CREDIT LOSSES
12B. Troubled Debt Restructurings
Bank Accounting Advisory Series
262
August 2018
Early adopters only
Staff Response
The restructuring should be accounted for as a TDR in accordance with ASC 310-40. The
ACL associated with this non-collateral dependent TDR should be measured using the DCF
method because the bank made an interest rate concession.
In this example, the ACL would be $20,000, which is calculated as the difference between the
present value of the amount expected to be collected of $80,000 (DCF amount) and the
$100,000 amortized cost basis of the loan.
Facts
A borrower owes the bank $100,000. The debt is restructured because of the
borrower’s financial difficulties and inability to service the debt. The loan does not share
similar risk characteristics with other loans. In partial satisfaction
of the debt, the bank accepts
preferred stock of the borrower with a face value of $10,000 and a fair value of only $1,000.
The bank agrees to reduce the contractual amount outstanding by the face amount of the
preferred stock ($10,000) and reduce the interest rate from 10 percent to 5 percent on the
remaining $90,000 of debt. The present value of the combined principal and interest payments
expected to be collected over the next five years, discounted at the effective
interest rate in the
original loan agreement, is $79,000.
Question 6
How should the bank account for this transaction?
Staff Response
Securities (either equity or debt) received in exchange for cancellation or reduction of a loan
should be recorded at fair value. The recorded amount of the debt ($100,000) is reduced by the
fair value of the preferred stock received ($1,000). The excess of the
amortized cost basis over
the fair value of assets received as a partial payment should be recorded as a credit loss. In this
case, because the securities have a fair value of $1,000 but the bank reduced the amount owed
by the borrower by $10,000 ($100,000 original value less $90,000 of remaining debt), the
additional $9,000 reduction in the amortized cost basis of the loan should be charged off.
Any expected credit loss on the remaining amortized cost basis of the restructured loan would
be measured according to ASC 326-20. In this case, the remaining loan balance of $90,000
would be compared with the present value of the expected
future payments, discounted at the
effective interest rate in the original loan agreement because the bank has granted an interest
rate concession (see Topic 12B, question 3).
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CREDIT LOSSES
12B. Troubled Debt Restructurings
Bank Accounting Advisory Series
263
August 2018
Early adopters only
An ACL of $11,000 should be established through a provision for credit losses. This
represents the difference between the $90,000 amortized cost basis and the $79,000
present
value of the expected future payments, discounted at 10 percent (the original effective interest
rate).
Facts
In 20X2, a 5/1 hybrid adjustable rate 30-year mortgage loan is made to a borrower with
an initial rate of 5 percent and a scheduled reset to the one-year U.S. Treasury rate plus
3 percent as of September 1, 20X7. In August 20X7, while the loan is still at the initial rate of
5 percent, the lender becomes aware that the borrower cannot make payments at the reset rate.
As of August 20X7, the one-year U.S. Treasury rate is 5 percent, so the loan’s interest rate is
expected to increase to 8 percent. Because of the borrower’s financial difficulty,
the bank
agrees to modify the terms of the loan at a fixed rate of 6 percent until maturity, which is
below the current market rate for a loan in this risk category. The bank appropriately classifies
the loan as a TDR. The bank does not have a policy in place to consider prepayment
expectations in the EIR.
Question 7
Is it acceptable for the bank to use the 5 percent initial rate as the effective interest rate in the
DCF method used to calculate the expected credit loss resulting from
the interest rate
concession?
Staff Response
No. The expected credit loss calculated as required by ASC 326-20-30-4 should capture the
concession (i.e., the lost interest). The effective interest rate for calculating the credit loss is
not the 5 percent initial rate. The bank may calculate the effective
interest rate using the
5 percent rate over the initial five-year period and applying the expected 8 percent reset rate
for the remaining 25 years of the loan. Alternatively, the bank may calculate the effective
interest rate using the 5 percent rate over the initial five-year period, the actual index rate for
the next year, and the bank’s expectations about projected changes in the variable rate, in this
case the one-year U.S. Treasury rate, over any remaining time in the reasonable and
supportable forecast period.
Facts
A borrower has a first lien residential mortgage with
Bank A and a second lien
residential mortgage with Bank B. Bank A modified the borrower’s first lien mortgage through
a TDR. At the time the first lien mortgage is modified with Bank A, the borrower is current on
the second lien mortgage with Bank B. Bank B has not modified the borrower’s loan but is
aware of the modification agreement made by Bank A.
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