Chapter 4 — Measurement of Expected Credit Losses

4.7 Considerations Related to TDRs Under ASC 326 Before the Adoption of ASU 2022-02

ASU 2016-13 does not affect the guidance in ASC 310-40 on identifying whether a modification is a TDR. That is, an entity would still continue to apply the guidance in ASC 310-40-15-5 that states that “[a] restructuring of a debt constitutes a troubled debt restructuring . . . if the creditor for economic or legal reasons related to the debtor’s financial difficulties grants a concession to the debtor that it would not otherwise consider.” Consequently, the CECL model will not affect an entity’s (1) process for determining whether a concession has been granted to the borrower as part of a modification, (2) analysis of whether the borrower is experiencing financial difficulty, and (3) accounting for the TDR on an individual loan basis.13

However, when discussing how an entity must estimate expected credit losses over the asset’s contractual life, ASC 326-20-30-6 states, in part:

An entity shall not extend the contractual term for expected extensions, renewals, and modifications unless either of the following applies:

The entity has a reasonable expectation at the reporting date that it will execute a troubled debt restructuring with the borrower.[14]
The extension or renewal options (excluding those that are accounted for as derivatives in accordance with Topic 815) are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the entity.

Given this guidance, stakeholders have asked questions regarding the nature of TDRs that an entity must consider in making the estimate (e.g., contractual term extensions, interest rate concessions), when and how to consider TDRs in making the estimate, and whether to consider reasonably expected TDRs on a portfolio basis or at the level of the individual financial asset.

These issues were initially addressed by the TRG at its June 2017 meeting and were later discussed by the FASB at its September 6, 2017, meeting. At that meeting, the Board indicated that ASU 2016-13’s guidance was intended to accelerate the recognition of an economic concession granted in a TDR from when the TDR is executed (as required under existing U.S. GAAP) to when the TDR is reasonably expected. As a result, the Board clarified that the allowance for expected credit losses should include all effects of a TDR when an individual asset can be specifically identified as a reasonably expected TDR.

In addition, the FASB acknowledged that depending on the nature of the economic concession granted in a TDR and the method used by an entity to measure the allowance for expected credit losses, such an allowance may not include the effects of the concession. For example, an entity’s allowance for expected credit losses may not include the effects of an interest rate concession if the entity measures the allowance by using a principal-only loss rate approach. Because ASU 2016-13 requires an entity to include all effects of TDRs in its allowance for expected credit losses, the FASB indicated that an entity must use a DCF method or a reconcilable method if the TDR involves a concession that can only be measured by using a DCF method (e.g., an interest rate or term concession).15

4.7.1 Measuring Credit Losses on a TDR

Under U.S. GAAP before the adoption of ASU 2022-02, an entity is required to measure credit losses on a TDR by using a DCF method on an individual financial asset basis. Such measurement is not necessarily required under ASU 2016-13, however. While the allowance for expected credit losses on a TDR comprises losses expected as a result of providing a concession from the restructuring, it also includes losses expected after the restructuring occurs. As a result, the unit of account in the measurement of expected credit losses on a TDR is no different from the unit of account required for all other assets measured at amortized cost (see Section 3.2 for more information). That is, an entity is required to evaluate expected credit losses on TDRs on a collective (i.e., pool) basis if the TDRs share similar risk characteristics. If a TDR’s risk characteristics are not similar to those of any of the entity’s other TDRs, the entity would be required to measure the expected losses on the TDR individually. Paragraph BC105 of ASU 2016-13 addresses the Board’s rationale for its decision about the unit of account for TDRs:

Separately, the Board rejected an approach that would have required expected credit losses on troubled debt restructurings to always be measured by using a discounted cash flow method on an individual basis because such a requirement would be inconsistent with the ability to estimate expected credit losses using approaches other than a discounted cash flow method for assets measured at amortized cost. This decision allows entities to assess credit risk on troubled debt restructurings individually, or in a pool using other expected credit loss methods such as loss rates. Entities may provide modification programs to troubled borrowers that meet certain characteristics of financial difficulties, such that the loan modifications may be easily pooled together to assess credit risk. To the extent that those estimates may be more easily determinable with approaches other than the discounted cash flow method, the Board preferred to provide that flexibility.

4.7.2 Measurement Approaches for TDRs

An entity generally has the same flexibility when choosing credit loss measurement approaches for TDRs as it does when choosing credit loss measurement approaches for assets that are not determined to be TDRs. Paragraph BC105 of ASU 2016-13 states that “the Board rejected an approach that would have required expected credit losses on troubled debt restructurings to always be measured by using a discounted cash flow method . . . because such a requirement would be inconsistent with the ability to estimate expected credit losses using approaches other than a discounted cash flow method for assets measured at amortized cost.” However, the FASB acknowledged that depending on the nature of the economic concession granted in a TDR and the method an entity uses to measure the allowance for expected credit losses, such an allowance may not include the effects of the concession. For example, an entity’s allowance for expected credit losses may not include the effects of an interest rate concession if the entity measures the allowance by using a principal-only loss rate approach. Because ASU 2016-13 requires an entity to include all effects of TDRs in its allowance for expected credit losses, the FASB indicated that an entity must use a DCF method or a reconcilable method if the TDR involves a concession that can only be measured by using a DCF method (e.g., an interest rate or term concession).

In addition, under ASC 326-20-35-4, when an entity determines that foreclosure of the collateral is probable, the entity must measure the allowance for credit losses on the basis of the fair value of the collateral (see Section 4.4.9.1 for more information about collateral-dependent financial assets).

4.7.3 TDR as a New Loan

Under U.S. GAAP before the adoption of ASU 2022-02, an entity is not permitted to treat a TDR as a new loan. The same is true under ASU 2016-13 before the adoption of ASU 2022-02. ASC 310-40-35-10 states, in part, that “[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.” Therefore, an entity should not establish a new fair value for a loan restructured in a TDR. Further, ASC 310-40-35-12 reiterates that a TDR does not result in a new loan and requires that “the interest rate used to discount expected future cash flows on a restructured loan . . . be the same interest rate used to discount expected future cash flows on the original loan” and not the rate specified in the restructuring.16

As discussed in paragraphs BC100 and BC101 of ASU 2016-13, a TDR is not considered to be a new loan because “the modified financial asset following a troubled debt restructuring [is] a continuation of the original financial asset.” Therefore, the Board concluded that the interest rate used is the same because, “within the context of the amortized cost framework, the effective interest rate on a financial asset following a troubled debt restructuring should be the financial asset’s pre-modification original effective interest rate (as opposed to a post-troubled-debt-restructuring modified rate).”

However, if a TDR is subsequently restructured, a financial institution should consider the September 2014 Call Report supplemental instructions issued by the Federal Financial Institutions Examination Council (FFIEC). The supplemental instructions state, in part:

When a loan has previously been modified in a troubled debt restructuring (TDR), the lending institution and the borrower may subsequently enter into another restructuring agreement. The facts and circumstances of each subsequent restructuring of a TDR loan should be carefully evaluated to determine the appropriate accounting by the institution under U.S. [GAAP]. Under certain circumstances it may be acceptable not to account for the subsequently restructured loan as a TDR. The federal financial institution regulatory agencies will not object to an institution no longer treating such a loan as a TDR if at the time of the subsequent restructuring the borrower is not experiencing financial difficulties and, under the terms of the subsequent restructuring agreement, no concession has been granted by the institution to the borrower. To meet these conditions for removing the TDR designation, the subsequent restructuring agreement must specify market terms, including a contractual interest rate not less than a market interest rate for new debt with similar credit risk characteristics and other terms no less favorable to the institution than those it would offer for such new debt. When assessing whether a concession has been granted by the institution, the agencies consider any principal forgiveness on a cumulative basis to be a continuing concession. When determining whether the borrower is experiencing financial difficulties, the institution’s assessment of the borrower’s financial condition and prospects for repayment after the restructuring should be supported by a current, well-documented credit evaluation performed at the time of the restructuring.

If at the time of the subsequent restructuring the institution appropriately demonstrates that a loan meets the conditions discussed above, the impairment on the loan need no longer be measured as a TDR in accordance with ASC Subtopic 310-10, Receivables — Overall (formerly FASB Statement No. 114), and the loan need no longer be disclosed as a TDR in the Call Report, except as noted below. Accordingly, going forward, loan impairment should be measured under ASC Subtopic 450-20, Contingencies — Loss Contingencies (formerly FASB Statement No. 5). Even though the loan need no longer be measured for impairment as a TDR or disclosed as a TDR, the recorded investment in the loan should not change at the time of the subsequent restructuring (unless cash is advanced or received). [Emphasis added]

According to the FFIEC’s instructions, an entity may treat a subsequent restructuring of a TDR as a new loan if it determines that (1) at the time of the subsequent restructuring, the borrower is not experiencing financial difficulties and (2) under the terms of the subsequent restructuring agreement, the entity has not granted any concession to the borrower.

4.7.4 Reasonable Expectation of Executing a TDR

ASC 326-20-30-6 states that an entity is not permitted to extend the contractual term unless it “has a reasonable expectation at the reporting date that it will execute a troubled debt restructuring.” An entity must use judgment in determining whether it reasonably expects to execute a TDR. Although the Board indicated that the guidance in ASU 2016-13 was intended to accelerate the recognition of an economic concession granted in a TDR from when the TDR is executed (as required under previous U.S. GAAP) to when the TDR is reasonably expected, ASU 2016-13 does not provide guidance on how an entity may conclude whether it reasonably expects to execute a TDR. Nonetheless, we generally believe that a logical interpretation of the phrase “reasonable expectation” would be to consider the point at which the lender internally decides to offer a modification to the borrower to maximize its recovery of cash flows. Keep in mind that this could occur before a borrower agrees to the modified terms or even before it is presented with these terms.

Example 4-2

Assessing Reasonable Expectation of Executing a TDR — Trial Modification Programs

Entity A believes that the best way to maximize the return on a loan is to offer a trial modification to certain qualifying borrowers that are experiencing financial difficulty. Under the trial modification program, A will accept terms that differ from the contractual terms of the loan for a trial period (e.g., three months). If the borrower is able to comply with the terms of the trial modification (e.g., make the modified payments for the required period), A is required to permanently replace the loan’s original contractual terms with the terms of the trial modification. However, if the borrower is not able to comply with the terms of the trial modification, A is not required to permanently replace the loan’s original contractual terms with the terms of the trial modification and may seek payment of the amounts that are past due in accordance with the contractual terms; A may also potentially consider other remedies (e.g., foreclosure).

In this example, although it is unknown whether the borrower will be able to comply with the terms of the trial modification, we believe that A’s decision to offer the trial modification is evidence that A is willing to provide a concession to the borrower to maximize its recovery of cash flows. Accordingly, we think that A would reasonably expect to execute a TDR at the time it offers the trial modification to the borrower, irrespective of whether the borrower agrees to, or complies with, the terms of the trial modification.

Note that this example is intended to describe how an entity would apply ASC 326-20-30-6 in determining when a trial modification should be considered a TDR. It is not intended to provide guidance on whether a trial modification should be considered a TDR, because all trial modifications are TDRs.

Footnotes

Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) provides temporary relief from the accounting and reporting requirements for TDRs with respect to certain loan modifications related to COVID-19 that are offered by insured depository institutions and credit unions. See Section 10.3.5.3 for more information.

[14]

See footnote 1.

Under ASU 2022-02, an entity is no longer required to use a DCF method (or reconcilable method) to measure the allowance for credit losses as a result of a modification or restructuring with a borrower experiencing financial difficulty.

ASU 2022-02 requires entities to evaluate all receivable modifications under ASC 310-20-35-9 through 35-11 to determine whether a modification made to a borrower results in a new loan or a continuation of the existing loan. In addition, an entity that employs a DCF method to calculate the allowance for credit losses will be required to use a postmodification-derived EIR as part of its calculation in accordance with ASC 326-20-30-4.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.