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Loan Loss Standard’s Troubled Debt Restructuring Guidance to Get Another Look

The FASB plans to discuss in early September a lingering question on its sweeping new rules for banks to calculate losses on souring loans. Banks, auditors, and regulators have questions on how to consider troubled debt restructurings when estimating credit losses.

As financial institutions gear up to implement the biggest change in accounting for banks in decades, the FASB has at least one lingering question to clear up: how to account for a type of loan modification called a troubled debt restructuring (TDR).

Banks and auditors have told the FASB that there is not enough clarity in the June 2016 standard, Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, about the accounting for these arrangements when assessing credit losses.

The board plans to discuss the issue in early September, a FASB spokesperson said.

Banks arrange TDRs when a borrower falls behind on payments. The restructuring usually either lowers the balance or allows a borrower extra time to pay it off. These restructurings are uncommon in good economic times, but in the aftermath of the 2008 financial crisis, banks restructured millions of worth of troubled loans.

At issue is evaluating how to consider TDRs when estimating credit losses. Estimating losses is the crux of the FASB’s new accounting model and the board’s chief response to the financial crisis. In one interpretation of the accounting standard, banks should assess troubled debt restructurings on a portfolio basis. In another, they would be assessed individually.

The FASB last discussed the issue in June at a meeting of its special group charged with tackling questions on the new standard, which shakes up how banks and other businesses calculate losses on souring loans and certain trade receivables and securities. The spirited discussion yielded no consensus view and revealed differences of opinion between bankers, who argued that they can identify troubled debts better on a case-by-case basis, and regulators, who said banks needed to estimate the effects of restructurings on groups of loans.

“Waiting until you identify individual loans feels like a delay to me,” said Jeffrey Geer, associate chief accountant at the Office of the Comptroller of the Currency, at the June 12 meeting of the FASB’s Transition Resource Group for the credit losses standard.

Geer gave the example of a bank calculating future losses on 100 loans. Based on experience, the bank estimates that five of the 100 will become troubled debt restructurings at maturity. Banks need to estimate the credit losses on those five loans on day one, not wait until they can identify which five will be the loans that have problems, he said.

To Michael Gullette, senior vice president for tax and accounting at the American Bankers Association, the regulator’s view was a major concern for banks.

“What they’re trying to do presents a lot of operational problems that are kind of contrary to the spirit of what [the credit losses standard] is,” Gullette said. “It’s either they don’t get it or they’re trying to have both accounting standards — the new and the old — work at the same time.”

The 2016 standard is a reaction to years of complaints by investors, analysts, and regulators that while current rules allow banks to record losses after they are “probable,” in practice it means the customer has stopped paying and the losses have already occurred. The delayed recognition of the losses made bank balance sheets during the crisis appear relatively healthy even when the mortgage market was collapsing and bank stocks were in a free fall.

The new standard will require banks to look to the future to estimate losses and book loan loss reserves. The standard goes into effect in 2020 or 2021, depending on the size of the financial institution.

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