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10A.3 Accounting for a troubled debt restructuring
Publication date: 31 May 2022
us Loans & investments guide
Under the guidance in ASC 310-40, a creditor does not recognize a new loan for a troubled debt restructuring. When a creditor has determined that a refinancing or restructuring is a troubled debt restructuring, unamortized fees and costs from the original loan, and other fees and costs associated with the TDR should be accounted for in accordance with the guidance in ASC 310-40 and ASC 310-20-55.
ASC 310-40-35-10 states that a TDR is not accounted for as a new loan.
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.
Since TDRs are not accounted for as new loans, unamortized fees and costs from the original loan should be carried forward and continue to be included in the amortized cost basis of the loan.
According to ASC 310-40-25-1, legal fees and other direct costs incurred by a creditor in connection with the troubled debt restructuring should be expensed when incurred.
ASC 310-20-35-12 states that any fees received by the creditor in connection with a TDR reduce the amortized cost basis of the loan.
Fees received in connection with a modification of terms of a troubled debt restructuring as defined in Subtopic 310-40 shall be applied as a reduction of the recorded investment in the loan. All related costs, including direct loan origination costs, shall be charged to expense as incurred.
See LI 12 for information on the disclosures creditors are required to make with regard to TDRs.
10A.3.1 TDRs and the allowance for credit losses
Under the CECL model in ASC 326-20, there is no separate impairment model for loans that have been restructured in a TDR. However, an entity may be required to use a discounted cash flow approach to measure the estimated credit losses of a loan that has been restructured in a TDR or if there is a reasonably expected TDR in order to capture the impact of certain concessions.
10A.3.1.1 Identification of a reasonably expected TDR
ASC 326-20 requires an entity to consider all of the effects of a TDR on estimated credit losses when it has a reasonable expectation at the reporting date that it will execute a TDR with the borrower. At the September 6, 2017 FASB meeting, the Board concluded that an entity should identify a TDR when it is reasonably expected at the individual loan level. Once identified (or forecasted), the effects of the TDR, including the benefit of loss mitigation, the economic loss related to concessions and any additional credit exposure over the extended term should be reflected in the estimate of expected credit losses.
Determination of when an entity reasonably expects to execute a TDR on a specific asset requires judgment. We believe a TDR is reasonably expected no later than when the entity determines that modification is the best course of action in an effort to maximize collection from a troubled borrower.
An entity should consider its credit risk management policies and any loan modification programs in place for troubled borrowers. Through leveraging information in servicing systems, entities may be able to identify borrowers with whom they reasonably expect to execute TDRs based on combinations of certain factors, such as delinquency, loan to value ratios, and other metrics. The identification of reasonably expected TDRs is a management judgment that will require processes and controls that should be continually re-evaluated based on management’s restructuring practices.
We do not expect each asset identified as a reasonably expected TDR to ultimately result in an executed TDR. Similarly, not all executed TDRs will have been previously identified as reasonably expected TDRs. A reporting entity should make a reasonable effort to appropriately identify reasonably expected TDRs.
10A.3.1.2 TDRs - allowance for credit losses
Although reasonably expected TDRs are required to be identified on an individual asset basis, expected credit losses under CECL may be measured either on a pool or individual asset basis, depending on the asset’s facts and circumstances, including whether it shares risk characteristics with other assets. Further, loans for which TDRs are reasonably expected and loans that have been restructured through TDRs may be pooled with loans that have not experienced and are not expected to experience TDRs when they share similar risk characteristics.
The measurement of the allowance for credit losses for TDRs and reasonably expected TDRs follows the CECL model, which is discussed in LI 7. While the CECL model is applicable to loans that have been restructured through TDRs and loans for which TDRs are reasonably expected, there are some additional items an entity should consider when measuring credit losses on these assets. These items include, but are not limited to, the following:
- Concessions granted through TDRs must be captured in an entity’s estimate of expected credit losses. While CECL does not require the use of a discounted cash flow (DCF) model, an entity may be required to use this method to capture certain concessions when measuring the allowance for credit losses on loans that have been restructured through TDRs and loans for which TDRs are reasonably expected. If the impact of a concession can only be measured through a DCF method, then a DCF method must be used. This may be applicable to interest rate concessions and term extensions, as the economic impact of these concessions is partly driven by the time value of money.
- When a reporting entity uses a DCF model to estimate expected credit losses on loans that have been restructured through TDRs or loans for which a TDR is reasonably expected, the effective interest rate used to discount the expected future cash flows should be the original effective rate of the loan, not the rate specified within the restructuring agreement entered into between the creditor and the borrower. By using the original effective rate, any interest concessions will be captured in the analysis. If a reporting entity uses a modeling technique other than a DCF analysis to determine its expected credit losses, it must incorporate the effect of a concession in its estimate.
- Entities are not required to adjust historical loss data that serves as a basis for elements of a CECL estimate to remove the effect of TDRs unless the entity expects that its historic loss mitigation activities are not representative of what it expects it will do in the future. At the September 6, 2017 FASB meeting, the FASB acknowledged that, depending how an entity maintains its historic data, certain effects of TDRs may already be included in an entity’s historical loss rates (e.g., the benefit of the loss mitigation achieved through TDRs may already be reflected through lower historical loss rates) while other effects may not be (e.g., the economic loss related to an interest rate concession).
The effects of a TDR, in addition to those embedded in an entity’s historical loss data, should be recognized once a reasonable expectation of a TDR has been identified on an individual instrument. When a reasonably expected TDR is identified, an entity should consider its impact that is not already captured in its estimate of expected credit losses.
If an entity expects that its future loss mitigation efforts will be different than those in the past, it should consider making appropriate adjustments to its loss estimates. For example, if an entity discontinued certain TDR programs offered to troubled borrowers in the past, this would need to be considered.
Question LI 10A-3
When assessing whether a concession has been granted on a purchased credit deteriorated (PCD) asset to determine if a restructuring is a TDR, is the lender required to evaluate whether the concession was granted based on contractual or expected cash flows?
When assessing whether a concession has been granted on a purchased credit deteriorated (PCD) asset to determine if a restructuring is a TDR, is the lender required to evaluate whether the concession was granted based on contractual or expected cash flows?
PwC response
A lender should base the evaluation of whether a concession has been granted on a PCD asset on the contractual terms and cash flows, similar to non-PCD assets. ASC 310-40-15-13 states that a creditor has granted a concession when, as a result of a loan modification, it does not expect to collect all amounts due, including interest accrued at the original contractual rate. See LI 9 for further information on PCD assets.
Entities with collateralized loans that have been restructured through TDRs and collateralized loans when a TDR is reasonably expected are required to estimate expected credit losses based on the fair value of the collateral when the entity determines foreclosure is probable. Entities also have the ability to elect the collateral-dependent practical expedient on these assets if the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the sale or operation of the collateral. In both cases (foreclosure is probable or when using the collateral-dependent practical expedient), the estimate of expected credit losses is based on the difference between the fair value of the collateral as of the balance sheet date and the amortized cost basis of the asset. See LI 7.3.6.6 and LI 7.4.1 for further information.
Question LI 10A-4
Assume an entity has a reasonable expectation to execute a TDR involving an interest rate concession on a collateralized loan. The loan qualifies for and the entity has elected to apply the collateral-dependent practical expedient for measuring expected credit losses. Should the entity adjust the fair value of the collateral to reflect the anticipated interest rate concessions when estimating expected credit losses?
Assume an entity has a reasonable expectation to execute a TDR involving an interest rate concession on a collateralized loan. The loan qualifies for and the entity has elected to apply the collateral-dependent practical expedient for measuring expected credit losses. Should the entity adjust the fair value of the collateral to reflect the anticipated interest rate concessions when estimating expected credit losses?
PwC response
No. When an entity elects the practical expedient, ASC 326-20-35-5 requires the estimate of credit losses to be based on the difference between the fair value of the collateral (less costs to sell, as applicable) as of the balance sheet date and the amortized cost basis of the asset. The economic impact of any concessions that may relate to the reasonably expected or executed TDRs should not be added to the allowance calculated under the practical expedient, as the fair value of the asset is used to determine expected credit losses.
Question LI 10A-5
Assume an entity had previously restructured a loan in a TDR by giving an interest rate concession and has now concluded that foreclosure is probable. When estimating expected credit losses, should the entity adjust the fair value of the collateral to reflect the economic impact of the interest rate concession?
Assume an entity had previously restructured a loan in a TDR by giving an interest rate concession and has now concluded that foreclosure is probable. When estimating expected credit losses, should the entity adjust the fair value of the collateral to reflect the economic impact of the interest rate concession?
PwC response
No. When foreclosure of a collateralized asset is probable, ASC 326-20-35-4 requires the estimate of credit losses to be based on the difference between the fair value of the collateral (less costs to sell, as applicable) as of the balance sheet date and the amortized cost basis of the asset. The economic impact of any concessions that may relate to the executed TDR should not be added to the allowance calculated based on the fair value of the asset.
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