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Memo for Credit Loss Standard to Explain Accounting for Troubled Debt Restructurings

Banks, auditors, and regulators questioned how to consider a form of loan modification called a troubled debt restructuring when banks estimate losses on loans according to the FASB’s credit loss accounting standard. The board agreed to clarify that lenders must identify and measure the effects of the restructuring when the individual troubled loan is identified.

The FASB on September 6, 2017, unanimously agreed to clarify the guidance for a type of loan modification called a troubled debt restructuring in its credit loss standard.

The FASB said its decision will not result in a formal amendment to Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Instead, the board plans to publish a memo about its discussion of the guidance for restructured loans, a spokesperson said.

The accounting board agreed that lenders must identify and measure the effects of the restructuring when the individual troubled loan is identified. In some circumstances, such as when restructuring information is not available, banks can apply what the FASB called a “portfolio-level” approach — making estimates based on known historic data.

“It moves the estimation of the TDR up earlier, to a point where it’s reasonably expected as opposed to the point that it’s executed,” FASB member Christine Botosan said of the board’s decision. “And at that point that it’s reasonably expected, the entity makes an estimate of what they’re anticipating based on the best information they have at that point as to what the impact of the concessions will be, and to the extent that they’re not already in the allowance, update the allowance for any difference.”

When a bank carries out the loan restructuring, it may make an additional adjustment if there is a difference between the loss it expected and the actual loss it incurred, Botosan added.

The FASB also agreed to not specify a particular method for calculating the loss from a restructured loan.

Banks sometimes modify loans when borrowers fall behind on their payments. A modification is considered a troubled debt restructuring if the lender makes a concession to a borrower experiencing financial difficulties that it otherwise would not consider.

When the bank agrees to modify the loan, it accepts that it will lose some money via a lower interest rate or some form of forgiveness of the loan’s principal, but it also is trying to stave off deeper losses if the borrower cannot meet the payments.

“TDRs are nothing but loss mitigation,” FASB member Harold Schroeder said.

ASU No. 2016-13 was issued in June 2016 as a reaction to years of complaints by investors, analysts, and regulators that while existing GAAP allows banks to record losses after they are “probable,” in practice the guidance means a borrower has stopped paying off the loan, and the lender has begun to lose money on it.

The delayed recognition of the losses made bank balance sheets during the build-up to the 2008 financial crisis appear robust even when the mortgage market was rapidly deteriorating. The new standard will require banks to look to the future to estimate losses and set aside reserves to cover the amount they expect to lose on their portfolios of loans and other financial instruments. The standard goes into effect in 2020 or 2021, depending on the size and type of the financial institution.

The FASB’s advisory panel for the credit loss standard, the Transition Resource Group, last met in June, and questions about the troubled debt restructurings dominated the meeting. The board plans to meet in early October to address another question from that meeting — how to consider losses on credit card receivables, a FASB staff member said.

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