Retail commercial loans and credit card delinquencies are expected to spike in 2018. According to the Wall Street Journal, credit card delinquencies have nearly doubled in the past year. On the commercial side, expectations are being set for delinquent retail loans to potentially triple this year. Not only are these concerns here and now, it is also important to reconsider what happened when interest rates rose on residential mortgages 12 years ago; while no one expects anything close to the 2008 financial crisis, banks need to start preparing for credit challenges as rates steadily increase over the next few years. As an accountant, why is it important to bring up this unwelcome news in seemingly good times? Now is the time to begin planning for the challenges that a tough economic climate (e.g., credit cycle deterioration) may bring upon your institution.
So what are the operational challenges that this year could bring as a result? Delinquent loans, whether commercial or consumer, require several pieces of accounting guidance to come together seamlessly; and managing them always adds an operational burden on teams and systems. The delinquency period must be carefully managed due to the long term effects as the changes that result to the accounting basis of the loan during this period may carry forward on its remaining life, even if the loan returns to performing status. The result of these accounting ‘differences’ to the loan basis are often handled via a process called ‘shadow accounting’. Shadow accounting means using contra, or offsetting ledger accounts to record the differences between a loan’s ‘accounting’ basis and the balances that the servicer is managing. One common use for shadow accounting are loans that are delinquent to the point that accounting guidance will not allow the bank to earn income on the loans until they have recouped their principal investment. This is referred to as non-accrual accounting, which is operationally challenging for many reasons, including:
- Amortization on any remaining deferred basis is discontinued
- Any outstanding accrued interest/fee receivable balances must be written off
- Interest or fee accruals received during the non-accrual period must be written off
- Interest or fee receivable payments received should be either be applied as a reduction in the loans remaining principal balance or, applied directly to income
- At the time a loan returns to a performing/accruing status, all previous interest applied to principal will prospectively amortize for the remainder of the loan’s life
Preparing journal entries is challenging enough when these items are working together, not to mention audit and tracking requirements moving forward. What about reporting requirements and management level questions and analysis? Recall that some impacts, such as the application of interest payments to principal, will need to be recorded and tracked on a loan-level over the remaining life of the loan. Can an Excel spreadsheet survive the next 10 years of month-end closes and reporting cycles? As discussed in my previous blog, Move over, Excel, Finance is evolving, Excel and other end-user calculations are no longer viable solutions. While servicing systems cover the operational lifecycle of a loan, they simply cannot handle every aspect of complex loan accounting.
To add further complexity, regulatory requirements surrounding non-performing investments continue to change. Financial institutions must take steps to build and maintain systems and processes to ensure they remain compliant with the latest series of regulations. For example, many investors have the complexity of separating their non-accrual portfolios into distinct populations, where subsets of loans may require different treatment than others (e.g., government guaranteed or schedule/schedule loans).
How can finance teams tackle complex shadow accounting requirements, while simplifying their close processes? The answer is leveraging an accounting solution such as SS&C Primatics’ EVOLV, which enables an automated, controlled, and predictable close process. EVOLV includes out-of-the-box, pre-configured functionality to support shadow accounting regardless of portfolio size and product types. EVOLV is easily configured to apply different policies to different loan populations, including non-performing loan identification logic. EVOLV reports on the entire non-accrual portfolio with both a servicing and accounting view. Finally, EVOLV creates and captures all journal entries in a singular space, which provides the convenience of transparency and ability to use a consistent set of data for varying reporting and disclosure requirements.
EVOLV eliminates costly manual processes by automating the entire end-to-end process in a controlled, yet nimble way. EVOLV also adapts along with changes in the market, so changes in regulations, accounting guidance and credit cycles are no longer a burden to your operations.
To learn more, download our whitepaper about how EVOLV eliminates the need to maintain multiple internal systems and spreadsheet-based processes. Contact us at email@example.com or 800-234-0556 for a demo and more information.
Asset Management, Regulation