PwC Comments on Proposed ASU, Clarifications to Accounting for Troubled Debt Restructurings by Creditors

PwC recommends that the troubled debt restructuring recognition and measurement model also be considered in the Board's deliberations on the financial instruments project. The firm believes it is important to consider the financial instruments accounting model, including the recognition and measurement for troubled debt restructurings, holistically in order to achieve a consistent framework. PwC also recommends that the Board modify the troubled debt restructuring measurement guidance such that the relevant impairment model is independent from the identification of a troubled debt restructuring.

Comment letter

December 13, 2010

Technical Director
Financial Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116

File Reference No. 1880-100, Proposed Accounting Standard Update, Receivables (Topic 310), Clarifications to Accounting for Troubled Debt Restructurings by Creditors

Dear Technical Director:

PwC appreciates the opportunity to comment on the Financial Accounting Standards Board’s (“FASB” or the “Board”) proposed Accounting Standards Update, Receivables (Topic 310) Clarifications to Accounting for Troubled Debt Restructurings by Creditors (the “Proposal”). We support the Board’s objective of promoting high-quality standards for impairment measurements and disclosures of debt restructurings. We also support the Board’s objective of improving comparability. We understand the Board’s motivation for undertaking this project at this time, but we recommend that the troubled debt restructuring recognition and measurement model also be considered in the Board's deliberations on the financial instruments project. We believe it is important to consider the financial instruments accounting model, including the recognition and measurement for troubled debt restructurings, holistically in order to achieve a consistent framework.

Although we believe that disclosures about restructurings designed to mitigate or avoid credit losses are important to users of the financial statements, we are concerned that the Proposal will result in some restructurings being inappropriately identified as troubled debt restructurings (further discussed below). We also recommend that the Board modify the troubled debt restructuring measurement guidance such that the relevant impairment model is independent from the identification of a troubled debt restructuring.

We have provided responses to the Board’s specific questions in the attachment to this letter.

The TDR model

The Board’s stated objective in issuing the Proposal is to achieve more consistent identification across institutions of restructurings that constitute troubled debt restructurings (TDRs). We understand that the Board is responding to certain constituents’ concerns regarding the diversity in practice in identifying TDRs.

We believe that disclosures about restructurings designed to mitigate or avoid credit losses are important to users of the financial statements. The TDR model was developed to provide an accounting and disclosure framework for creditors and debtors when the receivable is restructured to enable the debtor to avoid bankruptcy procedures or other consequences of default. The model precludes creditors from accounting for such restructurings as extinguishments and requires additional disclosures.

Currently, a restructuring of a receivable constitutes a TDR when the creditor, for economic reasons related to the debtor’s financial difficulties, grants a concession to the debtor. The creditor is required to make certain disclosures related to the TDR and to measure the allowance for credit losses for that receivable using the impairment guidance in ASC 310-10.

The Proposal

We are concerned that the guidance in the Proposal will require preparers to consider receivables to be impaired and disclose them as such even if they do not meet the criteria in the impairment model (ASC 310-10-35¹). This creates a number of conceptual issues, including:

• Disclosure of receivables as TDRs when they would otherwise not be considered impaired may confuse financial statement users and provide misleading information about the credit quality of an institution’s receivables.
• The requirement to calculate the allowance for credit losses under the provisions of ASC 310-10-35 as opposed to ASC 450-20-30
² as part of a larger pool may result in a lower overall allowance. This issue is most evident with respect to consumer loan portfolios.

We recommend that the identification of a TDR not require the application of a specific impairment model because existing literature already provides sufficient guidance as to when a receivable should be evaluated as an impaired receivable. In addition, guidance exists (including the recently issued Accounting Standards Update 2010-20, Receivables (Topic 310), Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses) requiring disclosures about credit quality and the allowance for credit loss.

We also recommend that the Board consider what circumstances would allow a receivable that was restructured in a transaction identified and disclosed as a TDR to be removed from TDR disclosures. For example, consider a situation where a receivable was restructured a number of years ago in a restructuring that was considered a TDR, but the debtor has been in full compliance with the revised receivable terms for a significant period of time and there is no specifically identifiable concern about the debtor's ability to continue to perform under the terms of the receivable. We do not believe that continuing to disclose that receivable as a TDR and requiring the calculation of the allowance for credit losses on that receivable under ASC 310-10 results in improved financial reporting and presents decision-useful information to financial statements users.

Identification of debtor’s financial difficulty

We support the proposed clarifications for determining when a debtor is experiencing financial difficulty. We believe that the factors included in the guidance for debtors on identifying a TDR (ASC 470-60-55) support the Board’s overall objective to ensure consistency in identifying TDRs and is also consistent with current practice.

We also agree that creditors should be required to perform an analysis to determine if a modification is a TDR when default is considered “probable in the foreseeable future.” We believe that creditors have existing processes to identify such potential defaults as part of their credit monitoring and loss-mitigation activities.

Definition of concession

We recommend that the Board provide a conceptual definition of what is considered to be a concession. We believe a clear articulation of this principle is critical to obtaining consistent application of the guidance. For example, when a modification is made such that the creditor obtains value (other than a reduction in the probability of default) equal to or in excess of what it surrendered, it is unclear why that is a concession.

Inclusion of market rates as a determination of a TDR

In determining whether a TDR exists, the Proposal seems to place additional focus on whether a restructured receivable’s interest rate is below market rates at the time of modification. The extension of a receivable at a below-market rate is currently a factor to consider in ASC 310-40-15. We agree that to understand the basis for restructuring a receivable, it is important to understand the creditor’s decision in establishing an interest rate on the restructured agreement. We also understand the concept that creditors should not rely solely on a rules-based approach to decide if a restructuring is a TDR when the contractual interest rate is not reduced. However, we also believe that there are restructurings, such as those that involve a reduction in the interest rate or for which the interest rate is not “reset” to a then-current market rate that should not be considered TDRs. For example, if a creditor agrees to reduce an interest rate in exchange for receiving additional collateral, it may not be clear that the creditor has made a concession to the debtor. Accordingly, we disagree with the notion that when the interest rate on the modified loan is not reflective of prevailing market rates at the time of the modification, it is conclusive evidence that a concession has been granted or the modification is a TDR.

We note that the identification of a market rate may also be difficult depending upon the type of loan being restructured and the prevailing market conditions. We understand that in many instances the market rate of a loan may not be observable even at its origination.

Debtor’s lack of access to funds at a market rate

The Proposal provides that if a debtor does not otherwise have access to funds at a market rate for debt with similar risk characteristics as the restructured debt, the restructured loan’s interest rate would be below a market rate and therefore considered a troubled debt restructuring. It is unclear if the intent of this guidance is to assist in the identification of a concession, or whether the Board believes that in these circumstances both elements of a TDR (concession and debtor is in financial difficulty) exist.

Recent experience in the credit markets has shown that the lack of availability of credit in the marketplace can impact debtors that are not currently experiencing financial difficulty. As a result, it is unclear why the ability to have access to funds should be automatically considered an event that would cause a restructuring to be considered a TDR. Such a condition may not be determinative of whether the debtor is currently experiencing financial difficulty.

In addition, we believe that in practice it will be difficult for creditors to determine whether a debtor has access to funds at a market rate for certain products and in certain market environments. Frequently, debtors will approach their creditors to restructure the terms as a method of refinancing instruments, as opposed to approaching new creditors. This may occur in situations where debtors and creditors have a relationship and the creditor has knowledge of the debtor’s business. In this example, it is unclear how a creditor would even know if a debtor has approached other creditors to obtain competitive offers.

It is also unclear what is meant by the phrase “access to funds at a market rate.” For example, debtors experiencing financial difficulty may have access to funds at very high interest rates from non-traditional creditors. We are unsure how access to these non-traditional creditors should be evaluated in the Proposal.

We recommend that the Board modify the Proposal such that a debtor's access to alternative financing is considered an indicator of the debtor's financial condition.

Insignificant delay in contractual cash flows

The Proposal indicates that a restructuring that results in an insignificant delay in contractual cash flows may still be considered a troubled debt restructuring. The Proposal notes that this factor should be considered along with other terms of the restructuring to determine whether a TDR exists. We are concerned with this proposed change because it could introduce another discrepancy between the TDR model and the current impairment guidance in ASC 310-10. That guidance suggests that a receivable is not impaired if there is only an insignificant delay in the contractual cash flows.

We also are concerned that this change could cause significant operational issues for creditors without significant benefit to financial statement users, particularly for situations involving restructurings of certain consumer loans. For example, a creditor with a large credit card portfolio will frequently receive requests to delay the payment from customers for an insignificant amount of time. The Proposal may require the creditors to put additional procedures in place to understand and validate the basis for the request, including determining whether the debtor is experiencing financial difficulty. These procedures could require significant investment and effort.

We acknowledge that certain creditors may undertake modification programs that may allow consumer receivables to be restructured based upon the terms of the program established. Although we believe disclosures of such programs would be important for financial statement users, we are concerned that there are often slight delays in payments granted to debtors in the normal course (i.e., not as part of a modification program) and the additional value to the users of considering those restructurings to be TDRs may not offset the preparer’s operational costs associated with capturing such disclosures. We recommend that the Board perform further outreach to understand users' perspectives in this regard.

Transition guidance

If the Board chooses not to de-link the impairment measurement from the identification of a TDR, we would agree with the prospective application of the impairment computation. However, as discussed above, we recommend that the impairment measurement be determined independently from the identification of a TDR. It is possible that many of the receivables identified as TDRs under the Proposal will not have or require an allowance for credit losses.

We support the Board’s requirement for retrospective application to disclosures regarding the number of TDRs, provided that the Board makes appropriate changes and clarifications to the Proposal as discussed above. If the Board does not make changes as discussed above, we believe that retrospective application would not be justified from a cost-benefit perspective.

We do not believe that the disclosures regarding allowance for credit losses need to be retrospectively adjusted. We believe that updating comparative disclosures relating solely to the number of TDRs will provide users with sufficient information for trend and other analyses. Further, the Proposal does not require preparers to calculate the allowance for credit losses that would have existed had a restructuring been identified as a TDR in the period the modification occurred. Thus, we expect that preparers would not otherwise develop the information needed to update comparative disclosures relating to the allowance for credit losses.

We appreciate the opportunity to express our views on this Proposal. If you have any questions regarding our comments please contact Donald Doran (973-236-5280) or Chip Currie (973-236-5331).

Sincerely,

PricewaterhouseCoopers LLP

¹ ASC 310-10-35, Receivables, Subsequent Measurement, Loan Impairment
² ASC 450-20-30, Loss Contingencies, Initial Measurement

Attachment

This Attachment contains our responses to your specific questions.

Question 1: Would precluding creditors from applying the guidance in paragraph 470-60-55-10, create any operational challenges for determining whether a troubled debt restructuring exists? If yes, please explain why.

PwC’s response: For institutions that will have to modify their systems to reflect this change, we believe that removing this provision will create some operational challenges for preparers in determining whether a TDR exists. However, more broadly, we are concerned that the Proposal will involve additional operational challenges that may not provide significantly more decision-useful information. See our comments in the section entitled Definition of concession above.

Question 2: Do you believe that the proposed changes to the guidance for determining whether a troubled debt restructuring exists would result in a more consistent application of troubled debt restructuring guidance? If not, please explain why.

PwC’s response: We believe that some of the provisions of the Proposal, such as the factors to consider in identifying whether a debtor is experiencing financial difficulty, will result in more consistent application of the TDR guidance. However, as discussed above, we believe that some of the guidance provided in the Proposal will lead to inappropriate identification of certain restructurings as TDRs. In addition, the lack of clarity regarding certain of the Proposal’s factors and the absence of clear principles will likely result in inconsistent application of the guidance.

Question 3: The Board decided that a creditor may consider that a debtor is experiencing financial difficulty when payment default is considered to be “probable in the foreseeable future.” Do you believe that this is an appropriate threshold for such an assessment? If not, please explain why.

PwC’s response: We believe that the use of “probable in the foreseeable future” is an appropriate threshold for the assessment of whether a debtor is experiencing financial difficulty. See our comments in the section entitled Identification of debtor’s financial difficulty above.

Question 4: Are the proposed transition and effective date provisions operational? If not, please explain why.

PwC’s response: See our comments in the section entitled Transition guidance above.

Question 5: Should the transition and effective date be different for nonpublic entities versus public entities? If so, please explain why.

PwC’s response: We believe the transition and effective date should be the same for public and nonpublic entities.

Question 6: Should early adoption of the proposed amendments in this Update be permitted? If so, please explain why.

PwC’s response: We are not opposed to permitting early adoption, but we believe it is unlikely that many reporting entities would elect to early adopt. See our comments in the sections entitled Definition of concession and Transition guidance above.