asset is both well secured and in process of collection. To return a loan to accrual status there are a few rules or guidelines that should be followed. Any loan that meets the following criteria can be returned to accrual status:

• None of the principal or accrued interest is past due and the bank expects repayment of the remaining contractual obligation. (see exceptions below)
• When the loan becomes well secured and in process of collection.

The exceptions to meeting the first criteria are as follows:

• If the loan has been formally restructured and the bank is reasonably assured of repayment and performance under the modified terms. There should be a history of performance of at least six months’ activity and adequate credit documentation of the restructuring.
• The loan is a purchased impaired loan.
• If the loan has been acquired at a discount.
• The borrower is making the contractual principal and interest payments and, while the loan may not be fully current, the bank is reasonably assured that the borrower will be able to get current within a reasonable period and the borrower has shown a sustained period (six months or more) of being able to make the contractual payments. Any loans meeting this last exception should continue to be reported as past due on schedule RC-N but can be returned to accrual status.

When the bank puts a loan on nonaccrual status and any payments received are applied toward the principal balance, these payments should not be reversed when the loan is placed back on accrual status. Generally, there is no immediate income recognition when putting a loan back on accrual status. The bank should record a discount for the amount of interest that was applied toward the principal balance during the nonaccrual status of the loan and the discount is then accreted to income over the remaining term of the loan.