This article was written by Jamie Card, Partner at The Bonadio Group & Chad Scott, Senior Accountant at The Bonadio Group.
As a result of the Financial Accounting Standards Board’s (“FASB”) post-implementation review of the current expected credit losses (“CECL”) standard on November 23, 2021, an exposure draft was issued proposing Accounting Standards Update (“ASU”) regarding Financial Instruments–Credit Losses (Topic 326), Troubled Debt Restructurings (“TDRs”) and Vintage Disclosures.
This was in response to financial statement users questioning the relevance of the troubled debt restructuring (“TDR”) designation and their associated disclosures. Financial statement users have indicated that measurement of expected losses under the CECL model already captures aspects of the TDR model and therefore enhanced disclosure (rather than TDR designation and disclosure) about modifications would provide more useful information.
Under the incurred loss model, the existence of special accounting treatment for TDRs was critical for the allowance for loan losses calculation due to the treatment of TDRs as impaired and the requirement to have a specific reserve calculation for these loans initially after modification. However, the expected credit loss model effectively considers the impact of TDRs at the time a loan is originated; thereby, negating the need to account for it subsequently. One of the key determinations regarding loan modifications under the expected credit loss model will be determining whether the loan(s) has been modified or whether a new loan has been originated. However, at this time, the proposed ASU requests feedback regarding this matter and has not yet been updated.
The most significant difference regarding whether a loan was a TDR under the incurred loss model and whether a loan will require new loan modification disclosures in the proposed ASU is the concept of a concession under the incurred loss model. Under the previous guidance, loan refinances, restructurings, renewals, modifications, etc. generally required borrowers to be experiencing financial difficulty and the creditor had to make a concession during the lending process to deem the modification a TDR. However, to qualify for the new disclosure requirements under the expected loss model, the loan modifications only need to be made to borrowers experiencing financial difficulties. The factors included in the guidance to determine whether a borrower is experiencing financial difficulties have not changed.
Under the proposed ASU, the disclosure requirements are quite robust compared to the previous disclosure requirements of TDRs and are aimed at providing analysts and investors with critical information regarding loan modifications. These enhancements include segregation of loan modifications and amounts by class of loan and then also by type of modification (ie. rate reduction, term extension, payment holiday, etc.). The disclosure requirements at this level of segregation will include the following under the proposed ASU:
- Pre-modification amortized cost basis of the modified loans
- Percentage of modifications as a percentage of the total loans included in each loan segment at the end of the reporting period.
- The financial effect of the modification by type of modification, which will include information about the modifications made and may include:
- The incremental effect of any principal forgiveness on the amortized cost basis of the modified loans
- The weighted-average reduction in interest rates for interest rate reductions and the range of the same.
- Loan performance status for the 12 months following the modification
Additionally, the disclosures, as proposed, will require qualitative information, by loan segment, about how the loan modifications and the debtors’ subsequent performance are factored into the expected credit loss methodology.
For loan modifications that default within 12 months following the modification, the disclosure requirements have not changed significantly. However, the disclosure requirements now need the impact of the defaults on the overall expected credit loss methodology.
Also addressed in this proposed ASU was the requirement for all public business entities to include current period gross charge-offs and recoveries by origination year to their vintage disclosures. This requirement was added to update a previous inconsistency within the original guidance.
Comments are due on this exposure draft December 23, 2021.
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