ABA Letter to FASB on Proposed Accounting Standards Update, Topic 326

Mr. Richard R. Jones
Chairman
Financial Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116

Via email: [email protected]

Dear Chairman Jones:

The American Bankers Association (ABA) welcomes the opportunity to comment on the Proposed Accounting Standards Update—Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures (the Exposure Draft). The Exposure Draft seeks to 1) eliminate Troubled Debt Restructurings (TDRs) while expanding disclosure requirements for loan modifications when a borrower is experiencing financial difficulty and 2) require banks to disclose current-period gross writeoffs by year of origination. Consistent with ABA’s previous recommendation, we support FASB’s efforts to reduce cost and complexity by eliminating the separate measurement model for TDRs especially in light of the lifetime loss measurement approach under the CECL standard. With this in mind, however, we believe the proposed expanded disclosure requirements in the Exposure Draft unintentionally introduce additional cost and complexity that outweighs the benefits of eliminating TDRs.

FASB should consider the elimination of TDRs in two distinct aspects, measurement and disclosure. Specifically, ABA agrees that the requirement to measure TDRs using a discounted cash flow method is unnecessarily complex and FASB should therefore remove prescriptive requirements for the measurement of TDRs (i.e., using discounted cash flows). However, ABA believes the expanded disclosure scope and content requirements in this Exposure Draft are inconsistent with FASB’s stated objectives of reducing cost and complexity. Considering FASB’s intent to issue a final standard that is sensitive to the timing of the end of the CARES Act, we believe the positive feedback FASB has received from financial statement users related to existing loan modification disclosures can justify an initial Accounting Standards Update that focuses solely on TDR measurement, with subsequent efforts that enable more deliberate outreach on the scope of loan modification disclosures. With this in mind, below are our specific recommendations:

ABA Strongly Supports Elimination of the Recognition and Measurement of TDRs

ABA has long called for the elimination of the complicated requirements to separately recognize and measure TDRs and therefore supports their removal for banks that have adopted CECL. Expected lifetime losses are estimated for all loans under CECL, so the need to separately recognize and measure such loans has been substantially diminished and then requiring a discounted cash flow method for them is inconsistent with the judgment and flexibility provided to preparers under CECL. Elimination of the prescriptive measurement requirement will allow management to measure expected credit losses of these loans on a collective basis when similar risk characteristics exist. Many consumer loans, for example, may remain in a pool for credit loss measurement purposes until writeoff. ABA believes this aspect of the Exposure Draft (that is, the removal of the separate recognition and measurement of TDRs) achieves FASB’s objective of eliminating cost and complexity. However, the reduced cost and complexity is counteracted by the proposed expanded disclosures that include almost all loan modifications, which will require the separate tracking of these and other loans.

The Scope of Disclosure Must be Reconsidered

Various aspects of the Exposure Draft indicate that the overall scope of disclosure should be reconsidered. Under current GAAP, banks provide specific disclosures for modified loans to customers in financial difficulty in which a concession was granted. In contrast, the Exposure Draft removes consideration of concessions. The proposed requirements would, thus, include modifications that do not affect cash flows, common financing to troubled borrowers that may otherwise reflect business as usual, as well as loss mitigation that may not necessarily involve a concession. As a result, many more loans will be subject to the proposed disclosures. ABA believes that the proposed broad requirements will require significant new processes and the resulting information will often obscure an investor’s analysis of credit risk.

Based on the disclosure examples in the Exposure Draft which focus on either interest rate reductions or principal forgiveness, ABA is concerned that the full range of modifications that are scoped in under this proposal may not have been considered. This is also apparent in the Exposure Draft’s stated objective.2 It implies that a modification with a borrower experiencing financial difficulty has a financial statement impact and is always executed with the intent of mitigating potential credit loss. More often than not modifications do not fit these criteria and inclusion of all modifications to borrowers experiencing financial difficulty can complicate an investor’s analysis of credit risk.

Below is discussion regarding these specific concerns.

The Scope of Disclosure should Exclude Modifications that do not Directly Impact Contractual Cash Flows

Requiring the disclosure of all modifications to troubled borrowers expands the scope to include modifications that do not directly impact cash flows, such as covenant waivers or collateral substitutions. ABA does not believe that these types of modifications provide decision-useful information. Modifications that do not directly impact a loan’s cash flows are not specifically contemplated in the Exposure Draft and may be an unintended inclusion in the scope. As a starting point, FASB must limit the scope to modifications of terms that directly change the amount of, or result in a delay in contractual cash flows.

FASB Should Consider the Purpose of the Modification

When working with borrowers experiencing financial difficulty, modifications of terms that change or delay contractual cash flows may be executed for loss mitigation purposes but more often than not are done in the normal course of business. These include refinancing, adjusting interest rates to market terms or other modifications to the credit agreement requested by commercial borrowers to better reflect their changing business needs. It may be appropriate to consider whether the modification is executed in response to the borrower’s experiencing financial difficulty. For example, modifications that result in a new loan are generally executed in normal business as routine activity and should be excluded from the scope.

Certain modifications executed for loss mitigation purposes may result in a concession to the borrower but many do not. Many of these modifications are made in return for additional compensation, addition of collateral, strengthening of covenants, other incremental consideration or risk reduction measures. These non-concessionary loan modifications are executed at market terms and in many cases may actually reduce the lender’s credit risk to the borrower. Scoping these types of modifications into the disclosure with those that actually include economic concessions would be confusing to investors and would inaccurately imply incremental credit risk, when none exists.

The Expanded Scope of Disclosure has Significant Cost

Tracking and reporting these additional modifications will require system enhancements to designate and report on these modifications as well as new processes and workflows to assign, review, and approve them. ABA estimates these enhancements will take at least 6-12 months and the new processes will have an ongoing cost. In particular, we anticipate a significant operational burden associated with the evaluation of all modifications under the loan refinancing and restructuring guidance. ABA recommendations include the exclusion of modifications that do not directly change or delay contractual cash flows or modifications that result in a new loan. This will reduce those costs. In addition, FASB should perform additional analysis to understand the range of loan modifications and further limit the scope to loan modifications that provide decision useful information about an entity’s credit risk.

Prescriptive Disclosure Guidance may Reduce Transparency

ABA believes that disclosure of modifications related to their impact on the estimate of expected credit losses is meaningful and decision useful-information. Because CECL provides significant flexibility in that process, ABA believes similar flexibly needs to be provided in these disclosures. Further, the fallout from the COVID-19 health crisis resulted in unprecedented efforts by banks to provide assistance to their customers and help them navigate the disrupted and uncertain economy. Banks rose to the occasion to provide their investors meaningful and timely disclosure regarding these modifications to help investors understand their impact. ABA believes that the disclosures were effective because they were done in a manner consistent with individual bank’s modification programs. The tremendous amount of resources devoted to these modification programs and disclosures were commensurate with the borrower and investor needs. As the activity and programs wind down, however, so will the relevance and demand for the related information. The resources used to collect and report this information should likewise be expected to decrease.

With this in mind, FASB must focus on principles that allow the preparer to disclose modifications in a manner consistent with the preparer’s modification programs and not prescribe disclosures based on specific modification types. The Exposure Draft proposes disclosure of modifications by whether they include an interest rate concession, a term extension, principal forgiveness, or a combination thereof, requiring loans with more than one modification be included in the separate “combination” bucket. Considering that inherent differences in modification programs and processes may not align with these modification types, some programs will be vastly over-weighted to the combination classification, thereby reducing transparency. ABA recommends FASB focus on a principle that requires disclosure of the effect on the estimate of credit losses, allowing banks to tailor their disclosures in a manner consistent with their modification programs and useful to the financial statement users.

A Different Transition Method is Warranted

FASB included both a prospective and a modified retrospective option to transition from the current guidance. Under a prospective transition, banks that continue to report existing TDRs would not realize the operational benefits intended. Specifically, mortgages could be outstanding for 30 years meaning that the intended operational ease provided by eliminating the TDR measurement model may not be realized until many years after adoption. To help address this challenge FASB also provided a modified retrospective method, which requires a cumulative effect adjustment at adoption. However, under a modified retrospective method, it may be overly difficult to isolate and measure the adjustment. ABA thus recommends the effect of transition should be recognized in the current credit loss provision consistent with other changes in estimate. Accounting for the effect as a change in estimate is both consistent with the underlying change and would eliminate the challenges presented in the current transition options.

Vintage Disclosures Should not Include Cumulative Writeoff Data

ABA supports the Board’s conclusion that the vintage disclosure should not be expanded to include cumulative writeoff data. The collection and presentation of cumulative writeoff information included in the “over five-year” vintage bucket, will create significant operational challenges, with little value provided to the financial statement user.

In summary, ABA supports the elimination of TDRs on a conceptual basis, but we believe FASB should reconsider the disclosure requirements as presented in the Exposure Draft. If the FASB does not amend the enhanced disclosure requirements, ABA believes this will be an overall increase in cost and complexity to preparers without significant benefit to users of the information. Thank you for considering our comments. If you need additional information or have questions, please contact me ([email protected]; 202-663-5318).

Sincerely,

Joshua Stein