The Financial Accounting Standards Board (FASB) has amended the accounting standards used to determine when a loan modification should be considered a troubled debt restructuring (TDR) and therefore recorded as an impairment loss. Accounting Standards Update No. 2011-02 issued on April 5 amends FASB’s Accounting Standards Codification Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. Under the new rule, a creditor, including a banking organization, must separately conclude that a loan modification constitutes a “concession” and that the debtor is experiencing “financial difficulties” when evaluating whether a loan modification constitutes a TDR. If a creditor determines that it has granted a concession to a debtor, the creditor must make a separate assessment about whether the debtor is experiencing financial difficulties to determine whether the restructuring constitutes a TDR. The amendments to Topic 310 clarify the guidance on a creditor’s evaluation of whether it has granted a concession and what constitutes financial difficulty. Public companies are required to apply the new TDR rule to financial statements covering the first interim or annual period ending on or after June 15, 2011. Nonpublic companies are required to apply the new rule to financial statements covering annual periods ending on or after December 15, 2012.

Nutter Notes: The application of the new TDR rules could increase the loans a bank must treat as TDRs, and therefore increase loan loss reserves. Accounting experts have reported that the new rules lower the threshold for when a bank would classify a loan modification as a TDR, which could mean more modifications will be classified as TDRs. For example, if a debtor does not otherwise have access to funds at a market rate for a loan with similar risk characteristics as the modified loan, the modification would be considered to be at a below-market rate, which may indicate that the creditor has granted a concession. In addition, a temporary or permanent increase in the interest rate as a result of a modification does not prevent the modification from being considered a concession because the new interest rate could still be below the market interest rate for a new loan with similar risk characteristics. Under the new rules, a debtor may be experiencing financial difficulties even if the debtor is not currently in default of payments due under the loan. In addition, the new rules clarify that a creditor may not use the “effective interest rate test” (under Topic 470, the debtor’s guidance on restructuring of payables) when evaluating whether a restructuring constitutes a TDR.