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3.6 Restructuring of a debt security – after adoption of ASU 2022-02
Publication date: 31 May 2022
us Loans & investments guide
ASC 310-20-35-9 discusses the conditions for when a creditor should account for a modification of the terms of an existing debt instrument as a modification or as an extinguishment of the original debt instrument.
If the terms of the new loan resulting from a loan refinancing or restructuring are at least as favorable to the lender as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the lender, the refinanced loan shall be accounted for as a new loan. This condition would be met if the new loan's effective yield is at least equal to the effective yield for such loans and modifications of the original debt instrument are more than minor. Any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted. The effective yield comparison considers the level of nominal interest rate, commitment and origination fees, and direct loan origination costs and would also consider comparison of other factors where appropriate, such as compensating balance arrangements.
ASC 310-20-20 clarifies that the term “loan” includes loans accounted for as debt securities.
A new or restructured debt instrument is considered an extinguishment of the existing instrument and origination of a new instrument by the lender/investor when both of the following conditions are met:
- The terms of the new or restructured debt instrument are at least as favorable to the lender as the terms for comparable debt instruments to customers with similar creditworthiness.
- A modification is more than minor quantitatively or if facts and circumstances and other relevant considerations indicate that the modification is more than minor.
The terms of the new or restructured debt instrument are considered at least as favorable to the lender/issuer as the terms for comparable debt instruments to customers with similar creditworthiness when the new or restructured debt instrument is at or above a market rate of interest for the investor.
A modification is quantitatively more than minor if the present value of the cash flows under the terms of the new debt instrument is at least 10% different from the present value of the remaining cash flows under the terms of the original debt instrument. The guidance in ASC 470-50 (which is applicable to borrowers) should be used to calculate the present value of the cash flows for purposes of applying the 10% test. If the difference is less than 10%, the facts and circumstances and other relevant considerations may nevertheless indicate that the modification is more than minor.
To determine which facts and circumstances might help determine whether a modification is considered more than minor, a lender should consider the guidance in ASC 470-50 for borrowers. See FG 3 for additional information on accounting for debt modifications.
3.6A Restructuring of a debt security – before adoption of ASU 2022-02
A creditor may agree to modify the terms of a debt security either by restructuring its terms or by exchanging one debt instrument for another. When a creditor and a debtor agree to modify the terms of an existing debt instrument (or to exchange debt instruments) the creditor should evaluate whether the restructuring constitutes a troubled debt restructuring under the guidance in ASC 310-40. A restructuring of a debt instrument is considered a troubled debt restructuring if both of the following conditions are present:
- The lender has granted a concession
- The borrower is having financial difficulties
For additional guidance on troubled debt restructurings by creditors, see LI 10A.
For debt restructurings that are not considered troubled debt restructurings, a creditor must determine whether the modification or exchange should be accounted for as (a) the creation of a new debt instrument and the extinguishment of the original debt instrument or (b) the modification of the original debt instrument.
ASC 310-20-35-9 discusses the conditions for when a creditor should account for a modification of the terms of an existing debt instrument as a modification or as an extinguishment of the original debt instrument.
If the terms of the new loan resulting from a loan refinancing or restructuring, in which the refinancing or restructuring is not itself a troubled debt restructuring, are at least as favorable to the lender as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the lender, the refinanced loan shall be accounted for as a new loan. This condition would be met if the new loan’s effective yield is at least equal to the effective yield for such loans and modifications of the original debt instrument are more than minor. Any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted. The effective yield comparison considers the level of nominal interest rate, commitment and origination fees, and direct loan origination costs and would also consider comparison of other factors where appropriate, such as compensating balance arrangements.
ASC 310-20-20 and ASC 310-20-15-4 clarify that the term “loan” includes loans accounted for as debt securities for the purposes of applying the guidance in ASC 310-20.
A new or restructured debt instrument is considered an extinguishment of the existing instrument and origination of a new instrument by the lender/investor when both of the following conditions are met:
- The terms of the new or restructured debt instrument are at least as favorable to the lender as the terms for comparable debt instruments to customers with similar creditworthiness.
- A modification is more than minor quantitatively or if facts and circumstances and other relevant considerations indicate that the modification is more than minor.
The terms of the new or restructured debt instrument are considered at least as favorable to the lender/issuer as the terms for comparable debt instruments to customers with similar creditworthiness when the new or restructured debt instrument is at or above a market rate of interest for the investor.
A modification is quantitatively more than minor if the present value of the cash flows under the terms of the new debt instrument is at least 10% different from the present value of the remaining cash flows under the terms of the original debt instrument. The guidance in ASC 470-50 (which is applicable to borrowers) should be used to calculate the present value of the cash flows for purposes of applying the 10% test. If the difference is less than 10%, the facts and circumstances and other relevant considerations may nevertheless indicate that the modification is more than minor.
To determine which facts and circumstances might help determine whether a modification is considered more than minor, a lender should consider the guidance in ASC 470-50 for borrowers. See FG 3 for additional information on accounting for debt modifications.
3.6.1 Securities received in a restructuring – after adoption of ASU 2022-02
ASC 320-10-15-6 and ASC 320-10-55-2 clarify that ASC 320 applies to all loans that meet the definition of a security. Therefore, if a loan is restructured such that it meets the definition of a security, it becomes subject to the guidance in ASC 320.
The guidance in this Topic applies to all loans that meet the definition of a security.
All of the following debt instruments are within the scope of this Topic if they meet the definition of a debt security:
a. Loans restructured as securities. For example, any loan that was restructured involving a modification of terms would be subject to the provisions of this Topic if the debt instrument meets the definition of a security. See paragraph 310-20-40-10 for additional information.
b. Beneficial interests in securitized financial assets that are in equity form but that meet the definition of a debt security. For example, some beneficial interests issued in the form of equity represent solely a right to receive a stream of future cash flows to be collected under preset terms and conditions (that is, a creditor relationship), while others, according to the terms of the special-purpose entity, must be redeemed by the issuing entity or must be redeemable at the option of the investor. Consequently, those beneficial interests would be within the scope of both this Topic and Subtopic 325-40 since they are required to be accounted for as debt securities.
c. Certificates of deposit (CDs) or guaranteed investment contracts. For example, certain negotiable jumbo CDs and guaranteed investment contracts might meet the definition of security, which was modeled after the definition provided in the Uniform Commercial Code.
Redeemable convertible preferred stock. For example, convertible preferred stock that has mandatory redemption provisions or is redeemable at the option of the investor is considered a debt security and this Topic would apply.
In a debt restructuring, the creditor may receive a debt security issued by the original debtor with a fair value that differs from the creditor's basis in the loan at the date of the debt restructuring. ASC 310-20-40-10 provides further guidance on how to account for the initial cost basis of a debt security of the original debtor received as part of a debt restructuring. The initial cost basis of a debt security of the original debtor received as part of a debt restructuring should be the security's fair value at the date of the restructuring. Any excess of the fair value of the security received over the net carrying amount of the loan should be recorded as a recovery on the loan. Any excess of the net carrying amount of the loan over the fair value of the security received should be recorded as a charge-off. Subsequent to the restructuring, the security should be accounted for according to ASC 320. In accordance with ASC 310-20-40-11, a security received in a restructuring in settlement of a claim for only the past-due interest on a loan should be measured at the security's fair value at the date of the restructuring, and accounted for in a manner consistent with the entity's policy for recognizing cash received for past-due interest. Subsequent to the restructuring, the security should be accounted for according to ASC 320.
For additional information on debt restructuring, see LI 10.
The initial cost basis of a debt security of the original debtor received as part of a debt restructuring shall be the security's fair value at the date of the restructuring. Any excess of the fair value of the security received over the net carrying amount of the loan shall be recorded as a recovery on the loan. Any excess of the net carrying amount of the loan over the fair value of the security received shall be recorded as a charge-off to the allowance for credit losses. Subsequent to the restructuring, the security received shall be accounted for according to the provisions of Topic 320.
A security received in a restructuring in settlement of a claim for only the past-due interest on a loan shall be measured at the security's fair value at the date of the restructuring and accounted for in a manner consistent with the entity's policy for recognizing cash received for past-due interest. Subsequent to the restructuring, the security received shall be accounted for according to the provisions of Topic 320.
3.6.1A Securities received in a restructuring – before adoption of ASU 2022-02
ASC 320-10-15-6 and ASC 320-10-55-2 clarify that ASC 320 applies to all loans that meet the definition of a security. Therefore, if a loan is restructured such that it meets the definition of a security, it is subject to the guidance in ASC 320.
The guidance in this Topic applies to all loans that meet the definition of a security.
All of the following debt instruments are within the scope of this Topic if they meet the definition of a debt security:
a. Loans restructured as securities. For example, any loan that was restructured in a troubled debt restructuring involving a modification of terms would be subject to the provisions of this Topic if the debt instrument meets the definition of a security. See paragraph 310-40-40-8A for additional information.
b. Beneficial interests in securitized financial assets that are in equity form but that meet the definition of a debt security. For example, some beneficial interests issued in the form of equity represent solely a right to receive a stream of future cash flows to be collected under preset terms and conditions (that is, a creditor relationship), while others, according to the terms of the special-purpose entity, must be redeemed by the issuing entity or must be redeemable at the option of the investor. Consequently, those beneficial interests would be within the scope of both this Topic and Subtopic 325-40 since they are required to be accounted for as debt securities.
c. Certificates of deposit (CDs) or guaranteed investment contracts. For example, certain negotiable jumbo CDs and guaranteed investment contracts might meet the definition of security, which was modeled after the definition provided in the Uniform Commercial Code.
d. Redeemable convertible preferred stock. For example, convertible preferred stock that has mandatory redemption provisions or is redeemable at the option of the investor is considered a debt security and this Topic would apply.
In a debt restructuring, the creditor may receive a debt security issued by the original debtor with a fair value that differs from the creditor's basis in the loan at the date of the debt restructuring. ASC 310-40-40-8A provides further guidance on how to account for the initial cost basis of a debt security of the original debtor received as part of a debt restructuring. The initial cost basis of a debt security of the original debtor received as part of a debt restructuring should be the security's fair value at the date of the restructuring. Any excess of the fair value of the security received over the net carrying amount of the loan should be recorded as a recovery on the loan. Any excess of the net carrying amount of the loan over the fair value of the security received should be recorded as a charge-off. Subsequent to the restructuring, the security should be accounted for according to ASC 320. In accordance with ASC 310-40-40-9, a security received in a restructuring in settlement of a claim for only the past-due interest on a loan should be measured at the security's fair value at the date of the restructuring, and accounted for in a manner consistent with the entity's policy for recognizing cash received for past-due interest. Subsequent to the restructuring, the security should be accounted for according to ASC 320.
The initial cost basis of a debt security of the original debtor received as part of a debt restructuring shall be the security's fair value at the date of the restructuring. Any excess of the fair value of the security received over the net carrying amount of the loan shall be recorded as a recovery on the loan. Any excess of the net carrying amount of the loan over the fair value of the security received shall be recorded as a charge-off to the allowance for credit losses. Subsequent to the restructuring, the security received shall be accounted for according to the provisions of Topic 320.
A security received in a restructuring in settlement of a claim for only the past-due interest on a loan shall be measured at the security's fair value at the date of the restructuring and accounted for in a manner consistent with the entity's policy for recognizing cash received for past-due interest. Subsequent to the restructuring, the security received shall be accounted for according to the provisions of Topic 320.
For additional information on debt restructuring, see LI 10A.
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