Understanding how to handle Loan Impairment in a changing market

Many Fund Managers spend a significant time evaluating both borrowers and market conditions for loan collectability. Changing economic and market conditions make these evaluations even more difficult and despite the best due diligence, some loan repayments fall short. Fund Managers must consider how these losses will impact the investors coming in and out of their offering. Redwood’s sound knowledge of accounting standards in both theory and application provides expertise and guidance in navigating these conditions.

Some key considerations for Fund Managers include:

  • Loan Loss Allowance or Reserve
  • Foreseeable Loan Losses
  • Impairment Valuation

Loan Loss Allowances/Reserves: Fund Managers should set a provision for loan losses that enables them to build a reserve on their balance sheet, which is similar to write-offs for bad debts or other similar events. Exactly how losses are determined and at what point they should be recognized differs, depending on whether the portfolio is being collectively evaluated or if a single loan has a foreseeable loss.

In the case of pooled mortgage loans with similar underwriting and smaller principal balances, Financial Accounting Standard (FAS) 5 guidance provides for a reserve or allowance to represent a small portion of the overall portfolio. While no one loan may have a foreseeable loss, economic and market conditions justify keeping the small allowance. However, when a loan does have a foreseeable loss a different accounting standard applies.

Foreseeable loan losses: As a result of periodically evaluating your portfolio of active loans, you may determine that one loan has become impaired. In this situation, accounting standard FAS 114 applies. Once a loan is determined to be impaired, a separate loss allowance can be calculated, in line with any loss that can be reasonably estimated.

Impairment Valuation: While accounting standards suggest several measurements of impairment, using the fair value of collateral may be most relevant to the SBRE community. If the fair value of the loan is less than the outstanding receivables to be collected, a separate allowance should be created along with a corresponding current period Expense to loan losses related to the impaired loan.

As always, you should consult with your duly licensed CPA to ensure that you are applying these rules appropriately for your fund. Although Redwood is not a CPA, we can help you understand how these issues may be treated, as well as exactly what issues you should raise with your CPA. Don’t hesitate to reach out to us if you have questions.

 

Nate Ashley

Redwood’s Senior Fund Accountant Nate Ashley provides expert guidance to his clients based on the accounting standards to make sound business decisions in the face of varied economic conditions. Feel free to reach out to Nate at nate.ashley@redwoodrea.com.

 

 

Neither Redwood nor any of its affiliated entities offer or provide any legal, accounting, or other advice that requires a professional license. None of the materials in this post or any related materials are intended to be or should be considered legal, accounting, or similar advice. No one receiving these materials may rely on them as a substitute for appropriate professional advice. Redwood strongly encourages and advises anyone receiving these materials to consult with their own independent attorneys, CPAs, and other professionals in order to ensure that any actions taken in connection with the materials complies fully with all applicable laws, rules, and regulations.