September 2014 Call Report Changes Goodwill & TDRs

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Edith Hampton
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1 September 2014 Call Report Changes Goodwill & TDRs

2 Table of Contents EXECUTIVE SUMMARY... 3 GOODWILL ALTERNATIVE... 3 BACKGROUND... 3 DEFINITION OF A PUBLIC BUSINESS ENTITY... 3 Financial Institution Considerations... 4 EFFECTIVE DATE & IMPLEMENTATION... 4 Implementation Dates for Institutions Applying ASU TROUBLED DEBT RESTRUCTURING... 5 FINANCIAL DIFFICULTIES... 6 INSIGNIFICANT DELAY... 6 MEASUREMENT... 6 TRANSITION... 7 CONTRIBUTOR

3 Executive Summary Federal banking agencies included two important updates in the September 2014 Call Report Supplemental Instructions. They have reversed their previous position and no longer recommend banks and savings associations not apply the goodwill accounting alternative in Accounting Standards Update (ASU) No , Intangibles Goodwill and Other (Topic 350): Accounting for Goodwill, when preparing their Consolidated Reports of Income and Condition (Call Report). The regulatory guidance change allows, but does not require, an institution meeting the private company definition to do both of the following: Adopt the goodwill accounting alternative in ASU for Call Report purposes Choose early adoption of this alternative Early adoption is permitted, meaning an eligible private institution could adopt the accounting alternative beginning with the September 30, 2014, Call Report. The agencies also provided guidance on when a loan may be removed from the Call Report s Troubled Debt Restructuring (TDR) classification. Due to changing economic conditions, it is not unusual for a TDR to undergo subsequent modification. A financial institution could remove the TDR designation if, at the time of the second (or third) restructuring, the borrower is not experiencing financial difficulties and no concessions are granted. Goodwill Alternative Background In 2014, banking agencies have been evaluating the legal and policy issues raised in allowing a bank or savings association to use private company accounting alternatives issued by the Financial Accounting Standards Board (FASB) for Call Report purposes. Since issuing the definition of a public business entity in late 2013, FASB has issued three ASUs providing accounting alternatives to private entities. ASU No , issued in January 2014, generally permits a private company to elect to amortize goodwill on a straight-line basis over 10 years (or less if more appropriate) and apply a simplified impairment model to goodwill. In contrast, existing U.S. generally accepted accounting principles (GAAP) do not permit an entity to amortize goodwill but instead require an entity to test goodwill for impairment annually more frequently if certain conditions exist. In addition, if a private company chooses to adopt the ASU s goodwill accounting alternative, the ASU requires the private company to make an accounting policy election to test goodwill for impairment at the entity level or the reporting unit level. A private company electing the alternative must test goodwill for impairment when a triggering event occurs indicating the fair value of an entity or reporting unit may be below its carrying amount. Regarding the private company accounting alternative covered in ASU on interest rate swaps, FASB determined financial institutions are ineligible to apply the guidance on interest rate swaps even if the financial institution meets the definition of a private company. ASU , on applying variable interest entities guidance to common control leasing arrangements, applies to all entities other than a public business entity, a not-for-profit entity or an employee benefit plan within the scope of Topics 960 through 965 on plan accounting. Definition of a Public Business Entity In December 2013, FASB issued ASU , Definition of a Public Business Entity. The standard defined a public business entity for U.S. GAAP financial reporting purposes and amended the Master Glossary. An entity meeting any of the five public business entity criteria contained in the standard is not considered a private company and may not adopt private company accounting alternatives for purposes of U.S. GAAP, including the goodwill alternative. The definition is broad, covering more than those entities that file with the Securities and Exchange Commission (SEC) under federal securities laws. Prior to its issuance, the public-private distinction related primarily to effective 3

4 dates of standards and certain disclosure requirements. The public-private distinction in ASU has greater implications for alternative recognition, measurement, disclosure and display guidance, as well as effective date and transition guidance for private companies reporting under U.S. GAAP. In short, the alternative guidance for private companies includes modifications or exceptions to otherwise applicable existing U.S. GAAP standards but still falls under U.S. GAAP. As discussed in depth in BKD s previous paper, Considering Private Company Alternatives, an entity is a public business entity for purposes of U.S. GAAP if it meets any one of five criteria. Criterion E states an entity is a public business entity if it meets both of the following conditions: 1. The entity has one or more securities not subject to contractual restrictions on transfer 2. The entity is required by law, contract or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis, e.g., interim or annual periods Financial Institution Considerations If a bank or savings association does not meet any one of the first four criteria, it would need to consider whether it meets both of the conditions included in the fifth criterion to determine whether it is a public business entity. A mutual institution, e.g., a mutual savings bank or community bank, does not meet the fifth criterion and generally will be a private entity qualifying to adopt the goodwill alternative. First Condition Under Criterion E With respect to the first condition under the fifth criterion, a stock institution must determine whether it has a class of securities not subject to contractual restrictions on transfer; FASB has stated this means the securities are not subject to management preapproval on resale. A contractual management preapproval requirement that lacks substance would raise questions about whether the stock institution meets this first condition. Special considerations apply to subsidiaries of a holding company, as explained in the supplemental instructions. In general, public business entities access the public capital markets by issuing publicly traded securities. This premise follows FASB s historical fundamental concept that in order to be defined as a nonpublic entity in U.S. GAAP, the entity must not have securities that trade in a public market either on a stock exchange or in an overthe-counter market. Criterion E is intended to capture securities not on an exchange or an OTC market. Second Condition Under Criterion E Banks and savings association institutions must evaluate whether they are private companies using the criteria in ASU As entities subject to multiple regulatory reporting requirements, financial institutions must consider all requirements when considering the second condition in Criterion E. An insured depository institution with $500 million or more in total assets as of the beginning of its fiscal year is required by Federal Deposit Insurance Corporation (FDIC) regulations to prepare and make publicly available annual U.S. GAAP financial statements. Consequently, FDICIA Annual Reports meet the second condition of Criterion E. In these situations, if the first condition of Criterion E also is met, the institution would not qualify as a private company and would not have the option to elect the goodwill alternative. The requirements to file quarterly and annual Call Reports and Thrift Financial Reports (TFR), conversely, do not meet the second condition of Criterion E. These reports do not require compliance with all of the disclosure requirements under U.S. GAAP and therefore are not U.S. GAAP reports. If none of the other criteria are met, these financial institutions, like other entities, qualify to elect the private company accounting alternative under ASU Effective Date & Implementation The ASU s goodwill accounting alternative, if elected by a private company, is effective prospectively for new goodwill recognized in annual periods beginning after December 15, 2014, and in interim periods within annual 4

5 periods beginning after December 14, A private entity may apply the goodwill accounting alternative for any annual or interim period for which its financial statements have not yet been made available for issuance. In addition, when a private institution issues U.S. GAAP financial statements and adopts the ASU, it should apply the ASU s goodwill accounting alternative in its Call Report in a manner consistent with its reporting of goodwill in its financial statements. Implementation Dates for Institutions Applying ASU Institution Year-End Early Adoption? Inclusion in Call Report Comments December 31, 2014 No December 31, 2015, and subsequent quarterly Call Reports Institution would report no amortization in 2014 annual or quarterly Call Reports December 31, 2014 Yes Beginning with the annual December 31, 2014, Call Report Institution would report in its year-end 2014 Call Report one year s amortization of goodwill existing as of January 1, 2014, and the amortization of any new goodwill recognized in 2014 December 31, 2014 Yes Beginning with the September 30, 2014, Call Report Institution would report nine months amortization of goodwill existing as of January 1, 2014, and the amortization of any new goodwill recognized in the first nine months of 2014 Goodwill amortization expense should be reported in Item 7.c.(1) of the Call Report income statement (Schedule RI) unless the amortization is associated with a discontinued operation; in that case, the goodwill amortization should be included in the results of discontinued operations and reported in Schedule RI Item 11, Extraordinary Items and Other Adjustments, Net of Income Taxes. Troubled Debt Restructuring The instructions also provide guidance on when a loan may be removed from the TDR classification on the Call Report. A TDR is defined as a restructuring in which a creditor for economic or legal reasons related to a debtor s financial condition grants a concession to the debtor that it would not otherwise consider; the TDR designation affects measurement and requires additional disclosure. Previously, a TDR loan was only derecognized through repayment, sale or full charge off. Due to changing economic conditions, it is not unusual for a TDR to undergo subsequent modification. A subsequent modification could result in a new loan rather than a continued TDR classification if, at the time of the second (or third) restructuring, the borrower is not experiencing financial difficulties and no concessions are granted. The modified terms must be consistent with market conditions and representative of terms the borrower could obtain in the open market. Institutions must consider principal forgiveness on a cumulative basis to determine if a concession has been granted. Debt forgiveness in the initial or subsequent restructuring would preclude full relief under the new guidance. If a loan meets these two criteria, the loan need no longer be disclosed as a TDR in the Call Report. All TDRs are loan modifications, but not all loan modifications are TDRs. 5

6 Financial Difficulties The Financial Accounting Standards Board (FASB) provides a number of indicators to assess whether a debtor is experiencing financial difficulty. The assessment requires judgment based on the borrower s specific facts and circumstances. Each indicator is a sign the debtor needs to restructure the debt to avoid default. No indicator is determinative of financial difficulty by itself. The following list of indicators should not be considered all-inclusive: Debtor currently is in payment default on any debt; a creditor may determine a debtor is experiencing financial difficulties even if the debtor is not currently in payment default, if it is probable the debtor would default without a restructuring Bankruptcy; cash flow forecasts indicate the debtor s cash flows will be insufficient to service any of its debt in accordance with the terms of the existing agreement in the near future Debtor cannot obtain funds from other sources at current market rates for similar debt for a nontroubled debtor; an increase in the interest on the debt can be considered a concession if the rate is still below the market interest rate that could be obtained from third parties; an interest rate increase is not precluded from being considered a concession for TDR treatment Financial institutions should fully document the new assessment of the borrower s financial condition at the time of the modification. Insignificant Delay A restructuring that results only in an insignificant delay in payments is not a concession. The following factors should be considered: The amount that the restructured payment subject to the delay is insignificant relative to the unpaid principal and will result in an insignificant shortfall in the contractual amount due Whether the delay in timing of the restructured payment period is insignificant relative to any of the following: Frequency of payments due under the debtor The debt s original contract maturity The debt s original expected duration If the debt previously has been restructured, the cumulative effect of the past restructurings should be considered when determining if the delay in payment is insignificant. Management judgment is required there are no bright lines in identifying insignificant delays in U.S. GAAP. Measurement The recorded investment in the loan should not change at the time of the subsequent restructuring unless cash is advanced or received. If any amounts previously were charged off, no recoveries should be recognized until collections on amounts previously changed off have been received. Any interest accrued on the TDR before restructuring should not be reversed or reported as interest income at the time of the restructuring. TDRs are evaluated for impairment under ASC , Receivables; if TDRs are impaired, a specific valuation allowance must be established. If the above criteria are met, the newly modified loan would be measured for impairment under ASC , Loss Contingencies, for loans not considered individually impaired and collectively evaluated for impairment. The federal banking agencies granted partial relief for a subsequent TDR loan modification if there was principal forgiveness in the original or subsequent restructuring. If the modified terms reflect a market interest rate for a new loan with a similar credit risk profile and the loan is performing in compliance with the new terms, the loan 6

7 may be removed from TDR classification in the calendar year after the subsequent modification took place. However, the impairment on the loan should continue to be measured as a TDR under ASC Any subsequent restructuring of a loan removed from TDR classification would need to be evaluated to determine if the modifications result in a TDR. Transition The guidance applies prospectively to any subsequent restructuring of a TDR meeting the above criteria. Outstanding TDR loans at September 30, 2014, previously restructured under terms that meet the above criteria can eliminate the TDR disclosure and measurement requirements, starting with the September 30, 2014, Call Report. Prior Call Reports should not be amended. For additional guidance on the permissible use of the private company accounting alternative for goodwill, as well as guidance on other accounting and reporting topics, contact your BKD advisor. For more information on other PCC initiatives, visit BKD s webpage on private company reporting topics. Contributors Connie Spinelli Director cspinelli@bkd.com Anne Coughlan Director acoughlan@bkd.com 7

33 LIBERTY STREET, NEW YORK, NY July 21, 2016

33 LIBERTY STREET, NEW YORK, NY 10045-0001 PATRICIA SELVAGGI ASSISTANT VICE PRESIDENT July 21, 2016 To: The Individual Responsible for Filing the Consolidated Report of Condition and Income for Edge and