CREDIT LOSSES
12B. Troubled Debt Restructurings
Bank Accounting Advisory Series
264
August 2018
Early adopters only
Question 8
How should Bank B account for the second lien mortgage after the first lien mortgage was
modified?
Staff Response
The second lien mortgage has not been modified by Bank B and is therefore not classified as a
TDR. Once Bank B becomes aware of the modification, however, the bank must consider if it
has a reasonable expectation of executing a TDR on the second lien mortgage. If the bank
determines that it has a reasonable expectation of executing a TDR, the full effect of the
expected TDR should be reflected in the ACL.
Even if Bank B determines that it does not have a reasonable expectation of executing a TDR
on the second lien mortgage, the bank should recognize that the second lien mortgage loan
borrower is facing financial difficulties and that the second lien mortgage has different risk
characteristics than other second lien mortgage loans that have not had their first lien mortgage
modified or are not suffering financial difficulties. Bank B should consider segmenting the
loan into a pool that reflects the increased risk associated with this loan. If this loan does not
share risk characteristics with other loans in the portfolio, the bank must measure the expected
credit loss on this loan individually. If, however, in a subsequent reporting period, the bank
determines that the loan shares similar risk characteristics with other loans, the expected credit
loss will be evaluated on a pool basis.
Question 9
How should a bank measure expected credit losses on a collateral-dependent TDR for which
foreclosure is not probable?
Staff Response
For regulatory reporting purposes, the bank should use the fair value of the collateral for
determining the ACL for a collateral-dependent loan when the borrower is experiencing
financial difficulty, even if foreclosure is not probable. An exception to this general rule may,
however, require using a DCF approach to capture the full extent of the credit loss when there
is an interest rate concession. See question 3.
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CREDIT LOSSES
12C. Acquired Loans
Bank Accounting Advisory Series
265
August 2018
12C.
Acquired Loans
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Early adopters only
ASU 2016-13 replaces the concept of PCI under existing GAAP with PCD. The standard
requires banks to estimate and record an ACL for all HFI purchased loans as of the date of
acquisition, regardless of management’s determination of whether or not the loan is PCD or
non-PCD.
The definition of PCD is broader than the definition of PCI. As a result, more purchased loans
will likely meet the PCD criteria than meet the PCI criteria today.
All of the staff responses included in Subtopic 12C comply with ASU 2016-13. These
responses should not be applied by an institution that has not adopted ASU 2016-13.
Facts
Bank A acquires Bank B in a transaction accounted for under the acquisition method in
accordance with ASC 805. Bank A does not elect to account for the acquired HFI loans under
the FVO.
Question 1
How should the bank account for the acquired loans at the acquisition date?
Staff Response
Assets and liabilities acquired in a business combination, including the loans, should be
recorded at fair value as of the acquisition date. Fair value should be determined in accordance
with ASC 820-10 (see Topic 11D), which states that fair value is the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a
forced liquidation or distressed sale) between market participants at the measurement date.
The bank also should determine whether the acquired loans are PCD or non-PCD (see
question 3). An ACL should be recorded for these acquired loans, although how the ACL is
established will depend on whether the acquired loans are PCD or non-PCD.
An ACL for non-PCD loans should be determined and recorded in a manner consistent with
originated loans. That is, the ACL should be calculated based on the loan’s amortized cost
basis (i.e., the acquisition date fair value in a business combination) and be established through
a charge to provision expense at the acquisition date.
ASC 326-20-30-14 allows for some flexibility in calculating the ACL for PCD loans. If an
institution choses a method other than the DCF, the estimated expected credit losses should be
based on the loan’s unpaid principal balance. The ACL should be recorded as an adjustment to
CREDIT LOSSES
12C. Acquired Loans
Bank Accounting Advisory Series
266
August 2018
Early adopters only
the loans, in addition to the fair value amount recorded in accordance with Topic 805, as of the
acquisition date, and not through provision expense. The acquisition date fair value plus the
ACL equals the loan’s new amortized cost basis as of the acquisition date. The difference
between the new amortized cost basis and the unpaid principal balance of the loan represents
the non-credit purchase discount/premium recorded. (See question 4 for an illustration).
Question 2
Should the fair value of the acquired loans be determined on a loan-by-loan basis or may it be
determined on a pool basis?
Staff Response
The fair value of the acquired loans should be determined on a loan-by-loan basis as of the
acquisition date. The staff will not object to a bank determining the fair value of a pool of
loans consisting of loans with similar risk characteristics and then allocating the fair value
adjustment to the individual loans within the pool. When allocating the fair value adjustment,
the bank should consider the remaining maturity of the loans and the current loan balance,
along with any other relevant factors, to ensure interest income recognition in future periods is
not misstated.
Question 3
What factors might a bank consider when determining if acquired loans should be accounted
for as PCD?
Staff Response
PCD loans are acquired loans that, as of the acquisition date, have experienced a more-than-
insignificant deterioration in credit quality since origination. Judgment must be exercised in
making this determination as “more-than-insignificant deterioration of credit quality” is not
explicitly defined in the accounting guidance.
As noted in ASC 326-20-55-59 (example 11), some indicators of loans that have experienced
more-than-insignificant deterioration of credit quality since origination may be loans
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that are delinquent at the acquisition date.
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that have been downgraded since origination.
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that have been placed on nonaccrual status.
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for which, after origination, credit spreads have widened beyond the thresholds stated in
the bank’s policy.
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