FASB to Clarify Troubled Debt Restructurings Guidance
Guidance for troubled debt restructurings under the Financial Accounting Standards Board’s (“FASB”) credit losses standard will soon receive an update. The FASB intends to clarify the recognition and measurement of troubled debt restructurings by allowing banking institutions that calculate allowances for credit losses on modified loans to select a prepayment-adjusted effective interest rate when implementing Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.
The clarified guidance would allow banks that calculate allowances for their credit losses on troubled debt restructurings to select a prepayment-adjusted effective interest rate when adopting the FASB’s credit loss standard. It is expected to prevent banks from reviewing when a loan modification occurred, and calculate their earlier prepayment expectations to decide the effective interest rate to be used.
Banks accumulating losses on restructurings measured via a discounted cash flow method would be impacted by the guidance updated. The FASB added that it believes only a few loans will be affected. The reasoning is due to FASB research indicating one percent of loans at the nation’s ten biggest banks are restructurings. Also, restructurings calculated using the discounted cash flow method will further reduce the number of impacted loans. However, troubled debt restructurings may rise if the economy tanks and bank customers are unable to pay their loans.
Instead of issuing a formal update to ASU No. 2016-13, the FASB will revise the meeting minutes of its advisory group that assists companies in adopting the credit loss standard.