FASB proposes acquired financial asset reporting changes

Breaking it down

Under existing GAAP, entities that acquire financial assets within the scope of Topic 326 must classify the assets as either purchased credit deteriorated (PCD) assets or non-PCD assets, depending on the level of credit deterioration that a PFA has experienced since its origination. While this distinction doesn’t affect how expected credit losses are measured, it does affect how the ACL is initially recognized, which ultimately affects the effective yield recognized on the acquired assets.

For a PFA that has experienced more-than-insignificant credit deterioration since origination (PCD assets), the ACL is established by adjusting the initial carrying amount of the PFA by the amount of the “Day 1” ACL. In contrast, for a non-PCD asset, the ACL is initially established through a charge to earnings.

As part of its post-implementation review (PIR) of ASU 2016-13, the FASB received feedback that the requirement to classify PFAs as either PCD assets or non-PCD assets is complex, requires significant judgment, and has led to reduced comparability among entities. Stakeholders also have asserted the requirement to recognize the allowance for non-PCD assets through a charge to earnings is unintuitive.

In response to this and other feedback, on June 27, 2023, the FASB issued a proposal to change the method used to determine how an entity records the initial ACL on PFAs. In place of using the level of credit deterioration experienced by the PFAs since origination, the proposal introduces a “seasoning” concept. For PFAs considered seasoned, the Day 1 ACL would be recognized by allocating the credit component of the purchase price directly to ACL – consistent with current PCD asset accounting. For all other PFAs, the Day 1 ACL would be recognized through a charge to earnings – consistent with the current accounting for non-PCD assets (that is, originated assets).

Example 1

On Jan. 1, 202X, Bank A acquired a loan in an asset acquisition. The relevant facts of the loan acquisition are as follows:

   Unpaid principal balance:      $1,000,000 
   Purchase price:                          $900,000 
   Stated coupon:                                 5.00% 
   Purchase yield                                  7.47% 
   Remaining term:                            5 years 
   Initial ACL:                                    ($60,000) 

The following table presents how the ACL initially would be recognized for the loan depending on whether the loan would be considered seasoned under the proposal.

Dr. Loan       $1,000,000 
    Cr. Discount           $100,000 
    Cr. Cash                  $900,000 

Dr. Loan          $1,000,000 
    Cr. Noncredit discount                $40,000 
    Cr. Allowance for credit loss      $60,000 
    Cr. Cash                                       $900,000 

   Dr. Credit loss expense                  $60,000
   Cr. Allowance for credit losses     $60,000

Interest income                 $16,807 
Credit loss expense        ($60,000) 

Interest income  $14,276

Crowe observation: The two models used to account for nonseasoned and seasoned loans are consistent with the accounting models used for non-PCD assets and PCD assets, respectively. Consequently, the main impact generally would be to increase the population of PFAs that would be subject to the current PCD asset accounting model.

Identifying seasoned PFAs

Under the proposal, a PFA would be considered seasoned when either of the following conditions is met:

• The PFA is part of a business and is acquired through a business combination accounted for in accordance with Topic 805.
• The PFA is acquired more than 90 days after its origination date and the acquiring entity did not have involvement with the origination of the asset.

To determine if the acquirer was involved with the origination of an asset, an entity would assess all relevant facts and circumstances, including:

• The acquirer’s exposure, either directly or indirectly, to the economic risks and rewards of ownership before obtaining control of the financial asset
• The nature of the relationship between the transacting entities, including arrangements made in contemplation of recurring transfers of similar financial assets and the acquirer’s ability to influence the originator’s underwriting standards
• The contractual terms of the transaction (including forward purchase commitments written by the acquirer to the originator or call options written by the originator to the acquirer)
• The existence of funding arrangements between the acquirer and the originator, or conveyance of a put option or similar contract from the acquirer to the originator
• The existence of a loss-sharing arrangement in which the acquirer has an obligation to reimburse an originator for an amount of principal loss incurred by the originator prior to the transfer of the financial asset
• The existence of a make-whole arrangement in which the acquirer has an obligation to reimburse the originator upon termination of the purchase transaction by the acquirer

Importantly, under the proposal, the seasoning assessment for PFAs acquired as a group through means other than a business combination would be performed at the group level. More specifically, for PFAs acquired as a group to be considered seasoned, “substantially all of the individual financial assets within the group” would have to meet the seasoning criterion. The following example demonstrates application of this grouping requirement.

Example 2

On June 30, 202X, Bank Z acquires two portfolios of fixed-rate residential mortgage loans from two separate, unrelated counterparties. The composition of the two portfolios is as follows:

Bank Z concludes that the transactions in which the portfolios are obtained are not business combinations accounted for under Topic 805. Bank Z also concludes it did not have involvement in the origination of either portfolio. Consequently, Bank Z next evaluates – at the portfolio level – whether the loans acquired were purchased more than 90 days since origination.

Bank Z determines substantially all the assets in portfolio 1 were purchased more than 90 days since origination. Consequently, Bank Z accounts for all the loans in portfolio 1 as seasoned loans and recognizes the initial ACL through an adjustment to the carrying amount of each loan. Bank Z also concludes some, but not substantially all, of the assets in portfolio 2 were purchased more than 90 days since origination. As a result, all the loans in portfolio 2 are treated as in-substance originations and the initial ACL for each loan is recorded through a charge to earnings.

Other matters: Scope

The proposal would not apply to debt securities classified as available for sale. It would, however, include credit card and other revolving credit arrangements. When developing the proposal, the FASB received feedback from stakeholders that applying the proposal to credit cards and other similar arrangements could be operationally complex. However, the FASB ultimately concluded “excluding those asset types could impose a significant cost on investors because those portfolios represent a more than inconsequential amount of financial institutions’ outstanding assets.”

The FASB also ultimately decided not to provide a scope exception for trade accounts receivable in the proposal “because doing so would have conflicted with this project’s objective of providing a uniform accounting approach for all acquired financial assets.”

Transition

The proposal would require entities to adopt its provisions using a modified retrospective approach. More specifically, entities would apply the proposed guidance retrospectively to all acquisitions of financial assets since the beginning of the first reporting period in which an entity adopted ASU 2016-13. A cumulative effect adjustment, if needed, would be recorded as of the later of 1) the beginning of the first period of adoption of ASU 2016-13 and 2) the beginning of the earliest period presented in the financial statements.

Crowe observation: The modified retrospective application of this guidance could create operational complexity for entities with material purchases of financial assets since their adoption of Topic 326. Obtaining the loan-by-loan information necessary to assess seasoning could be burdensome.

Effective date and next steps

The proposal does not include a proposed effective date. The FASB will determine one based on feedback received on the proposal. Comments are due by Aug. 28, 2023.