August 15, 2018
TRG Meeting June 11, 2018
Co- Author, Practice Fellow
Co-Author, Project Manager
Postgraduate Technical Assistant
Transition Resource Group for Credit Losses
June 2018 Meeting - Summary of Issues Discussed and Next Steps
1. The third public meeting of the Transition Resource Group for Credit Losses (TRG) was held on June 11, 2018. The purpose of the meeting was for the TRG members to inform the FASB about potential issues with implementing Accounting Standards Update No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
, to help the Board determine what, if any, action may be needed to address those issues.
2. The purpose of this memo is to provide a summary of (a) the issues discussed at the June 11, 2018 meeting, (b) the views expressed at the meeting by the TRG members, and (c) the planned next steps, if any, for each of those issues.
3. The following topics were discussed at the June 11, 2018 meeting:
(a) Topic 1: General Technical Inquiries
(i) Loans and Receivables Between Entities Under Common Control
(ii) Gains and Losses on Subsequent Disposition of Leased Assets
(iii) Operating Lease Receivables
(b) Topic 2: Capitalized Interest
(c) Topic 3: Accrued Interest
(d) Topic 4: Transfer of Loans from Held-for-Sale to Held-for-Investment and Transfer of Credit Impaired Debt Securities from Available-for-Sale to Held-to-Maturity
(e) Topic 5: Recoveries
(f) Topic 6: Refinancing and Loan Prepayments.
4. The staff's memos for each of these topics were made public to all stakeholders before the TRG meeting and are available on the FASB's
website. A direct link to the staff memos also is included within each topic below. This summary should be read in conjunction with those staff memos, which contain a more detailed description of the issues, stakeholders' views, and the staff's analysis.
5. A recording of the June 2018 TRG webcast
is available on the FASB's website.
Topic 1: General Technical Inquiries (Memo 7)
6. Before the TRG meeting on June 11, 2018, stakeholders submitted technical inquiries about the amendments in Update 2016-13 regarding (a) loans and receivables between entities under common control, (b) gains and losses on subsequent disposition of leased assets, and (c) operating lease receivables.
7. Specifically, stakeholders asked:
(a) At which reporting level the scope exception in Subtopic 326-20
for loans and receivables between entities under common control should be applied (that is, parent or subsidiary)
(b) Whether expected gains on the disposition of leased assets should be considered when measuring expected credit losses under Subtopic 326-20
on a portfolio of net investments in leases
(c) Whether operating lease receivables are within the scope of Subtopic 326-20
8. The staff informed the TRG members of its interpretations regarding these inquiries. Specifically, the staff noted (a) the scope exception for loans and receivables between entities under common control is applicable to all standalone reporting levels (that is, parent and subsidiary), (b) entities should estimate expected cash flows from the subsequent disposition of leased assets (whether those result in expected gains or losses on disposal) when calculating expected credit losses on a portfolio of net investment in leases if that estimate is determined consistent with the requirements for other forward-looking inputs to the calculation of expected credit losses, and (c) the Board did not intend to include operating lease receivables within the scope of Subtopic 326-20
9. The staff noted that stakeholders have diverse opinions regarding the technical inquiry (c) concerning operating lease receivables because some stakeholders believe that those receivables appear to meet the definition of a financing receivable. For that reason, the staff asked for TRG members' input on potential amendments to clarify whether operating lease receivables should be within the scope of Subtopic 326-20
Views Expressed at the TRG Meeting
10. Overall, the TRG members supported the staff's interpretations about these technical inquiries. However, TRG members discussed the need for clarity regarding operating lease receivables and recommended that if the Board intended to exclude operating lease receivables from Subtopic 326- 20, it should consider amending the guidance to clearly indicate that intent. Making these amendments would facilitate application of the guidance in leasing Subtopic 842-30
without confusion or diversity in practice.
11. Some TRG members suggested that both operating lease receivables and accrued interest receivables should be treated in the same manner because they are both accrued revenues that potentially become no longer probable of collection. One TRG member noted that if the Board considers including operating lease receivables within the scope of Subtopic 326-20
, the Board also should consider changes to the transition guidance for leases because Accounting Standards Update No. 2016-02, Leases (Topic 842)
, is effective before Update 2016-13.
12. Regarding technical inquiries (a) and (b) in paragraph 8, the staff believes the guidance is clear and the staff does not plan any additional work on these issues. For technical inquiry (c) concerning operating lease receivables, the staff discussed the issue with the Board at the July 25, 2018 meeting and the Board decided to clarify its original intent through a Codification improvement that operating lease receivables are not within the scope of Subtopic 326-20
. The Board anticipates that a proposed Accounting Standards Update including the proposed amendments clarifying the scope of Subtopic 326-20
will be issued for public comment in the third quarter of 2018.
Topic 2: Capitalized Interest (Memo 8)
13. Before the TRG meeting on June 11, 2018, stakeholders informed the staff that there were questions about the amendments in Update 2016-13 on how entities should consider interest amounts that will be earned when estimating the expected credit losses following a method other than the discounted cash flow (DCF) method.
14. The staff noted that the issue submitted on capitalized interest overlapped with a broader issue raised by stakeholders about how to measure expected credit losses applying a non-DCF method to loans at a premium or discount. Therefore, the staff first discussed the broader issue related to the inclusion of premiums or discounts when measuring expected credit losses and provided clarification for certain areas of Subtopic 326-20
. The staff thought clarifying the guidance in Subtopic 326-20
on premiums and discounts first would assist in addressing the specific issue raised in the submission on whether expected accrued interest can be included in the measurement of expected credit losses before those interest amounts are capitalized.
Premiums and Discounts
15. Prior to turning the discussion over to the TRG members, the staff noted that when performing research and outreach for this issue it was brought to the staff's attention that some stakeholders interpret the phrase "…when an entity expects to accrete a discount into interest income, the discount should not offset the entity's expectation of credit losses" in paragraph 326-20-30-5 (and provided in paragraph 7 of the TRG Memo 8, "Capitalized Interest") to mean that preparers must estimate the timing of the loss when using a non-DCF method. Consequently, entities applying a non-DCF method would be precluded from applying the expected credit loss guidance in a manner that results in an allowance that increases (or decreases) over time. This interpretation could have direct influence on conclusions about how to apply CECL to a loan with future capitalizable interest.
16. The staff noted that they did not think this interpretation of the guidance (provided in paragraph 15 above) was appropriate or consistent with the Board's intent. Additionally, the staff provided a few clarifying points on TRG Memo 8. Specifically, the staff noted:
(a) The memo was premised on the fact that when calculating the allowance for credit losses using a DCF method, all components of the amortized cost basis are inherently considered because the allowance reflects the difference between the amortized cost basis and the present value of expected cash flows. However, the Board decided that using a DCF method was not required and allowed entities to calculate expected credit losses using other methods. The Board acknowledged that a non-DCF method may produce a different allowance for credit losses than a DCF approach all things being equal and that is acceptable. However, the end goal of the estimation process is the same, which is to calculate an allowance for credit losses on the basis of relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectibility of a financial asset, which is deducted from the amortized cost basis of the financial asset to present the net carrying value at the amount expected to be collected on the financial asset.
(b) Under any non-DCF method, the starting point for calculating the allowance is the balance sheet amount of amortized cost basis of the financial asset. That is, the allowance should represent expected losses on the current balance sheet amount at the reporting date. The staff acknowledged that there are multiple ways to arrive at this outcome and the staff illustrated one way in the examples provided in the memo by applying a loss rate to the current amortized cost basis because the staff thought that to be the most straight forward way to meet the requirement of the standard. However, the staff was not trying to eliminate non-DCF methods through the examples; on the contrary, the memo was intended to clarify the flexibility provided in the standard.
(c) The phrase "… when an entity expects to accrete a discount into interest income, the discount should not offset the entity's expectation of credit losses" was not intended to force entities to project the amortized cost basis when applying a non-DCF method. However, an entity may project the amortized cost basis when calculating the loss rate as part of a non-DCF method if it so chooses.
(d) The allowance for credit losses may increase or decrease with the passage of time as the amortized cost basis of the financial asset increases or decreases. While there are acceptable methods of calculating losses on the current amortized cost basis that result in a theoretically "flat" allowance, these methods are not required but are also acceptable.
(e) The staff believes that unearned interest is fundamentally different from discounts and premiums.
17. Finally, the staff included an example in the appendix to TRG Memo 8 that portrayed two of the many possible ways of applying loss-rate methods to a zero-coupon bond and to a student loan with a deferment period. The purpose of the illustration was to show the differences between a zero-coupon bond (at a discount) and a loan with expected future capitalized interest, and to illustrate that a discount and future accrued interest are not analogous because of the differing par amounts over the lives of the instruments. This example assumes that the holder of the zero-coupon bond is entitled to the par amount in the event of a default prior to maturity. However, there can be other provisions that would determine the amount the debt holder is entitled to, such that the holder is only entitled to the accreted value upon default. In those cases, the allowance amount may differ from the staff's example. The staff stressed that the examples included in the memo were not the only way to perform loss rate calculations and that the goal of the CECL standard is to allow multiple estimation and calculation methodologies.
18. TRG members agreed that the guidance as written and the current interpretations of how to measure an allowance on a loan at a premium or discount using a non-DCF method is confusing. Some TRG members noted that providing additional guidance or examples of ways to calculate the allowance in different scenarios with premiums and discounts may be helpful to further illustrate the flexibility provided in the standard. Other TRG members disputed the need for additional guidance or examples, stating that it is not reasonable to include every iteration of loss rate calculations and that more examples could lead some to believe that the methods presented in the examples are the only approaches to be used in measuring expected credit losses. Regardless of the flexibility in calculating an allowance under non-DCF methods, TRG members generally agreed that the overall goal or principle in determining the allowance remains the same, which is to measure and record an estimate of expected credit losses on an entity's financial assets as of the reporting date.
19. One TRG member suggested that the staff provide clarity on the flexibility in how to calculate an allowance using a non-DCF method. On one hand, the guidance is clear that a discount cannot offset the allowance in its entirety. The staff clarified that this guidance should be interpreted such that an entity may not have a zero allowance if the discount on a financial asset is greater than the expected losses on the financial asset. On the other hand, stakeholders understand that the allowance on a financial asset at a premium or discount will be affected by that premium or discount because the entity has a larger or smaller amount of amortized cost basis to write off or lose upon default. While the allowance may change over time as the amortized cost basis changes over time, the ability to calculate or estimate the effect that premiums and discounts will have on the allowance that results in an effect that is "flat" or the same amount from period to period also is not precluded by the guidance or the staff's interpretations depicted in TRG Memo 8.
20. As with all estimates in GAAP, significant professional judgment is required to measure and record an estimate that is reasonable and supportable. An observer to the TRG meeting stated that because of the variations in products, information systems, and methods involved with the estimation of an allowance for credit losses, entities must exhibit sound internal controls and procedural discipline around the allowance estimate. Additionally, the observer noted the importance of disclosures related to the estimation process and the allowance for credit losses such that users of the financial statements can understand how an entity's processes and reported financial results are comparable to their peers.
21. Some TRG members asked for clarity in certain areas of this guidance that continue to cause confusion, even with the staff's clarification about the flexibility provided in the standard. Specifically, one TRG member asked the staff to clarify, through examples or additional standard setting, the guidance in paragraph 326-20-30-5 that states "the discount should not offset the entity's expectation of credit losses" and the Board's intent in writing this sentence in the guidance. Another TRG member asked the staff to clarify that an entity is permitted to use par-based loss rates in a non-DCF calculation of the allowance. That is, an entity may calculate a loss rate that considers expected losses on par in the numerator and the total par in the denominator, and then apply that loss rate to the current amortized cost basis of the asset. The member noted that this method would not require entities to project either amortized cost or expected losses and would closely align with methods that many entities use today in practice. Finally, another TRG member requested that the staff clarify in the guidance that the numerator and denominator do not have to be consistent with current amortized cost basis, and that the basis in either the numerator or denominator does not need to be consistent with the amount to which the loss rate is applied.
22. The staff thinks the interpretations of the guidance within TRG Memo 8 are clear as written. Specifically, the staff reemphasizes that the phrase in paragraph 326-20-30-5 "… when an entity expects to accrete a discount into interest income, the discount should not offset the entity's expectation of credit losses" was not intended to force entities to project the amortized cost basis when applying a non-DCF method. Rather, the phrase is intended to preclude an entity from measuring a zero allowance on a financial asset held at a discount when an entity does have an expectation of credit losses on the asset. However, the staff also highlights that entities are not precluded from projecting the amortized cost basis when applying a non-DCF method.
23. Additionally, the staff reemphasizes that there are several acceptable ways to calculate an allowance using a non-DCF method, which could result in an allowance that increases, decreases, or remains the same over the contractual life of the financial asset. However, the overall goal of the allowance estimate process under CECL remains the same, which is to measure and record an estimate of expected credit losses resulting in the presentation of the net amount expected to be collected on an entity's financial asset(s) as of the reporting date.
24. The staff will discuss suggested actions by TRG members with the Board at an upcoming meeting.
25. With respect to the submission on capitalized interest, stakeholders questioned how entities should consider expected interest amounts when estimating expected credit losses using a non-DCF method. The submission provided a brief example in which an entity issues a loan and over four years the loan accrues a significant amount of interest. Periodically the entity capitalizes the accrued interest and adds the amount to the outstanding principal balance. The submission provided three views regarding the estimation of expected credit losses on this loan.
26. View A stated that future interest amounts that are expected to be capitalized should be considered in the estimate of expected credit losses using a non-DCF method. Proponents stated that future capitalizable interest is akin to a discount on a zero-coupon bond and, therefore, should be treated as such.
27. View B stated that future interest amounts expected to be capitalized should not be considered when estimating expected credit losses. Proponents stated that the basis for estimation of credit losses using a non-DCF method is the current amortized cost basis, which does not include future expected capitalized interest.
28. View C stated that the future expected capitalized interest should be treated like an unfunded loan commitment with a liability recognized and measured for expected future credit losses on the off-balance sheet exposure. Proponents stated that future accrued interest that will ultimately be capitalized to the principal balance of the loan is economically similar to a line of credit that has not been fully drawn down on Day 1. Therefore, future accrued interest should be treated like an unfunded loan commitment.
29. The staff disagreed with View A because it would require an entity to consider all expected interest income when calculating the allowance using a non-DCF method, which was not the Board's intent. Furthermore, the staff believes that a discount represents a difference between the net proceeds received upon issuance of the debt and the amount repayable at the debt's maturity. The staff noted that future unearned interest amounts do not meet the definition of a discount because the net proceeds received upon issuance of the debt equal the face value of the debt at issuance. Additionally, the staff believes that the borrower is not obligated to repay the lender unearned interest or any amount greater than the outstanding principal plus any accrued interest to date. However, the issuer of a bond or debt security at a discount would be obligated to pay the stated face value of the instrument at any point between the issuance date and maturity if there are no terms and conditions in the indenture that limit the issuers obligation to the accreted value of the contract. For these preceding reasons, the staff believes that unearned interest on a loan issued at par and the discount on a bond or debt security are fundamentally different.
30. Additionally, the staff disagreed with View C because unearned accrued interest represents the time value of money or the return to lending money to the borrower. In contrast, a loan commitment is a legally binding commitment to extend credit to a counterparty under certain prespecified terms and conditions. Thereby, unearned accrued interest differs from a loan commitment because the lender has already disbursed credit to the borrower and the obligation to repay lies solely with the borrower. Finally, the staff noted that this "loan commitment" view of future unearned interest would be applicable to all loans, which would create operational and theoretical issues that the Board did not intend through the issuance of Update 2016-13.
31. The staff agreed with View B in which an entity would not consider future expected amortized cost basis and, instead, consider the amortized cost basis as of the reporting date when estimating expected credit losses. The staff believes that it is inappropriate to measure and record an allowance on an asset that is not recorded on the balance sheet and for which there is no contractual obligation to repay at default, which is the case with future unearned interest.
32. The TRG members generally agreed with the staff's interpretation and supported View B relative to the discussion on capitalized interest, under which entities would not consider future interest amounts expected to be capitalized in estimating expected credit losses. TRG members noted that those future amounts do not represent an asset on the balance sheet today and, thus, should not be considered in an allowance estimate. These members also questioned how an entity would determine whether to consider future accrued interest in the allowance calculation on various financial assets. Specifically, these members were concerned about determining when future accrued interest would be material to the allowance calculation and that requiring a materiality assessment on future expected amounts would be operationally complex and burdensome.
33. One TRG member echoed the staff's reasoning for why the expected future capitalized interest is different from a discount on a financial asset, which is the amount legally due upon default of the counterparty. For a financial asset at a discount, absent any terms and conditions that only require the repayment of "accreted value" at any point in the term of the financial asset, the amount due upon default is the par amount and accrued interest to date (which would be greater than the amortized cost basis for a financial asset at a discount). For a financial asset issued at par with expected future capitalized interest, the amount due upon default is also the par amount and accrued interest to date, which would equal the amortized cost basis at the time of default (assuming no other adjustments to amortized cost basis, such as net deferred fees or costs, and so forth). Therefore, an entity would not consider any unearned interest, regardless of the expectation that it will be capitalized in future periods, in the calculation of an allowance for credit losses because the legal amount owed upon default would not include that future expected accrued interest. On the contrary, an entity may consider the future amortized cost basis for a financial asset at a discount if it so chooses, in accordance with paragraph 16(c) of this memo, because the amount legally owed upon default would include the unamortized discount (absent any terms and conditions that only require the repayment of "accreted value" at any point in the term of the financial asset).
34. Alternatively, some TRG members stated that a discount on a financial asset and future expected capitalized interest are economically the same and, therefore, should be accounted for in the same manner. One member noted that if an entity did not consider the future expected capitalized interest amounts, the measurement of the allowance for a financial asset at a discount should be the same in that the allowance would be based on the amortized cost as of the reporting date (which includes the discount). Thereby, an entity would have measured the same allowance for both the loan at a discount and the zero-coupon bond in the staff's example in TRG Memo 8.
35. One observer to the TRG meeting agreed with View C from TRG Memo 8, which would require the measurement of an allowance for the future expected capitalized interest similar to the accounting for an off-balance-sheet credit exposure, such as a loan commitment or line-of-credit arrangement. This observer noted that View C will result in earlier loss recognition and ensure the same credit loss estimate is reached for loans with economically similar structures. For example, the loan in the example provided by the stakeholders could be structured like a $100 line of credit, with $60 drawn on Day 1 and the remainder drawn over 4 years to pay the interest on the initial $60 drawn, and this structure would result in a different credit loss estimate under View B. The observer noted that his view was limited to loans structured with long periods in which the borrower is not required to make interest payments, as these structures effectively result in the lender committing to loan future interest payments. Additionally, the TRG observer expressed concern that line-of-credit arrangements could be structured as a loan with capitalized interest to avoid measurement of an allowance. Other TRG members disagreed with this observer and noted that this type of structuring would be operationally unfeasible. Those TRG members noted that any such structuring would be an extreme case that does not occur often in practice and that the discussion and standard-setting initiatives should focus on the accounting for the most likely scenarios. Some observers agreed that the discussion on View C was more theoretical than practical.
36. The staff will discuss suggested actions by TRG members with the Board at an upcoming meeting.
Topic 3: Accrued Interest (Memo 9)
37. Before the TRG meeting on June 11, 2018, stakeholders informed the staff of two issues with the amendments in Update 2016-13 regarding accrued interest:
(a) Issue 1: Inclusion of Accrued Interest in the Definition of Amortized Cost Basis
(b) Issue 2: Reversal of Accrued Interest on Nonaccrual Loans.
38. With regard to the first issue, stakeholders indicated that including accrued interest in the definition of amortized cost basis will be operationally burdensome and costly to implement. Those stakeholders stated that although accrued interest amounts are tracked on a loan system, many financial reporting systems do not track accrued interest amounts on the individual loan level, which would be needed when measuring expected credit losses on a pool basis, when preparing vintage disclosures, and when implementing presentation requirements. Stakeholders asked whether including accrued interest in the definition of amortized cost basis is appropriate.
39. The staff recommended an approach whereby applicable accrued interest remains in the definition of the amortized cost basis with practical expedients that would allow entities to:
(a) Perform a CECL evaluation for the accrued interest amounts separately from their associated loan balances
(b) Allow entities to retain their current practice when presenting accrued interest
(c) Disclose the accrued interest amounts included in amortized cost for the vintage disclosure table by either (1) including the amounts in the vintage year and class of financing receivable amounts, (2) including the amounts in the class of financing receivable amounts only, or (3) adding a footnote to the table that states the total amount of accrued interest.
40. The staff believes that the Board's intent in defining amortized cost basis was to reflect a financial asset on the balance sheet at the net amount of future contractual cash inflows that an entity expects to collect. To stay true to this intent, the contractual interest earned but not yet received on the asset should be included in the amortized cost basis and the allowance for credit losses should include an amount that reduces that portion of amortized cost to reflect the amount expected to be received. However, the staff believes that the Board did not intend to impose significant systems and operational changes by including applicable accrued interest in the definition of amortized cost basis. As a result, the staff believes that the practical expedients recommended will alleviate stakeholders' concerns when adopting the guidance in Update 2016-13, in certain areas.
41. The second issue raised by stakeholders stated that a conflict exists between current nonaccrual practices and the writeoff guidance in paragraph 326-20-35-8, regarding accounting of previously accrued, but unpaid interest, applicable to loans placed in nonaccrual status. While the writeoff guidance in Update 2016-13 would require the reversal of that accrued interest through the allowance, current nonaccrual policies (which are followed by most regulated entities) allow the reversal of accrued, but unpaid interest, through interest income. Stakeholders provided two views in their submission to the TRG about how to reverse accrued interest on nonaccrual loans, as follows:
(a) View A: The reversal of accrued interest applicable to a loan placed in nonaccrual status should be accomplished through a debit to interest income and a credit to the amortized cost basis of the loan. The reversal would include a reduction to the allowance against the credit loss expense that will reverse any amount of allowance previously established for outstanding amounts of accrued interest.
(b) View B: For all entities, regardless of whether they adhere to nonaccrual policies, the reversal of accrued interest applicable to loans placed in nonaccrual status, or otherwise deemed uncollectible, should be accomplished through a debit to the allowance for credit losses and a credit to the amortized cost basis of the loan, identical to a partial writeoff of a portion of the principal balance of the loan. There should be no effect on the interest income line item for the reversal of accrued interest applicable to loans placed in nonaccrual status or otherwise deemed uncollectible because the loss would be reflected entirely in the credit loss expense line item.
42. Consistent with paragraph BC99 of Update 2016-13, the staff believes that it was not the Board's intent to change existing nonaccrual practices broadly. The staff believes those long-standing practices include reversing accrued interest through the interest income line item for the related loan when placed on nonaccrual status. However, the staff notes that the amendments in Update 2016- 13 apply to all entities that have financial assets measured at amortized cost basis and an entity may or may not have a nonaccrual policy similar to those established by financial institutions. The staff believes that the views proposed by the stakeholders would not adequately address concerns with the reversal of accrued interest on nonaccrual loans for all entities and, as a result, the staff proposed an alternative view (View C) that would provide a practical expedient for all entities.
43. Under the practical expedient of View C, for entities that abide by sufficient nonaccrual policies, the reversal of accrued interest applicable to a loan placed on nonaccrual status may be accomplished through a debit to interest income and a credit to the amortized cost basis of the loan. Furthermore, entities would not be required to measure an allowance on accrued interest that is reversed through interest income in accordance with that entity's nonaccrual policy. For entities that do not follow a sufficient nonaccrual policy, View B described above would apply and because the accrued interest amounts would be reversed through the allowance, these entities would be required to measure an allowance on accrued interest.
44. Overall, TRG members agreed with the staff's views on both issues related to accrued interest and noted that the staff views were practical approaches to resolving stakeholders' concerns. One TRG member emphasized that each of the issues also are applicable to the requirements of Subtopic 326- 30 and that any practical expedients provided concerning accrued interest should extend to and address available-for-sale debt securities guidance under Subtopic 326-30
45. In relation to Issue 1, some TRG members noted that the proposed practical expedients to alleviate entities from certain operational burdens may not provide as much relief as intended. These members noted that the accrued interest would still need to be assessed on a pool basis under Subtopic 326- 20 for credit losses if an entity did not elect or was not eligible to apply the practical expedient in Issue 2, which exempts an entity from measuring an allowance on accrued interest. When applying this guidance, an entity would need to consider the risk characteristics of each accrued interest balance, which likely would be a similar assessment of the risk characteristics of the related loan. TRG members acknowledged that the proposed staff alternative for the disclosure requirements, specifically related to the vintage disclosures, would alleviate entities from significant implementation costs.
46. In relation to Issue 2, some TRG members noted that determining what constitutes a "sufficient" or "reasonable" nonaccrual policy will require judgment and could lead to diversity in practice when applying the staff's proposed alternative, View C. Observers noted that the eligibility for the practical expedient proposed in the staff's alternative is unclear about whether an entity would need to measure an allowance on accrued interest. These observers suggested that the nonaccrual policy in place would need to consider or state which types of receivables or loans are within the scope of each particular element of its policy. Overall, TRG members discussed the difficulties to operationalize the staff's alternative that would link the treatment of accrued interest to an entity's nonaccrual policy. TRG members emphasized that the drafting of any proposed practical expedient would need to clearly delineate how an entity would be eligible to reverse accrued interest through the interest income line item rather than being required to write off those amounts against the allowance for credit losses, and how an entity would be exempt from measuring an allowance on accrued interest.
47. Highlighting these issues, several TRG members and observers questioned how the proposed practical expedients regarding the reversal of interest income should interact with portfolios of credit card receivables. They noted that entities capitalize accrued interest and fees on credit card receivables to the principal balance of the receivable and measure the allowance for credit losses on this balance because they do not typically apply a nonaccrual policy. Additionally, TRG members noted that the interest and fee revenues not expected to be collected are generally reversed as a reduction to the interest or fee income line item to which it was originally recorded.
48. TRG members noted that credit card receivables are not subject to regulatory nonaccrual policies and that many entities do not place credit card receivables on nonaccrual status. Instead, regulatory practice mandates a full writeoff of credit card balances when they become 180 days past due. TRG members indicated that interest and fee revenue line items are generally "purified" or adjusted for uncollectible amounts upon that writeoff of the credit card balances. Therefore, the staff proposal, as written, would not contemplate credit card receivables because they would not be linked to a nonaccrual policy and entities would be required to change practices in how they write off credit card receivables and the associated accrued interest and fees revenue. Specifically, entities would be precluded from "purifying" or adjusting the revenue line items for uncollectible amounts without a practical expedient from the writeoff guidance of Subtopic 326-20
49. To address the problems noted in the staff's alternative View C for Issue 2, TRG members and observers suggested to define the elements of an entity's nonaccrual policies that would make an entity eligible to apply the practical expedients. Specifically, members noted that the two aspects contemplated in nonaccrual policies that are relevant for discussion on this issue are the following:
(a) The discontinuance of interest accrual
(b) The reversal of previously accrued interest not expected to be collected through interest income simultaneous with the discontinuance of interest accrual.
50. The staff's alternative, View C, only contemplates nonaccrual policies that provide for both items above. However, as noted by the TRG members, some entities discontinue the accrual of interest without reversing previous accrued interest through interest income (some nonregulated entities), and some entities reverse previously accrued interest and fees through interest income without formally discontinuing the accrual of interest and fees in accordance with a nonaccrual policy, but rather by simply writing off the entire principal and accrued interest balance (credit cards).
51. One TRG member proposed that the two areas of relief provided in the staff's View C be separated between (a) the policy election to reverse accrued interest through interest income and (b) the exemption from measuring an allowance on accrued interest. Different populations of portfolios qualify for each area of relief based on an entity's policies regarding nonaccrual and the reversal of accrued interest not expected to be collected. Under this approach, an entity would be able to make a policy election to reverse accrued interest amounts through the interest income line item on portfolios that are not subject to nonaccrual policies and for which allowances have been measured. Furthermore, for portfolios that are subject to an entity's nonaccrual policy that requires a timely halt to the accrual of interest and at the same time reversal of previously accrued interest, entities would be able to elect a practical expedient to be exempt from measuring an allowance on the accrued interest from those portfolios. The TRG members noted that disclosing these accounting policy elections and practical expedients would be extremely important to provide users with insight about the effects on key metrics.
52. The staff plans to discuss with the Board at an upcoming meeting potential targeted improvements to the Codification to address the issues raised regarding accrued interest, including (a) the inclusion of accrued interest in defining amortized cost basis and (b) reversal of accrued interest on nonaccrual loans. The staff will address within issues (a) and (b) specific discussions raised by TRG members and observers regarding application of any potential practical expedients to credit cards and what is considered an acceptable nonaccrual policy.
Topic 4: Transfer of Loans from Held-for-Sale to Held for Long-Term Investment and Transfer of Credit Impaired Debt Securities from Available-for-Sale to Held-to-Maturity (Memo 10)
53. Before the TRG meeting on June 11, 2018, stakeholders informed the staff of questions on how the expected credit loss guidance should be applied upon transferring loans classified as held-for-sale (HFS) to loans held as long-term investments (HFI) and, similarly, how the expected credit loss guidance should be applied when transferring credit impaired debt securities classified as available-for-sale (AFS) to held-to-maturity (HTM).
54. The guidance in Update 2016-13 requires that an entity calculate an expected credit loss on an HFI loan held for long-term investment upon transfer from the HFS classification. Stakeholders are concerned that this requirement could lead to double counting expected credit losses if the entity had previously recorded a valuation allowance for a loan HFS. In addition, the guidance in Update 2016- 13 requires an entity to calculate an allowance for credit losses for debt securities classified as HTM. Stakeholders raised similar concerns about the debt security guidance because it could lead to double counting expected credit losses if the entity had previously recorded a credit loss for a debt security classified as AFS.
55. Stakeholders provided several views that they believe could resolve the questions on how to account for loan and debt security transfers:
(a) View A (Day 1 Loss Approach)—Under this view, an allowance and related credit loss expense for lifetime expected credit losses would be required at the time of the transfer.
(b) View B (Discount Reduces Allowance)—Under this view, an allowance for credit losses would be required at the time of the transfer; however, unlike View A, the amount of the allowance for credit losses would be reduced by any discount attributable to losses already recognized in the income statement while classified as a loan HFS or an AFS debt security.
(c) View C (Direct Write-Down)—This view would be applicable only to loans. Under this view, the valuation allowance established while classified as HFS is treated as a direct write-down upon transfer to HFI. As a result, no allowance is required upon transfer or at subsequent reporting dates unless the expected credit losses exceed the amount of the write-down. Stakeholders indicated that this view would not be applicable to debt securities because the guidance in paragraph 320-10-35-10
(d) requires the discount for the difference between the fair value and amortized cost to be recognized subsequently using the interest method.
56. Certain stakeholders suggested a fourth approach whereby entities would be permitted to treat loan and debt security transfers as purchased financial assets with credit deterioration (PCD) assets.
57. After reviewing stakeholders' views and performing outreach with various stakeholders, the staff recommended an alternative approach to those suggested by stakeholders. Under this alternative, an entity would be required to reverse a previous valuation allowance or expected credit loss when transferring between categories for loans and debt securities and then apply the relevant guidance applicable to that loan or debt security classification. The staff noted that the memo intentionally did not address the differences between inputs used to measure a valuation allowance and an expected credit loss. The staff acknowledged that there may be differences when calculating an allowance using fair value inputs and transferring to an expected credit loss model that uses inputs determined in accordance with the requirements of Topic 326
, and that difference may cause a "true-up" in the income statement. The staff believes this approach is a simplified method for accounting for transfers between categories for debt securities and loans and should resolve concerns about double counting expected credit losses when transferring between certain loan and debt security classifications.
58. The staff also recommended that an entity should present the effects of transferring loans between HFS and HFI and debt securities between AFS to HTM on a gross basis in the statement of income under the suggested alternative approach, which is consistent with the existing presentation and disclosure requirements in GAAP that are intended to increase transparency.
59. Overall, TRG members supported the reversal approach alternative put forth by the staff and agreed that the proposed alternative provides a reasonable and operational solution. The members acknowledged that the proposed alternative may result in an effect on the income statement upon reclassification of a loan or debt security. However, the members noted that the benefits of having a clean and simple reclassification method for loans and debt securities is preferable, even at the cost of some income statement volatility upon reclassification. Additionally, TRG members agreed that the volume of transfers between classifications would increase in periods of financial distress, and, therefore, while transfers are not a prevailing issue in the current environment, transfers between classifications and the effects on the financial statements could become material when the economic environment changes. A TRG observer complimented the FASB staff for proposing a solution that is simple and elegant.
60. Some observers noted that the models for transferring debt securities from AFS to HTM and loans from HFS to HFI could be aligned further by allocating the valuation allowance on an HFS loan to HFI between a credit component and noncredit component at the transfer date. Subsequently, an entity would accrete into income the noncredit discount determined upon transfer, similar to the treatment of a noncredit discount determined upon the transfer of debt securities from AFS to HTM. The observers stated that accreting the noncredit discount in a transfer of loans from HFS to HFI would prevent entities from reclassifying loans to intentionally record a gain because the previous valuation allowance for the noncredit component would be eliminated. Some TRG members disagreed with those suggestions and noted that determining the noncredit portion of the valuation allowance at the date of transfer would require significant changes to preparers' systems, which would impose greater implementation costs. In particular, another TRG member noted that if a transfer of a loan from HFS to HFI were to occur mid-reporting period, an entity would be required to perform a CECL calculation on the transferred HFI loan at that transfer date to determine the noncredit component within the HFS valuation allowance that would need to be amortized. Again, that TRG member noted that this midperiod CECL calculation would introduce additional complexity to the accounting for a transfer of a loan from HFS to HFI, which is counterintuitive to the intention of the proposed reversal alternative. Some TRG members opposed the view that HFS loans should be treated similarly to AFS debt securities and noted that the noncredit valuation loss on an HFS loan was recognized because the entity expected to realize that loss through sale of the loan. If the entity decides not to sell a loan that is classified as HFS and transfers the loan to the HFI classification, the noncredit valuation loss recognized on the HFS loan should be reversed upon transfer to HFI.
61. Another TRG member suggested applying the HFS loan accounting model to AFS debt securities, by reversing the unrealized loss (that is, the noncredit component adjustment recorded to other comprehensive income when the fair value of an AFS debt security declines below the amortized cost basis) to the balance of the amortized cost basis of HTM debt security upon transfer from AFS to HTM. Therefore, by applying the HFS loan accounting model to AFS debt securities, any unrealized loss recorded in accumulated other comprehensive income at the time of the transfer to HTM would be reversed as an adjustment to the amortized cost basis of the HTM security. The TRG member stated that the unrealized loss amount in accumulated other comprehensive income that is subsequently amortized to interest income over the remaining life of the financial asset is simply a mechanics exercise to maintain the yield on the debt security. By reclassifying the amount to the HTM debt securities balance and re-establishing the cost basis of that security, complexity would be reduced, and the model would be symmetrical to the transfer of loans from HFS to HFI.
62. In relation to the presentation of the effects of transferring loans and debt securities between classifications, observers and TRG members expressed mixed views in support of either a net or gross presentation on the face of the financial statements or in the notes to the financial statements. Those observers who agreed with the staff's recommendation for a gross presentation noted that a gross presentation would provide the most transparency of loan or debt security reclassifications to financial statement users. However, some TRG members stated that they preferred a net presentation on the income statement at the time of transfer. Those TRG members noted that a net presentation would eliminate potential noise or volatility between the credit expense line item and other expenses when the adjustment relates to a transfer between categories. In addition, they noted that subsequent change in valuation allowances or expected credit losses would continue to flow through the income statement and financial statement users would be able to see those increases or decreases.
63. Some TRG members specifically focused on the wording in paragraph 27 of TRG Memo 10 and questioned the intent of the following statement:
Regardless of the AFS or HTM classification, a debt security must be evaluated for credit losses, the only difference is that the AFS debt security is floored at the fair value of the debt instrument and the evaluation is done on an individual basis. Whereas, an HTM debt security is evaluated by following the expected credit loss guidance in Subtopic 326-20
, which is a best estimate model with no fair value floor, and this evaluation is done on a pool basis.
64. The staff clarified in the TRG meeting that other differences between the accounting models for debt securities classified as AFS and HTM exist that are not listed in this paragraph. The staff's intent in writing this paragraph was to highlight that both models involve the measurement of a credit loss that is reflected in the same line item on the income statement. This paragraph should not be interpreted to include an exhaustive list of differences between the AFS and HTM accounting models for debt securities and should be considered in conjunction with prevailing, authoritative guidance on these accounting models in the Codification. Additionally, this paragraph should not be interpreted to indicate that the calculation or measurement of an allowance for credit losses would be the same between debt securities classified as AFS and HTM.
65. Many TRG members remarked that when drafting any Codification changes, the staff should consider cleaning up the language in existing GAAP that relates to mortgage and non-mortgage loans.
66. Finally, one TRG member suggested that the staff consider the effect of a previous charge-off on a loan that is transferred and how that could affect the accounting for the transfer.
67. The staff plans to discuss with the Board at an upcoming meeting potential targeted improvements to the Codification to address the issues raised regarding the accounting for transfers between various categories. The staff will address specific discussions raised by TRG members and observers regarding the presentation of transfers, the treatment of prior charge-offs when transferring a loan or debt security, and modifying the measurement guidance for loans and debt securities—specifically related to the measurement of expected credit losses or declines in fair value of the loan or debt security.
68. Before the TRG meeting on June 11, 2018, stakeholders informed the staff that there was diversity in views on whether future expected cash receipts (expected recoveries) from a financial asset that had been written off or may be written off in the future should be included in the calculation of expected credit losses under Update 2016-13. Specifically, the TRG submission describes how the principle in paragraph 326-20-30-1 implies that recoveries of financial assets should be included in the net amount expected to be collected and, therefore, by extension be included in the allowance calculation. However, because paragraph 326-20-35-8 specifically states that recoveries on written off assets should be recorded when received, stakeholders disagree about whether it is appropriate or, if appropriate, whether an entity is required to include estimates of expected recoveries when measuring the expected credit loss for financial assets on an individual or pool basis.
69. The staff noted that although this issue does not appear to be new as noted in the submission, there appears to be general disagreement among stakeholders about how to implement the guidance related to recoveries in the context of paragraph 326-20-30-1 given the perceived conflicts with paragraph 326-20-35-8.
70. The staff provided the following interpretations and recommendations for discussion of this issue in TRG Memo 11:
(a) The staff believes that the Board's intent is clear that expected recoveries should be estimated and included in the calculation of the allowance if the information used to measure expected recoveries is determined to be reasonable and supportable, consistent with the treatment of other forward-looking inputs used in the measurement of expected credit losses
(b) Given that the issue of including expected recoveries is a broad issue about the application of the CECL model, the staff believes including expected recoveries should be applied consistently. The staff acknowledges that applying expected recoveries to an individual financial asset may yield different results than including expected recoveries on a pool basis; however, the overall framework of Topic 326
must be consistently applied regardless of whether an entity is measuring the allowance for credit losses on a pool basis or on an individual financial asset
(c) The staff believes that because the estimation of expected recoveries is an input to the overall calculation of the allowance for credit losses that offsets the expected amount of loss, it relates to the measurement of the underlying asset and, therefore, should be included as part of the valuation account and not a direct write up of the asset
(d) The staff also highlighted that if an estimate of expected recoveries is included when measuring expected credit losses, this may result in assets with expected recoveries that are greater than their amortized cost basis. The staff understands that many entities have historical practices in this area because this phenomenon occurs today and believes the Board's intent in this area has always been to avoid changing practice for writeoffs as expressed in the excerpts from the basis for conclusions provided in paragraph 21 of TRG Memo 11. Moreover, the staff believes that current practices do not violate the concepts in Topic 326
but rather are an operational outcome of the overall model for calculating expected credit losses.
71. Overall, TRG members supported the staff's interpretation that expected recoveries should be included in the calculation of allowance for credit losses. However, TRG members raised the following concerns about the interpretation of including expected recoveries when measuring the allowance for credit losses and the other interpretations and recommendations in Memo 11.
72. Several TRG members questioned whether entities would be required to include an estimate of expected recoveries in the allowance calculation. These TRG members instead supported providing entities with the option to include expected recoveries in the calculation of the allowance for credit losses, noting that this would be a more practical outcome, especially for certain portfolios such as credit cards. In reaching this view, these TRG members highlighted difficulties with creating internal controls for calculating recoveries on loans that have been previously written off and noted that entities would need to disclose their policies for developing expected recovery inputs. The staff clarified that the Board's intent in this area was to require the inclusion of expected recoveries, and that an entity should use judgment when estimating the allowance for credit losses and that inputs used in the measurement of the allowance should be reasonable and supportable. Therefore, if an estimate of expected recoveries is not reasonable and supportable, then the expected recovery input should not be included in the allowance for credit losses. Alternatively, if an estimate of expected recoveries is reasonable and supportable, then the expected recovery input should be included in the allowance for credit losses.
73. Some TRG observers did not support including expected recoveries in the allowance calculation for individual assets. Those observers noted that it may be difficult to justify having expected recoveries on an individual asset without any incremental performance. The staff clarified that any estimate of expected recoveries (including the estimate of expected recoveries to be zero), on either a pool or individual asset level, would need to be reasonable and supportable. One TRG observer stated that an entity must employ procedural discipline for an estimate and forecast to meet the reasonable and supportable threshold. The observer stated that evaluating available information and determining whether an estimate and forecast are reasonable and supportable is not optional. Furthermore, the observer stated that there is a difference between allowing a permissive policy to consider expected recoveries and a requirement to have a reasonable and supportable approach to consider expected recoveries, which, again, would not be optional. Another observer also expressed concern about transparency and that the period over which reasonable and supportable estimates of recoveries are made is not boundless.
74. Some TRG members supported requiring that expected recoveries in excess of amortized cost basis be classified as an asset on the balance sheet as opposed to a debit-balance allowance. Those members noted that asset presentation would be more helpful to users who closely follow coverage ratios and would prevent any netting within an allowance that includes a hidden debit balance. However, other TRG members noted the cost and complexity that this requirement would create and the infrequency with which this phenomenon would occur in any reported figure. In addition, a TRG member noted that the information for expected recoveries would likely be included in rollforward disclosures and, therefore, a modification to the presentation of the allowance for credit losses may not be necessary.
75. One TRG member suggested that all estimated recoveries on financial assets previously written off as of the reporting date should be reported as assets, regardless of whether the total allowance was negative or not. Other TRG members noted operationality concerns with this approach.
76. A TRG member noted that any Codification improvements in this area should consider the guidance in Subtopic 326-30
77. The staff plans to discuss with the Board at an upcoming meeting, potential targeted improvements to the Codification to address the issues raised regarding the treatment of recoveries when measuring expected credit losses. The staff will address specific discussions raised by TRG members and observers regarding when recoveries should be a required input that is used to measure the allowance or if entities should be provided with an accounting policy election to include recoveries in the measurement of expected credit losses either on a group or individual basis, how recoveries should be accounted for if measuring the allowance on an individual basis, relative disclosures, and whether any presentation requirements are necessary for situations in which the allowance is a negative or "asset" balance.
Topic 6: Refinancing and Loan Prepayments (Memo 12)
78. Before the TRG meeting on June 11, 2018, stakeholders informed the staff that there is diversity in views on whether entities are required to use the loan refinancing or restructuring guidance in paragraphs 310-20-35-9 through 35-12 (the loan modification guidance) to determine what constitutes a prepayment for the purposes of the expected credit losses measurement under Update 2016-13. Specifically, the TRG submission asks for clarification on this question in the context of refinancing a loan with the same lender for which the refinancing is not considered to be a troubled debt restructuring. 79. TRG Memo 12 identifies the two views from stakeholders on this issue:
(a) View A: To apply the expected prepayment guidance in paragraph 326-20-30-6 to an expected refinancing with the same lender before contractual maturity, assuming the refinancing is not a troubled debt restructuring, an entity must first apply the guidance in paragraphs 310-20-35-9 through 35-12 to determine whether the refinancing is expected to be a modification of the original loan or a new loan. If the refinancing is expected to be a modification under paragraphs 310-20-35-9 through 35-12, it will not be considered in determining the term over which expected credit losses are estimated. Conversely, if the refinancing is expected to be an extinguishment of the original loan under paragraphs 310-20-35-9 through 35-12, it will be considered in the same manner as an expected prepayment with cash settlement.
(b) View B: Topic 326
does not define a specific framework for the consideration of prepayments and, consistent with other elements of CECL, whether a transaction or amendment should be considered a prepayment in accordance with paragraph 326-20-30-6 is a matter of professional judgment. Moreover, although the framework articulated in paragraphs 310-20-35-9 through 35-12 may provide one approach to considering prepayments—it is not the only approach— and for many types of loans it may not represent an approach that is either conceptually appropriate or operationally feasible.
80. As described in TRG Memo 12, the staff's interpretation is that entities should not be required to use the loan modification guidance in paragraphs 310-20-35-9 through 35-12 to determine what constitutes a prepayment. However, the staff believes that an entity should not be precluded from using the guidance if the entity determines that the guidance provides an appropriate basis for determining prepayments given its specific portfolios and facts and circumstances. In reaching this interpretation, the staff placed more weight on the discussions in TRG Memo 12 about the following:
(a) The Board's overall intent to provide flexibility in Update 2016-13
(b) The primary purpose of the modification guidance (that is, recognition versus measurement)
(c) The fact that Update 2016-13 generally does not define specific inputs to the calculation of the allowance for credit losses
(d) The significant costs noted by stakeholders to adjust market prepayment data for the Subtopic 310-20
(e) The potential cross-cutting issues.
81. TRG members supported the staff's interpretation that entities should not be required to use the loan modification guidance in paragraphs 310-20-35-9 through 35-12 to determine what constitutes a prepayment. TRG members agreed with the staff's support for the view, noting that using market prepayment information would become significantly more complex if using the loan modification guidance was required and that the cross-cutting issues, especially with hedging, could become problematic if prepayments are defined for credit loss purposes. TRG members also noted that performing the analysis in the loan modification guidance to a set of assumptions when measuring credit losses is fundamentally different and perhaps more challenging than applying the loan modification guidance in its context of loan recognition.
82. One TRG member raised a concern about the inconsistency of using the loan modification guidance for some loans but not others and suggested that the FASB require a portfolio-level accounting policy election indicating whether the entity will use the loan modification guidance. This member also suggested that it would be helpful to provide further explanation of what the judgments around prepayment expectations should be based on if an entity does not use the loan modification guidance. The staff continues to believe that entities should have flexibility in how to determine inputs to the measurement of credit losses, including prepayments, and it would be inappropriate to provide prescriptive guidance for one input in the context of this framework. The staff believes that an entity's flexibility is not without bounds and that any accounting policy an entity elects for determining estimates should be supportable and applied consistently.
83. The staff plans no further work on this issue.