By: Ted Lloyd
Shadow accounting for troubled debt is a relatively new concept that many financial institutions are starting to use because of its transparency to the borrower, its ease of tracking, and its financial accuracy; making the recovery of troubled debt more likely.
Federal and state regulations require creditors “charge-off” delinquent loans after a period of time (usually 60 to 180 days depending on the type of loan). The financial institution must put the loan in a non-accrual status at that point. However, as far as the financial institution and the borrower are concerned, the debt is still in force and should be paid back as if there was no charge-off of the loan made. Interest can still be calculated on the balance and presented to the borrower using the same or modified payment schedule.
The problem is that since the financial institution’s accounting system is not calculating interest for the bank’s accounting books, it can be difficult for the lender to keep track of what the borrower owes on the debt unless two sets of books are kept. Reconciliation of the two accounts can be difficult and error prone. Many times, a borrower calling their lender to ask what amount is owed, may get several different answers depending on who is trying to calculate all the accrued interest as they try to reconstruct the loan as if it had never gone on non-accrual.
Shadow accounting is a great solution to this problem. When an account is charged-off, two sibling accounts are created – one for the “Charged-off” balances where no interest is calculated and a second “Shadow” account. This shadow account, not missing a beat, has all the same balances, continues to accrue interest, create statements etc., as if the loan was never charged-off.
When a payment from the borrower is received, for customers using Shaw’s SPECTRUM RECOVERY software, the payment amount is automatically posted to both charge-off and shadow accounts. The two account balances are perfectly accounted for, both for the lender and for the borrower. No more having to reconcile two unconnected accounts or manually calculating a payoff amount.
But it gets even better. SPECTRUM can create multiple shadow accounts to accommodate a myriad of troubled debt situations. For example, if after contacting the delinquent borrower, the institution may decide to renegotiate the loan terms to help the borrower get back on track. The interest rate may be reduced and the term of the loan extended for a few more years, thus bringing down the monthly payment amount to something the borrower can more easily manage. However, this agreement is made with the stipulation that if the terms of the new arrangement aren’t met, the loan will revert back to the pre-renegotiated state. A new, second shadow account is created with the new terms and it becomes the “primary” account for the borrower.
SPECTRUM can automatically keep track of the charge-off, pre-renegotiated account and the new negotiated account balances, all at the same time. When a payment is received, the system can be configured to post the payment automatically to all three accounts. If the lender has to revert to the pre-settlement loan, the loan has been kept up-to-date all along and going back to it is as simple as setting a system flag on the older shadow account to let the system know it is now the “primary” account for the borrower.