How does one determine if a loan is impaired?

Under FAS 114, a loan is impaired when it is probable that a bank will be unable to collect all amounts due, including both interest and principal, according to the contractual terms of the loan agreement. Generally, a loan is impaired for the purposes of FAS 114 if it exhibits the same level of weaknesses and probability of loss as loans or portfolio of loans classified as doubtful or loss within their portfolio. In practice, some banks consider a loan impaired if it would be reported as a non-accrual loan or a TDR on the report of conditions in income.

The OCC writes in its Bank Accounting Advisory Series, “A loan is impaired when, based on current information and events, it is probable that an institution will be unable to collect all amounts due, according to the original contractual terms of the loan agreement.” As stated within this publication, the definition of an impaired loan centers on whether the borrower is paying according to the contractual agreement.

Loans that have been restructured (TDRs) would automatically fall into the impaired bucket because the original contractual terms have been altered and, therefore, will not be collected according to the original structure. Nonaccrual loans are by nature non-performing and, therefore, can easily be defined as impaired loans. The definition of a non-accrual loan as written by the Federal Reserve is, “(1) any asset which is maintained on a cash basis because of deterioration in the financial position of the borrower, (2) any asset for which payment in full of interest or principal is not expected, or (3) any asset upon which principal or interest has been in default for a period of 90 days or more unless it is both well secured and in the process of collection.” Regulatory guidance does not specifically state how an institution should determine whether repayment is probable but does specifically refer to TDR
loans and the probability of repayment as it relates to accrual status. As a result, institutions should, at the least, adopt these two methodologies as ways of identifying impaired loans. Aside from non-accrual and TDR distinctions, institutions have the ability to determine additional characteristics from which to identify impaired loans. Institutions will often use risk ratings (substandard or worse) and days past due to monitor loans that are deteriorating and should be considered impaired.

Access a complimentary FAS 114 Impairment Analysis Worksheet.