In 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2022-02, Financial Instruments — Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The ASU eliminated the accounting and reporting requirements for troubled debt restructurings (TDRs) for banks that have adopted the current expected credit losses (CECL) allowance methodology. 

At the same time, ASU 2022-02 introduced enhanced disclosure requirements for loan modifications. Although the update took effect in 2023 for most banks, given the uncertain economic climate, now is a good time for banks to review their policies, procedures and controls to be sure they’re tracking the information needed to fulfill their disclosure obligations. 

What’s changing and why? 

Prior to ASU 2022-02, banks were required to evaluate loan modifications to determine whether they should be classified as TDRs. A modification was a TDR if the bank granted a concession to the borrower for economic or legal reasons related to a borrower’s financial difficulties. Such a concession might include principal forgiveness, a lower interest rate (below the current market rate) or an extension in maturity — that the bank otherwise wouldn’t have considered. 

If a loan modification was classified as a TDR, the bank had to measure it for impairment and, if appropriate, recognize a valuation allowance or loss. The loan would also likely have to be placed on nonaccrual status. 

Under the CECL methodology, banks must measure and record lifetime expected credit losses on loans, including modified loans classified as TDRs. Because these loan modifications are incorporated into the allowance for credit losses (ACL) under CECL, the FASB felt that the additional designation as a TDR, together with the related accounting requirements, was unnecessarily complex. 

What’s required now? 

Under ASU 2022-02, banks are no longer required to apply the recognition and measurement guidance for TDRs. Instead, they must apply existing loan refinancing and restructuring guidance to determine whether a modification results in a new loan or a continuation of an existing loan. Generally, a modification is treated as a new loan if 1) the terms are at least as favorable to the bank as the terms of similar loans to borrowers with similar risk characteristics, and 2) the modifications are “more than minor.” If a modification constitutes a new loan, the bank can recognize any related net deferred fees in earnings during the current period. 

The ASU also prescribed new qualitative and quantitative disclosures for specific loan modifications made for borrowers experiencing financial difficulties. (See “Indicators of financial difficulties” below.) Modifications that trigger the disclosure requirements include principal forgiveness, interest rate reduction, “other-than-insignificant” payment delays and term extensions.  

Which details must be disclosed? 

Required disclosures for each reporting period include: 

By class of financing receivable. Qualitative and quantitative information about the types of modifications, the financial effect of the modifications (by type) and the borrower’s performance in the 12 months following the modification. 

By portfolio segment. Qualitative information about how modifications and the borrower’s subsequent performance are factored into determining the ACL. 

In addition, for each reporting period, banks should disclose the following information about payment defaults during the period on modifications granted in the 12 months preceding the default to borrowers experiencing financial difficulties, including: 

By class of financing receivable. Qualitative and quantitative information about defaulted receivables, including types of modifications and amounts defaulted. 

By portfolio segment. Qualitative information about how defaults are factored into determining the ACL. 

Keep in mind that the systems you previously used to track TDRs won’t necessarily capture the information needed to comply with the updated disclosure requirements. For example, prior to ASU 2022-02, an interest rate reduction that wasn’t considered a “concession” (because it still qualified as a market rate) wouldn’t have triggered a TDR classification. But under the updated guidance, an interest rate reduction for a borrower experiencing financial difficulties should be disclosed — regardless of whether it’s considered a concession.  

Review, review, review 

Banks should review their policies, procedures and controls to ensure they’re tracking the information they need to meet their disclosure obligations. Contact an accounting professional to ensure you’re complying with the latest accounting rules. 

Sidebar:   Indicators of financial difficulties   

The current accounting rules call for detailed disclosures when modifying loans for borrowers experiencing financial difficulties. (See main article.) Examples of a few situations that might require enhanced disclosures include when: 

• The borrower is currently in payment default on any of its debt or would probably be in default in the foreseeable future without a loan modification, 
• The borrower has declared or is in the process of declaring bankruptcy, 
• There’s substantial doubt whether the borrower will continue as a going concern, 
• The borrower has securities that have been delisted, are in the process of being delisted or are under threat of being delisted from an exchange, or 
• The bank forecasts, on the basis of current estimates and projections, that the borrower’s cash flows will be insufficient to service any of its debt for the foreseeable future.