Reporting credit loss and debt restructuring during the COVID-19 pandemic

The Consolidated Appropriations Act (CAA) contains various COVID-19 economic relief measures. The law includes provisions that extend previous relief provided to large banks on the accounting rules related to credit loss as well as troubled debt restructuring (TDR) until January 1, 2022.

CECL guidance

In 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. It was originally scheduled to go into effect for most public companies in 2020.

The standard was issued in response to the 2008 financial crisis. Regulators and investors complained that the existing incurred loss model delayed recognition of losses. This model made banks’ balance sheets appear healthy even when the mortgage market was collapsing in 2006 and 2007.

The updated standard is controversial. The banking industry has always been unhappy about moving from the incurred loss model to the current expected credit loss (CECL) model. The new model requires businesses to look to the future. This involves making reasonable and supportable estimates, calculating potential losses on loans and certain securities as soon as they issue them, and setting aside corresponding loss reserves.

In short, the CECL model will require estimated credit losses to be recognized earlier than under the previous guidance. Due to the controversial nature of this guidance, the FASB had previously postponed the effective date of ASU 2016-13 for smaller banks until 2023.

Option to delay CECL standard

The CARES Act — a massive COVID-19 economic stimulus package that passed into law in late March 2020 — gave large public insured depository institutions (including credit unions), bank holding companies and their affiliates the option to delay the adoption of ASU 2016-13 until the earlier of:

  • The end of the national emergency declaration related to the COVID-19 crisis, or
  • December 31, 2020.

The CAA extends this provision. Specifically, it allows large banks to defer implementing the CECL model until the first day of their fiscal year that begins after the national emergency ends or January 1, 2022, whichever comes earlier. However, the relief measures may be unnecessary

for large banks that have already started to apply the accounting rule and expect to implement it in 2020.

TDR guidance

During the COVID-19 pandemic, lenders may be working with struggling borrowers on loan modifications. Under ASC Topic 310-40, Receivables — Troubled Debt Restructurings by Creditors, a debt restructuring is considered a TDR if:

  • The borrower is troubled, and
  • The creditor, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession it wouldn’t otherwise consider.
  • Under U.S. Generally Accepted Accounting Principles (GAAP), types of loan modifications that may be classified as TDRs include, but aren’t limited to:
  • A reduction of the stated interest rate for the remaining original life of the debt,
  • An extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk,
  • A reduction of the face amount or maturity amount of the debt as stated in the instrument or other agreement, and
  • A reduction of accrued interest.

The concession to a troubled borrower may include a restructuring of the loan terms to alleviate the burden of the borrower’s near-term cash requirements, such as a modification of terms to reduce or defer cash payments to help the borrower attempt to improve its financial condition.

Option to delay TDR standard

The CARES Act permits financial institutions not to classify a COVID-19-related loan modification as a TDR if:

  • It was made between March 1, 2020, and the earlier of December 31, 2020, or 60 days after the end of the public health emergency, and
  • The underlying loan wasn’t more than 30 days past due as of December 31, 2019.

In general, the CARES Act encourages financial institutions to consider short-term debt modifications that can ease cash flow pressures on affected borrowers, improve their capacity to service debt, increase the potential for financially stressed residential borrowers to keep their homes and facilitate the financial institution’s ability to collect on its loans. These concessions may help mitigate the long-term impact of the pandemic on borrowers by avoiding delinquencies and other adverse consequences.

The CAA extends this relief to the earlier of:

  • 60 days after the national emergency ends, or
  • January 1, 2022.

“Extending this provision for an additional year, to January 1, 2022, will allow banks and credit unions to continue to use every tool available to support consumers and businesses impacted by the COVID-19 pandemic,” said Republican members of the House Financial Services Committee.

Welcome relief

The challenges of the COVID-19 pandemic are expected to continue well into 2021. In these unprecedented conditions, the American Bankers Association supports these congressional regulatory relief measures.