Earlier this year, the FASB issued new accounting standards as they apply to banks and what some are calling “troubled debt.” The FASB accounting standards codification is the source of Generally Accepted Accounting Principles (GAAP) recognized by the FASB and are to be applied by non-governmental entities.
FASB issued its accounting standards update in response to the downturn in our economy. In that regard, the volume of debt restructuring by creditors has increased greatly. Accordingly, several stakeholders raised concerns about what additional guidance or clarification was needed to help creditors in determining whether a creditor had granted a concession or whether a debtor was experiencing financial difficulties for purposes of determining whether a restructuring constituted a troubled debt. It was believed that there was a need for some uniformity so that the practices between the various financial institutions could be streamlined. In essence, so there could be equal comparisons.
The amendments adopted by FASB apply to all creditors, both public and non-public, that restructure receivables. In evaluating whether a restructuring actually constitutes a troubled debt, a creditor must conclude that both of the following exist:
- The restructuring constitutes a concession; and
- The debtor is experiencing financial difficulties.
The guidance adopted in the FASB update should result in a more consistent application of U. S. GAAP principles for debt restructures.
The amendments in this update are effective for the first interim or annual period beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption.
A restructuring of a debt constitutes a troubled debt restructuring for purposes of the new FASB accounting standards 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 (see, §310-40-15-5) and that concession is granted by the creditor in an attempt to protect as much of its investment as possible. The concession may stem from an agreement between the creditor and the debtor or it may be imposed by law (§310-40-15-6).
If a debtor that can obtain funds from sources other than the existing creditor at market interest rates at or near those for troubled debt it is not involved in a troubled debt restructuring (§310-40-15-8).
For purposes of the FASB guidelines, none of the following are considered troubled debt restructures:
- Changes in lease agreements.
- Changes in employment related agreements.
- Unless they involve an agreement between debtor and creditor restructure, either of the following:
- Debtor’s failure to pay trade accounts according to their terms.
- Creditor’s delays in taking legal action to collect overdue amounts of interest and principle.
- Modifications of loans within a pool.
- Changes in expected cash flows of a pool of loans resulting from the modification of one or more loans within the pool.
A debt restructuring is not necessarily a troubled debt restructuring for purposes of the FASB guidelines even if the debtor is experiencing some financial difficulties. For example, none of the following debt restructurings are considered troubled debt restructurings:
- The fair value of cash, other assets or an equity interest accepted by a creditor from a debtor in full satisfaction of its receivable at least equals the creditor’s recorded investment in the receivable.
- The fair value of cash, other assets or an equity interest transferred by a debtor to a creditor in full settlement of its payable at least equals the debtor’s carrying amount of the payable.
- The creditor reduces the effective interest rate on a debt primarily to reflect a decrease in market interest rates in general or a decrease in the risk so as to maintain a relationship with a debtor that can readily obtain funds from other sources at the current market interest rate.
- The debtor issues in exchange for its debt, new marketable debt having an effective interest rate based on its market price that is at or near the current market interest rates of debt with similar maturity dates and stated interest rates issued by non-troubled debtors.
A creditor has granted a concession when, as a result of the restructuring it does not expect to collect all amounts due, including interest accrued at the original contract rate (§310-40-15-13).
In addition to the above-referenced accounting changes, banking regulators have also required some lenders to go back and reclassify some of their receivables as troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a lender must separately conclude that both the borrower is experiencing financial difficulties and the restructuring constitutes a concession. Concessions could include transfer of assets from the debtor to the lender; granting an equity interest to the lender or modification of debt terms.
It is anticipated that the new FASB accounting standards will potentially increase the number and level of loan modifications that will be reported.