TDR DEAL STRUCTURING CONSIDERATIONS
There are many ways to structure a deal to make it as much of a WIN-WIN as possible. While calculating the loan modification/TDR using TValue software, payments can easily be tiered over any period of time with interest only payments, rate reductions and potential rate increases, extended terms, and/or a balloon. This allows the lender to lower the payments to save the loan but limit the term of the reduced cash flows to minimize the loss.
You can use one or a combination of these concepts to create the best possible deal to help meet the payment needs of your customers/members and minimize the impairment for the Allowance for Loan Losses (ALL) / Allowance for Loan and Lease Losses (ALLL).
- Lowering the overall interest rate for the full term
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- Allowing interest only payments for a period, e.g., 6 to 24 months, to reduce the initial payments and then amortizing the remaining loan (sometimes at a different interest rate)
- Creating a step-up interest rate loan structure, e.g., 3% for 12 months, 4% for 12 months, and 5% for the remaining term, to reduce the initial payments in the early years
- Lowering the interest rate for a short term, e.g., 5 to 10 years, and ballooning the loan
- Extending the term to lower the payments
Effects of "what if" calculations for TDRs
Following are different TDRs and a quick look at the ALLL impact from these considerations
Rate change (6% to 5% or 4%)
The impact of doing a straight rate reduction lowers the payment and affects the ALLL.
- If you lower the rate by 1% for the TDR for 30 years, it will cost you 11% of the loan
- If you lower the rate by 2% for the TDR for 30 years, it will cost you 21% of the loan
Balloon in 10 years (6% to 5% or 4%)
The impact of doing a 10 year balloon will positively affect your ALLL.
- If you lower the rate from 6% to 5% for the TDR, amortize for 30 years, and balloon the loan in 10 years, it will reduce the loss by 40%, e.g. 11% to 7%
- If you lower the rate from 6% to 4% for the TDR, amortize for 30 years, and balloon the loan in 10 years, it will reduce the loss by 35%, e.g. 21% to 14%
Interest only payment
The impact of doing “interest only” payments for a period of 6 months to 2 years will allow you to reduce the borrower’s payment and minimize the ALLL.
- With a 6% interest rate, you can lower the payment by 20% by just doing an “interest only” payment
- With a 1% interest rate reduction, 6% to 5%, you can reduce the payment by 30% by doing an “interest only” payment
Interest rate step
The impact of doing an interest rate step can have a material impact on the ALLL. The goal should be to get back to the effective rate or as close as possible over time to minimize the cost of carrying the loan at a discount for 30 or 40 years.
Extending the term
Extending the term from 25 to 30 years or 30 to 40 years can actually increase the ALLL by as much as 18% if you don’t either do an interest rate step to get back to the effective rate or balloon the loan at some reasonable period.
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