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MEMO
Memo No.
Issue Date
Meeting Date(s)
6A
September 11, 2017
BM September 6, 2017
Contact(s)
Andrew Thornburg
Industry Fellow
Ext. 344
Seth Drucker
Practice Fellow
Ext, 317
Damon Romano
Practice Fellow
Ext. 334
Shane Kinley
Postgraduate Technical Assistant
Ext. 359
Jared Cline
Postgraduate Technical Assistant
Ext. 388
Shayne Kuhaneck
Assistant Director
Ext. 386
Project
Transition Resource Group for Credit Losses
Project Stage
Post-Issuance
Issue(s)
Accounting for Troubled Debt Restructurings
[Note: This memo serves as an addendum to Transition Resource Group for Credit Losses (TRG) Memo No. 6 June 2017 Meeting—Summary of Issues Discussed and Next Steps.]
Memo Purpose
  1. At the meeting of the Transition Resource Group for Credit Losses (TRG) on June 12, 2017, TRG members discussed the guidance in Accounting Standards Update No. 2016–13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which addresses accounting for troubled debt restructurings (TDR).
  2. The purpose of this memo is to provide the Board with the staff's analysis and recommendations regarding the following key discussion items that were unresolved at the TRG meeting on June 12, 2017:
(a) Whether all effects of a TDR should be recorded in the allowance for credit losses
(b) The use of a discounted cash flow (DCF) method (or a reconcilable method) to measure concessions given on TDRs that can be measured only using a DCF
(c) The timing of when the effects of a TDR are recorded.
Question for the Board
1) Does the Board agree with the staff’s analysis and conclusion in this memo?
Issue Background
Accounting for Troubled Debt Restructurings: Current GAAP
[Note: This section is only a summary of requirements in current generally accepted accounting principles (GAAP).Readers should refer to the FASB Accounting Standards Codification® at www.fasb.org for the authoritative guidance on accounting for TDRs.]
Identification of a Troubled Debt Restructuring
3. A TDR exists when a creditor grants a concession to the debtor for economic or legal reasons related to the debtor's financial difficulties that it otherwise would not consider. A concession is deemed to have occurred when an entity does not expect to collect all amounts due according to the contractual terms of the original loan as a result of restructuring. Therefore, in all TDRs, the entity does not expect to collect all amounts due according to the original agreement.
Measurement of a Troubled Debt Restructuring
4. If a creditor determines, based on current information and events, that it is probable it will be unable to collect all amounts due according to the contractual terms, an individual loan is deemed to involve impaired loans. Accordingly, based on the conclusion in paragraph 3 above, all TDRs are deemed impaired. Once a loan is deemed impaired, the creditor is required to measure the individually impaired loan using the present value of expected future cash flows discounted at the loan's original effective interest rate, assuming the creditor does not apply one of two available practical expedients (that is, the loan's observable market price or the fair value of the loan's collateral if collateral dependent). Consequently, TDRs that effect both principal and future interest are measured under current GAAP because a DCF method is applied.
Accounting for Troubled Debt Restructurings: Amendments in Update 2016–13
5. The following represent the key changes made by the amendments in Update 2016–13 that affect the accounting for TDRs:
(a) The concept of an individually impaired loan has been removed, but the concept of a TDR has been retained.
(b) Various measurement methodologies are permitted for measuring credit losses. A DCF method (or reconcilable method) is not explicitly required.
(c) Measurement of expected credit losses is based on the contractual term of financial asset(s), considering the effect of prepayments; however, the measurement period is extended for reasonably expected TDRs.
(d) Credit losses should be measured on a pool basis unless a financial asset does not share similar risk characteristics with other financial assets.
(e) Forward-looking information is considered in order to estimate all expected credit losses for the financial assets.
(f) Concessions given to a borrower in a TDR must be recorded through the allowance for credit losses.
June 12, 2017 TRG Discussion
6. The FASB staff presented to the TRG members the issue regarding whether entities should forecast all types of reasonably expected future TDRs on a portfolio basis and include the effect of those reasonably expected TDRs in the calculation of expected credit losses. The staff identified two views:
(a) View A: Entities should include the effect of reasonably expected TDRs that do not extend the contractual term in their estimates of credit losses (for example, interest rate concessions). Entities also should forecast reasonably expected TDRs that extend the contractual term on a portfolio basis and include the effect of those reasonably expected TDRs in the calculation of expected credit losses.
(b) View B: Entities should include the effect of reasonably expected TDRs that do not extend the contractual term in their estimates of credit losses (for example, interest rate concessions). Entities should extend the term over which they are measuring credit losses when a TDR is reasonably expected at an individual financial asset level (that is, the loan for which a TDR is expected can be specifically identified) and include the effect of that reasonably expected TDR in the calculation of expected credit losses.
7. The staff notes that under both of these views, all effects of a TDR are considered in the estimate of credit losses. The only difference between the two views is that in View A, the effects of a contractual term extension (that is, additional credit risk exposure over an extended measurement period and the effect of other expected concessions, if applicable) would be forecasted at a portfolio level before assets are specifically identified as being troubled. Whereas in View B, the effects of a contractual term (that is, additional credit risk exposure over an extended measurement period and the effect of other expected concessions, if applicable) extension should be considered only upon specific identification of a reasonably expected TDR.
8. Various forms of TDRs were discussed throughout the discussion at the June 12, 2017 TRG meeting. Some members noted that such loss mitigation activities may have a direct or indirect effect on loss history. For example, the loss history for an entity would reflect both the credit risk for troubled loans and the offsetting loss mitigating effect of successful TDRs. Therefore, some effects of TDRs may already be captured in a portfolio's historical loss information. Some TRG members suggested that because of these factors, future TDRs may already be appropriately reflected in the measurement of credit losses for portfolios of performing financial assets (that is, the estimate may incorporate a lower amount of historical credit losses because of successful TDRs). Under this view, any incremental adjustment to portfolios of performing financial assets could misrepresent the effects of TDRs on performing portfolios and could result in additional cost and complexity.
9. Certain TRG observers noted that if the loss mitigating aspects of TDRs are recognized in loss rates for performing pools, all concessions related to the loss mitigation also should be reflected. Those TRG observers argued that to obtain this symmetry, all of the effects of reasonably expected TDRs should be forecasted on a portfolio basis for all loans, including performing pools, before troubled loans are specifically identified.
10. TRG members noted that while some TDR activity is captured in overall loss history, the subsequent accounting for certain TDRs (for example, interest rate concessions and term extensions, which are often provided as part of the same modification) may not be reflected in that loss history because of nonaccrual policies. In addition, considering various methods are allowed under the new standard, some questioned if certain accounting concessions (for example,interest rate concessions) would be captured if a DCF analysis was not explicitly required.
Staff Analysis
Measurement Methodology for TDRs
11. The discussion at the June 12, 2017 TRG meeting with regards to measuring concessions given on TDRs revealed a potential area of confusion between the various methods permitted in the guidance to measure credit losses in paragraph 326-20-30-3 and paragraph 310-40-35-10, which states:
A loan restructured in a troubled debt restructuring shall not be accounted for as a new loan because a troubled debt restructuring is part of a creditor's ongoing effort to recover its investment in the original loan.Topic 326 provides guidance on measuring credit losses on financial assets and requires credit losses to be recorded through an allowance for credit loss account, including concessions given to the borrower upon a troubled debt restructuring.[Emphasis added.]
12. The staff believes the combination of the following guidance means that all effects of reasonably expected TDRs need to be incorporated into the allowance for credit losses:
(a) Paragraph 310-40-35-10, which requires TDR concessions to be recorded in the allowance (see paragraph 11 of this memo).
(b) Paragraph 326-20-30-6, which requires the additional exposure to credit risk over an extended period to be considered in the estimate. The relevant excerpt from this paragraph is included below:
An entity shall not extend the contractual term for expected extensions, renewals, and modifications unless it has a reasonable expectation at the reporting date that it will execute a troubled debt restructuring with the borrower.
(c) Paragraphs 326-20-30-7 through 30-8, which require consideration of all available and relevant historical loss information on similar assets and which may include the benefits of loss mitigation strategies typically employed by the entity. The relevant excerpts from these paragraphs are included below:
326-20-30-7 When developing an estimate of expected credit losses on financial asset(s), an entity shall consider available information relevant to assessing the collectibility of cash flows.
326-20-30-8 Historical credit loss experience of financial assets with similar risk characteristics generally provides a basis for an entity's assessment of expected credit losses.
13. Stakeholder feedback has indicated that there are no concerns with considering the benefits of loss mitigation strategies or, once a TDR is specifically identified on an individual basis, considering additional exposure to credit risk over an extended term. Rather, questions have been raised on the requirement to reflect economic losses related to concessions in the allowance and when to reflect those losses under the new standard. The staff agrees with the TRG discussion (summarized in paragraph 10) that entities may be able to measure some concessions only through a DCF methodology (or reconcilable method). For further context, the staff prepared the example below, which illustrates several fact patterns for a problem loan and describes why different measurement methodologies may not reflect certain concessions, such as interest rate concessions.
Illustrative Example
14. Assume that at period 0 an entity holds a par loan with a single borrower that produces contractual cash flows at 5 percent on a principal balance of $100 over 3 periods. Assume that at the end of period 1 the borrower has experienced financial difficulty and that the entity has decided to offer an economic concession by lowering the interest rate to 3 percent in a TDR. Loan A in the following table is a hypothetical loan that would result if the borrower had not experienced financial difficulty and the TDR had not been performed. Loan B represents the reality of the loan described above. The difference in column (a), total interest cash flows, results from differences in cumulative interest income, and if there was any difference in column (b), total principal cash flows, it would result from differences in cumulative principal cash flows.
Table 1: Historical Loan Cash Flows
Amortized Cost
Cash Flows by Period
Total Interest Cash Flows
(a)
Total Principal Cash Flows
(b)
1
2
3
Loan A - not a TDR
100
5
5
105
15
100
Loan B - TDR beginning period 2
100
5
3
103
11
100
Difference between Loan B and Loan A
(4)
0
15. The following table illustrates various credit loss measurement methodologies and the basis for that measurement. Non-DCF methodologies typically are based on net charge-offs (NCOs), which may not capture all losses of interest cash flows, while DCF calculations consider the differences in all interest and principal cash flows (both columns (a) and (b) above). In this example that assumes the entity continues to receive current payments on Loan B, historical NCO data does not provide any information on the economic loss from the interest rate concession. As noted in the table below, neither a loss rate or probability of default and loss given default (PD/LGD) measurement methodology (if based solely on NCO information) reflect differences in interest cash flows; therefore, both result in a loss statistic of zero in this example.
Table 2: Historical Credit Loss Measures
Measure
Basis for loss statistic
Calculated loss statistic
Loss rate
PD/LGD
DCF
NCOs
NCOs
Cash Flows
0%
0%
>0%
View table
16. Additionally, U.S. banking regulators generally require a nonaccrual policy to be in place for problem loans, which exacerbates the issue of capturing interest related losses in historical loss information. These nonaccrual policies remove the effect of "lost interest" from the historical loss data in accounting systems and make the comparison of interest cash flows between the original and modified loan even more difficult. For example, the table below shows the interest income accruals recorded each period for the Loan B cash flows if the loan was placed on nonaccrual status at the end of period 1. Loan B represents a nonaccrual policy with no reversal of previously recorded interest income, while Alternate Loan B represents a nonaccrual policy for which period 1 interest is reversed.
Table 3: Historical accounting system entries with nonaccrual policy
Interest Income Recorded by Period
Total Interest Income
1
2
3
Loan B - TDR beginning period 2
5
0
0
5
Alternate Loan B
0
0
0
0
View table
17. As compared with loans that are not accounted for using a nonaccrual policy, the above table shows that an entity’s accounting system no longer is accruing any interest on a loan that has been placed on nonaccrual status. Therefore, the entity would not reflect losses of interest cash flows in its historical loss data when a nonaccrual loan is ultimately charged off. In order to determine the amount of lost interest, the entity would have to manipulate existing data outside of the current system to simulate the interest income that would have been accrued under both the original and modified terms of the loan. This would add another layer of operational complexity and cause the measurement of lost interest in a non-DCF methodology to be difficult to determine with sufficient precision.
18. Based on the differences between DCF and non-DCF measurement methods and application of nonaccrual policies noted above, the staff believes it would be difficult, if not impossible, for an entity to determine, with the appropriate level of precision, an allowance that considers lost future interest with a non-DCF method.
19. The example above highlights that certain measurement methods may not capture losses related to interest rate concessions. Loan term concessions would similarly not be captured by certain measurement methods. However, because various measurement methods are permitted under Update 2016–13, some stakeholders have questioned whether the Board intended to extend the flexibility in measurement method to capturing concessions given on TDRs, even if that means some of those concessions might not be captured.
20. The staff believes that while Topic 326 provides flexibility regarding different measurement methodologies, the requirement in paragraph 310-40-35-10 for concessions to be reflected in the allowance cannot be ignored. Accordingly, it is the staff's view that if a concession is given on a TDR that can be captured only through a DCF methodology, that concession must be measured using a DCF methodology (or a reconcilable method) either on a pool or individual basis. The staff notes that because a DCF methodology is required for impaired loans, including TDRs under current GAAP, this view should not represent a significant operational issue for most institutions.
Timing of Recording TDRs
21. There have been two different stakeholder interpretations of the following paragraph regarding reasonably expected TDRs. Paragraph 326-20-30-6 states in part:
An entity shall not extend the contractual term for expected extensions, renewals, and modifications unless it has a reasonable expectation at the reporting date that it will execute a troubled debt restructuringwith the borrower.
22. The differences in interpretation hinge upon what was meant by the Board's use of the phrase reasonably expected. Some stakeholders maintain that reasonably expected means that the effects of TDRs should be recognized before they are specifically identified. If those effects are to be recognized before specific identification, the assessment of reasonably expected TDRs would be done on a portfolio basis for performing assets. These stakeholders assert that an entity may be able to reasonably expect a specific level, or percentage, of TDRs that will occur in the future. Under this logic, earlier recognition of the effects of TDRs would result as compared with if the assessment were made on an individual financial asset basis because entities generally would be unable to reasonably expect individual TDRs until the borrower is experiencing financial difficulty. These stakeholders note that this aligns with certain objectives of Update 2016-13. Those objectives include earlier recognition of credit losses and elimination of thresholds before losses are recorded.
23. However, other stakeholders maintain that TDRs are reasonably expected only when they can be specifically identified on an individual financial asset basis, which is consistent with the statement in paragraph 326-20-30-6 on executing a TDR with "the borrower." These stakeholders add that the objective of paragraph 326-20-30-6 is to limit the estimation of credit losses to the contractual term except in limited situations (that is, when an expected TDR can be specifically identified) to avoid requiring a "life of relationship" estimate. If the measurement period is extended beyond the contractual term based on portfolio-level forecasts of TDRs, these stakeholders note that the estimate of credit losses would be one step closer to a "life of relationship" approach, which was not the Board's intent. Additionally, these stakeholders observe that the Board's decisions on TDRs in Update 2016-13 only addressed the measurement of TDRs, not the identification of TDRs, which historically has been performed on an individual financial asset basis.
24. As noted in the TRG discussion summarized in paragraphs 8 through 10 of this memo, some of the effects of TDRs already are reflected in historical loss information (for example, the benefit of lower losses resulting from loss mitigation activities). However, stakeholders have noted that for portfolios of performing loans, it is not practical for entities to develop an expectation for specific loans that will become TDRs and the related effects that are not already reflected in historical loss information. Many of these stakeholders do not currently capture data on other effects of TDRs that are not reflected in historical loss information, such as interest rate concessions, to the extent necessary for an appropriate incremental adjustment to be made at the portfolio level before expected TDRs can be specifically identified. The staff also notes that because of the large extent to which TDRs were executed during the last financial crisis, in many cases through government mandated programs, many entities' historical data will reflect an economic period and modification programs that may be inconsistent with the current and future economic periods and programs. Therefore, this data may not be indicative of future TDRs, which means entities may not find it to be relevant information to consider when estimating credit losses.
25. Beyond the practical issues of identifying TDRs within portfolios of performing loans noted in the previous paragraph, stakeholders also observed that such an approach may create conceptual issues when trying to support that loans in a portfolio share similar risk characteristics. If an entity believes certain loans within the portfolio will become TDRs, then those loans inherently have different risk characteristics than the other loans in the portfolio and would need to be evaluated separately (which would be impractical because they have not yet been identified). Some stakeholders believe that to address this potential issue, they would need to create a hypothetical pool of loans for purposes of measuring credit losses, which they believe was not the Board's intent.
26. Overall, the staff believes there are three alternatives for the timing of when the effects of a TDR not already included in historical loss information are recorded:
(a) View A: When a TDR is executed. This approach is consistent with current GAAP, but is not consistent with an expected loss model that is more forward-looking.
(b) View B:View B: When an individual asset is specifically identified as a reasonably expected TDR. This approach results in accelerated timing compared with current GAAP and may result in process changes to identify assets that eventually will be subject to a TDR earlier.
(c) View C: Before individual assets are specifically identified as a reasonably expected TDR (from "day 1"). This approach results in incorporating all effects of potential TDRs over the entire life of a portfolio of assets, although this would be a highly subjective new estimate that would require significant changes to systems and processes. Additionally, this approach would not align with the Board's intent in that it would change how TDRs are currently identified and it could create added complexity in measuring credit losses for portfolios of similar assets (as discussed in paragraphs 23 through 25).
27. The staff believes requiring forecasts of a TDR's activity to be made on pools of performing loans is inappropriate because the lack of appropriate historical data in this area most likely would preclude the “reasonably expected” notion from being met for most entities. Because many entities do not have the data or systems to achieve an appropriate level of precision, the staff believes that it is unreasonable to expect an entity to forecast the effects of future TDRs on loans in performing pools.
28. Furthermore, the staff notes that most assets are evaluated for restructuring based on each asset’s unique facts and circumstances surrounding the individual borrower (whether that is based on an individual analysis or a programmatic analysis, such as assets exceeding a certain delinquency threshold). Additionally, the staff acknowledges the potential circularity issues that may arise when determining credit losses for a portfolio in which TDRs are forecasted before they are specifically identified (as discussed in paragraph 25). Accordingly, the staff believes that the incremental effects of TDRs outside of those already reflected in historical loss information should be recognized when an asset is specifically identified as an expected TDR, which would be before execution. The staff believes it was not the Board’s intent to require separate tracking and calculation of the effects of TDRs that may potentially occur within performing asset portfolios from day 1. The staff believes that if such an approach were required, it would result in additional subjectivity and complexity and it would not provide a significant benefit in terms of the information on credit losses being provided.
29. The staff notes that entities typically will have processes in place to help them identify certain loans that they may decide to attempt to recover on through a TDR. These processes may be different depending on the risk characteristics of the loans being considered, but there always will be indicators of potential TDRs before execution of the TDR. For example, entities may have policies in place that require a modification to be considered for all loans past a certain delinquency threshold. Entities may even have additional policies that specify the kinds of concessions that should be offered depending on the borrowers’ specific circumstances. Therefore, the staff believes that entities will need to consider their own policies and practices for modifying assets when determining the point in time a TDR is considered reasonably expected. The staff believes a TDR would always be reasonably expected before execution, and there often would be indications of a reasonably expected TDR before individual negotiations with a borrower begin. Determining the exact timing of when a reasonably expected TDR exists is an area where entities will need to apply judgment based on their individual facts and circumstances. The staff also notes that entities may incur additional costs to develop new processes to capture data on when TDRs become reasonably expected in their systems because this is a new concept that has not previously been applied for financial reporting purposes.
Unit of Account for Identifying Reasonably Expected TDRs
30. The staff believes that consistent with the analysis in paragraphs 26 through 29, identification of a reasonably expected TDR should be on an individual asset basis. The staff notes that the guidance for identifying TDRs was not amended by the new standard, and the requirement in current GAAP to individually identify TDRs also should apply to identifying reasonably expected TDRs.
31. The staff understands that in limited circumstances in which third-party loan servicers are used, there may be cases in which the servicer does not report TDRs to the lender until after they have been executed. In these cases, because of the operational challenges of developing a reasonable expectation of TDRs on an individual asset basis, the staff would not object to an entity estimating reasonably expected TDRs on a portfolio basis based on metrics that represent the individual loans within the pool that are TDRs as of the reporting date, but for which information on the modification has not yet been received from the servicer. While the staff would not object to a portfolio-level approach that is a proxy for View B as described above, the staff would object to View A and View C because those views would not meet the objective of the guidance on identifying TDRs (as described in paragraph 30).
Unit of Account for Measuring the Effects of TDRs
32. The staff believes that because the concept of an individually impaired loan has been removed as an accounting concept, it was the Board's intent for the unit of account with which an entity should measure TDRs to be consistent with that which is applicable to all of Topic 326. That is, once a TDR is individually identified, it may be measured either individually or on a pool basis depending on the risk characteristics of the loan(s). Paragraph 326-20-30-2 states in part:
An entity shall measure expected credit losses of financial assets on a collective (pool) basis when similar risk characteristic(s) exist (as described in paragraph 326-2055-5). If an entity determines that a financial asset does not share risk characteristics with its other financial assets, the entity shall evaluate the financial asset for expected credit losses on an individual basis.
33. The staff understands that when the effects of TDRs are measured with a DCF methodology under current GAAP, the measurement typically is performed on an individual asset basis, which should continue to be an operable and acceptable approach for most entities under the new guidance.
However, the staff notes that the new guidance allows an entity to pool TDR loans that have similar risk characteristics and measure the effects of TDRs for that pool. If the entity has compiled historical TDR data on past loans with similar risk characteristics, the staff believes a measurement of the effect of expected TDRs at a pool level would be an acceptable approach.
Staff Recommendation
Identification of Reasonably Expected TDRs
34. The staff believes the result of the new guidance surrounding TDRs and credit losses is to accelerate the recognition of the economic concessions offered in TDRs from the point of execution to the point at which they are reasonably expected. However, the staff notes that the Board did not change guidance on identifying TDRs from current GAAP, which requires TDR guidance to be applied at the point a loan can be specifically identified as a TDR on an individual basis. Therefore, the staff believes that when a loan is individually identified as a reasonably expected TDR (View B), all effects of the TDR should be reflected in the allowance for credit losses.
35. The staff believes it was not the Board's intent to require the effects of TDRs to be forecasted on a portfolio basis before a loan is specifically identified as a reasonably expected TDR (View C). This would require an entity to adjust non-DCF measurement methodologies on performing pools of loans for the effects of future TDRs not already reflected in loss statistics. Because certain concessions in TDRs can be measured only using a DCF method (or reconcilable method), the only way for all effects of TDRs to be reflected in the allowance for credit losses on a portfolio basis would be to require all entities to use a DCF method (or reconcilable method) to measure credit losses on all portfolios of loans for which TDRs are expected to occur. Additionally, there may be separate issues with segmentation of portfolios for which TDRs are expected to occur because loans that are expected to become TDRs inherently have different risk characteristics than other loans, which may introduce additional complexity into an entity's evaluation of similar risk characteristics. The staff believes that these points conflict with the Board's intent to allow flexibility when measuring credit losses. Additionally, the intent to reduce cost and complexity of applying the new guidance because identifying TDRs on a portfolio basis is operationally unfeasible for most entities. Therefore, the staff believes that reasonably expected TDRs are those that can be specifically identified, and at the point of individual identification all effects of the reasonably expected TDR should be reflected in the allowance. The staff notes that this would result in earlier recognition of the effects of concessions compared with current practice, which is generally when a TDR is executed.
Measurement of Reasonably Expected TDRs
36. Because there is flexibility regarding the methods used to measure expected credit losses under the new standard, there may be situations in which some effects of TDRs, such as the effect of loss mitigation, already are reflected in the allowance from day 1, while other effects, such as the economic impact of concessions, are considered later (that is, at the point that a reasonable expectation exists) in a refinement of the initial estimate. Because of the requirement in paragraph 310-40-35-10 that requires concessions to be recorded in the allowance for credit losses, the staff believes that at the point a loan is specifically identified as a reasonably expected TDR, an entity must use a DCF method if the TDR involves a concession that can be captured only using a DCF method (or reconcilable method), such as an interest rate or loan term concession. The staff notes that current GAAP requires the use of a DCF method for impaired loans, including TDRs; therefore, this should not represent a significant operational issue for most entities.
37. The staff notes that the standard requires credit losses to be evaluated on a pool basis unless risk characteristics change to an extent that they must be assessed separately. Because there is no further specification about to the unit of account under which the effects of TDRs must be measured, the staff believes it was the Board's intent to allow entities to measure the effects of TDRs either on a portfolio basis or individual basis depending on which is most appropriate for the facts and circumstances of the assets. Accordingly, the staff believes that the effects of TDRs may be measured either individually or on a portfolio basis, as long as all concessions are being captured.
Summary of September 6, 2017 Board Meeting
38. Regarding the identification of TDRs, the Board agreed (7-0) with the staff's recommendation that when a loan is individually identified as a reasonably expected TDR (View B), all effects of the TDR should be reflected in the allowance for credit losses. The Board also agreed that the application of View C for identification of TDRs would not be consistent with current or future guidance under Topic 326.
39. Regarding the measurement of TDRs, the Board agreed (7-0) with the staff's recommendation that at the point an individual loan is specifically identified as a reasonably expected TDR, an entity must use a DCF method if the TDR involves a concession that can be captured using only a DCF method (or reconcilable method).
40. The Board also noted that if an entity uses a DCF method for measurement of credit losses on a performing loan portfolio, any effects of TDRs that are incremental to what is embedded in the historical loss information should not be incorporated as an input to the DCF method until a TDR is individually identified in accordance with the approach in paragraph 38. However, if certain effects of TDRs are embedded in the historical loss information, adjustments may be made to account for differences between historical TDR activity and reasonable and supportable forecasts of future TDR activity.
41. The staff notes that the Board decisions have no effect on the timing of when TDRs should be reflected in the applicable disclosures, which will continue to be at the time a TDR is executed.
1Effects of a TDR may include: The benefit of the loss mitigation strategy on credit losses Any economic loss related to the concession Any additional exposure to credit risk over an extended term.
2The staff notes that the fair value of collateral practical expedient is permitted only when the entity expects repayment to occur solely through operation or sale of that collateral. Because in most cases a TDR indicates that an entity is trying to recover on the original loan through the new contractual terms, it is unlikely that this requirement will be met (however, the staff notes that Chapter 7: Bankruptcy and similar types of modifications are exceptions).
3 Nonaccrual policies are required by U.S. bank regulatory agencies. The general rule for when nonaccrual status is applied is set forth in the FFIEC call report instructions as follows: Banks shall not accrue interest, amortize deferred net loan fees or costs, or accrete discount on any asset (1) which is maintained on a cash basis because of deterioration in the financial condition of the borrower, (2) for which payment in full of principal or interest is not expected, or (3) upon which principal or interest has been in default for a period of 90 days or more unless the asset is both well secured and in the process of collection.
4 Effects of a TDR may include: The benefit of the loss mitigation strategy on credit losses Any economic loss related to the concession Any additional exposure to credit risk over an extended term.
5 Expected credit losses determined via loss rates are commonly calculated as follows: historical portfolio lifetime NCOs ÷ historical portfolio beginning amortized cost basis = historical loss rate % Then: historical loss rate % × current portfolio amortized cost basis = unadjusted expected credit losses A PD/LGD approach uses historical NCO data in a similar manner but allows for a more granular analysis.
6Paragraph 326-20-30-7 states, "…an entity is not required to develop a hypothetical pool of financial assets."
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