Since the issuance of the Financial Accounting Standards Board's (FASB) Accounting Standard Update (ASU) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and its introduction of the current expected credit loss (CECL) model, the FASB has been focused on the effective implementation of CECL. The FASB's Post-Implementation Review (PIR) process began before the standard was even effective and included the creation of a Transition Resource Group and other efforts to solicit constituent feedback.
Not long after implementation, there was a growing consensus that the CECL model essentially rendered the existing accounting for troubled debt restructurings (TDRs) as redundant and no longer meaningful. While the historic TDR model in ASC 310-40, Receivables – Troubled Debt Restructurings, required a measurement of an expected loss in the accounting for a specific loan subject to a modification determined to be a TDR, the new CECL model reflects a measurement of expected losses for all loans in the allowance for credit losses. In addition, as part of the Coronavirus Aid, Relief, and Economic Security Act of 2020 and as extended by the Coronavirus Response and Consolidated Appropriations Act of 2021, temporary relief was provided for application of TDR accounting for certain loans through Jan. 1, 2022, without an outcry from investors or regulators.
As a result of that feedback, on March 31, 2022, following a relatively expedited exposure and comment period, with virtually no investor comment letters, the FASB issued ASU 2022-02, Financial Instruments – Credit Losses (Topic 326) – Troubled Debt Restructurings and Vintage Disclosures, to eliminate the TDR model in ASC 310-40. The ASU also clarified some confusion over certain disclosures and introduced a few new disclosures.
Elimination of the TDR Measurement Model
When adopted, application of the TDR measurement model will no longer be required for an entity that has adopted the CECL model in ASC 326-20. That is, when a loan is modified, the creditor will not need to determine if both a) the borrower is experiencing financial difficulty and b) the modification represented a concession to the borrower to determine the proper accounting for the modification. However, the creditor will still need to evaluate the first criterion (e.g., the borrower is experiencing financial difficulty) as those modifications will now require new disclosures. A modification to a loan with a troubled borrower will now be accounted for and measured as any other loan modification, following the current guidance in ASC 310-20-35 to determine if the loan is to be accounted for as a new loan or as the continuation of the old loan.
As there will no longer be any accounting measurement distinctions for modifications based on the old TDR guidance, a creditor is no longer permitted to consider reasonably expected extensions, renewals and modifications as it did when measuring the allowance for a TDR loan. However, the FASB clarified that a creditor need not reverse the effects of historical credit management strategies from its historic data used in its CECL model.
In addition, certain CECL modeling concessions that were allowed for TDR loans have been eliminated, again because there will be no measurement differences from other loan modifications. The TDR model effectively required the use of a discounted cash flow (DCF) model to measure the allowance for certain concessions (e.g., extending the timing of cash flows or reducing the interest rate). Now, consistent with all other loans, loans modified with troubled borrowers will have an allowance calculated under the same CECL methodology as unmodified loans, so all the various CECL methods are allowed (e.g., DCF, loss rate, probability of default).
However, if a DCF model is applied, then different from the DCF approach under the TDR model, the estimated cash flows will be based on the post-modification loan terms and the discount rate will be based on the effective interest rate post modification.
When originally issued, a discrepancy in ASU 2016-13 was noted between certain credit quality disclosures by vintage required in the standard and the related illustrative disclosures in the implementation guidance regarding current-period gross write-offs and current-period recoveries. Gross writeoffs and recoveries were not required by the standard but both were included in the illustration. Based on feedback from investors finding this information valuable, the ASU clarifies that the disclosure of gross writeoffs by vintage is now required for public business entities.
As with many ASUs, the FASB took the opportunity to make other improvements in the disclosures around loans and especially those related to troubled borrowers.
The additional disclosures are required for modifications of loans to borrowers experiencing financial difficulty in the form of principal forgiveness, an interest rate reduction, an other-than-insignificant payment delay or a term extension (although covenant waivers and modifications of contingent acceleration clauses are not considered term extensions). There are some loans excluded from the disclosures (e.g., loans measured at fair value through earnings among others). Finally, the disclosures are applicable regardless of whether a modification results in a new loan under the guidance.
Quantitative and qualitative disclosures, by class of loan, are to be made in each period for which a statement of income is presented as follows:
- The types of modifications utilized by an entity, including the total period-end amortized cost basis of the modified loans and the percentage of modifications of loans made to debtors experiencing financial difficulty relative to the total period-end amortized cost basis of loans in the class
- The financial effect of the modification by type of modification, providing information about the changes to the contractual terms as a result of the modification and including the incremental effect of principal forgiveness on the amortized cost basis of the modified loans, as applicable, or the reduction in weighted-average interest rates (versus a range) for interest rate reductions
- Loan performance in the 12 months after a modification of a loan made to a borrower experiencing financial difficulty
- Disclosure of qualitative information, by portfolio segment, about how those modifications and the borrower’s subsequent performance are factored into determining the allowance for credit losses is required
If a loan is modified in more than one fashion, disclosures are required sufficient to understand the different types of combinations of modifications provided to borrowers. Multiple separate combination categories may be necessary, and the same loan’s period-end amortized cost basis is presented in a single category.
For a loan modified as described above within the previous 12 months and experiencing a payment default in the period covered by a presented income statement, the following qualitative and quantitative information, by class of loan, is required for the defaulted loan:
- The type of contractual change that the modification provided
- The amount of loans that defaulted, including the period-end amortized cost basis for loans that defaulted
- Disclosure of qualitative information, by portfolio segment, about how those defaults are factored into determining the allowance for credit losses
As a catch-all, the standard suggests providing information around the significant changes in the type or magnitude of modifications, including those modifications that, for example, were caused by a major credit event, even if the modifications otherwise would not require the disclosures above.
The transition provisions are generous, allowing flexibility between the adoption of the TDR changes and related disclosures and the adoption of the vintage disclosures.
- For entities that have already adopted ASU 2016-13, the amendments are effective for fiscal years beginning after Dec. 15, 2022, and interim periods within that fiscal year. Early adoption is permitted, with the entity being able to early adopt either separately or as a package, the TDR model and related disclosures and the vintage disclosures. Early adoption may be for a quarter during the fiscal year but must be as of the beginning of that fiscal year.
- For entities that have not adopted ASC 2016-13, the guidance in the ASU will be effective concurrent with the adoption of ASC 2016-13.
When adopting the elimination of the TDR model, an entity may elect between:
- A prospective adoption for modifications occurring after the effective date
- A modified retrospective adoption, which would include a cumulative-effect adjustment to retained earnings
The adoption of the additional TDR disclosures and vintage disclosures is prospective.
- Financial Accounting Standards Board, ACCOUNTING STANDARDS UPDATE 2022-02—FINANCIAL INSTRUMENTS—CREDIT LOSSES (TOPIC 326): TROUBLED DEBT RESTRUCTURINGS AND VINTAGE DISCLOSURES, March 2022.