Read this if you are a Chief Financial Officer at a financial institution.
The Financial Accounting Standards Board (FASB) issued its second Accounting Standards Update (ASU) of 2022 on March 31, 2022. Seen as a fairly quiet year thus far on the accounting standards issuance front, both ASUs issued so far should catch the attention of financial institutions’ accounting and finance teams. For readers who may have missed it, on March 31, 2022, we wrote about the FASB’s first ASU of 2022: ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method. Seen as enhancing the flexibility of hedge accounting, this ASU, among other things, expands on the “last-of-layer” hedging method by allowing multiple hedged layers to be designated for a single closed portfolio of financial assets or one or more beneficial interests secured by a portfolio of financial instruments.
The most recently issued ASU, ASU No. 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, responds to feedback received during the FASB’s Post-Implementation Review process of ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Commonly known as the “CECL (current expected credit loss) standard,” financial institutions that have not yet adopted ASU No. 2016-13 should be well into their CECL implementation plan. ASU No 2016-13 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.
The CECL standard is seen as a major disruptor event for financial institutions. I encourage you to check out my colleague Susan Weber’s CECL implementation series (the latest article can be found here) for best practices on a successful CECL implementation.
As soon as you see the acronym “CECL” in an article, especially one in regards to a new accounting standard, you may be already looking to “X” out of your web browser and save whatever horrors this ASU brings for another day. But, the changes that are forthcoming as a result of ASU No. 2022-02 are generally seen as being well received by accounting and finance teams (and likely credit teams as well).
As its name implies, ASU No. 2022-02 addresses two separate issues: Troubled debt restructurings and vintage disclosures.
Troubled debt restructurings
The ASU eliminates the current troubled debt restructuring accounting guidance within Accounting Standards Codification (ASC) Subtopic 310-40 in its entirety. To help illustrate the impact of the proposed changes, let’s quickly review ASC Subtopic 310-40. ASC Subtopic 310-40, among other things, indicates a troubled debt restructuring should 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. A loan modification is considered a troubled debt restructuring if made to a borrower experiencing financial difficulty and if the modification grants a concession. Furthermore, all troubled debt restructurings are considered impaired loans. After adoption of the ASU, financial institutions will evaluate whether the modification represents a new loan or a continuation of an existing loan, in accordance with current ASC guidance (ASC 310-20-35-9 through 35-11).
Current ASC guidance indicates a loan modification shall be treated as a new loan if the terms of the modification 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. 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. A modification is considered “more than minor” if the present value of the cash flows under the terms of the new debt instrument is at least 10 percent different from the present value of the remaining cash flows under the terms of the original instrument. However, even if the difference is less than 10 percent, the financial institution should evaluate whether the modification is more than minor based on the specific facts and circumstances surrounding the modification.
The ASU also modifies disclosure requirements. Rather than disclosing information on troubled debt restructurings, financial institutions will now be required to disclose information on loan modifications that were in the form of principal forgiveness, an interest rate reduction, an other-than-insignificant payment delay, or a term extension (or a combination thereof) made to debtors experiencing financial difficulty. Among other things, ASC 310-10-10-50-42 through 50-44 requires financial institutions to disclose, by class of financing receivable, the types of modifications utilized and certain financial effects of the modification, depending on the type of modification. ASC 310-10-55-12A provides an example of the disclosures required by ASC 310-10-10-50-42 through 50-44. The new disclosures must be made regardless of whether a modification to a debtor experiencing financial difficulty results in a new loan. In part, this section of the ASU is seen as providing structure around some of the types of modification disclosures financial institutions were providing during the coronavirus pandemic.
Financial institutions have long had internal controls surrounding the determination of troubled debt restructurings given the impact such restructurings can have on the allowance for loan losses and financial statement disclosures. Although internal controls surrounding loan modifications will still need to exist, they will likely need to evolve as a result of ASU No. 2022-02. Furthermore, the data gathered for preparation of financial statement disclosures will also change. However, the data needed to satisfy the new disclosure requirements should be readily available, with possibly minor manipulation required to obtain the information needed under the new disclosure requirements.
Vintage disclosures
The ASU amends ASC 326-20-50-6 to require public business entities to disclose current-period gross writeoffs by year of origination for financing receivables and net investment in leases within the scope of ASC Subtopic 326-20. ASC 326-20-55-79 provides an example of this disclosure.
ASU No. 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years—the same effective date for those who have not yet adopted ASU No. 2016-13. As always, if you have any questions as to how this ASU may impact your financial institution, please reach out to BerryDunn’s Financial Services team or submit a question via our Ask the Advisor feature.