As part of a business combination, a Bank acquired a portfolio of construction loans (the "loans"). The maximum borrowing capacities of the loans are based on a percentage of the applicable construction projects' budgeted cost (i.e., 80 percent of the projected construction cost). The loan proceeds are disbursed through a "draw" process. As the construction project progresses, the draws are applied against the construction budget and are paid directly to the material suppliers and contractors. The draw schedule is set so that the outstanding loan amount is never more than 80 percent of the incurred costs of the construction project. At the date of acquisition, the construction loans are not fully-drawn and are eligible for future advances. A portion of the loans show evidence of deterioration of credit quality. The Bank believes it is probable they will be unable to collect all contractually required payments receivable on these loans.

PwC Response: Whether a construction loan is within the scope of ASC 310-30 is dependent on whether the borrower has revolving credit privileges at the acquisition date of the loans. If the borrower has the option to make multiple borrowings up to a specified maximum amount, to repay portions of previous borrowings, and then re-borrow under the same loan, the loans are considered revolving credit agreements which are not within the scope of ASC 310-30. In the above fact pattern, the loans do not contain revolving privileges. Therefore, the loans are within the scope of ASC 310-30. However, only the drawn portions of the loans are within the scope of ASC 310-30. This guidance is applicable to acquired loans with evidence of deterioration of credit quality since origination. Because a loan is not originated until funds have been disbursed, the undrawn portions of the loans are not considered originated. Accordingly, the undrawn portions are not within the scope of ASC 310-30. In essence, the Bank has acquired construction loans (e.g., the drawn portion of the loans) and construction loan commitments (e.g., the undrawn portion of the loans). As part of the purchase accounting of the business combination, the Bank should initially recognize the drawn portion of the loans and the loan commitments separately at their respective fair values. Refer to Question 2 below for more detail on the purchase accounting for the acquisition of the loans.

A Bank acquires a portfolio of construction loans in a business combination. One of the loans has a maximum borrowing capacity of $500,000, of which $300,000 is outstanding as of the acquisition date. The loan is in default and the Bank estimates that if it forecloses on the property it will incur a loss of approximately $75,000. However, the Bank further estimates that, if it allows the construction project to continue to completion, the projected loss will decrease to approximately $30,000. The Bank believes the borrower will be able to pay more towards the loan through another financing or by selling the property. As a result, the Bank decides to allow the borrower to draw the remaining $200,000 and complete the construction.

PwC Response: As described in Question 1 above, the $300,000 drawn portion of the construction loan is within the scope of ASC 310-30, while the $200,000 undrawn loan commitment is not. As part of the purchase accounting, the Bank is required to allocate a value to each of the two components. Ultimately, in accordance with ASC 310-30, the amount recognized by the Bank for the fair value of the drawn portion of the loan represents the present value of the amounts to be received solely on the drawn portion of the loan. However, the determination of the amounts to be received on the drawn balance is complex. For example, the cash flow analysis will need to consider that, after the Bank advances new money and subsequent principal and/or interest payments are received by the Bank, whether the payments received should be applied first against the acquired $300,000 loan, the new advances, or on a pari passu basis. We believe the Bank should determine a systematic and rational approach for determining which portion of the loan's total expected cash flows are considered applicable to the drawn and the subsequent advanced portions of the loan. Further, we would expect the allocation process for the cash flows to be consistent with the allocation of the fair value between the drawn portion of the loan and the loan commitment. The expected cash flows allocated to the $300,000 less its estimated present (fair) value is the loan's accretable yield. The allocation methodology selected should be consistently applied for all similar loans. See Question 3 below for an example of an allocation method that we believe is a reasonable method for determining the value of two components of the construction loan.

As part of a business combination, a Bank acquires a construction loan and related loan commitment that has a combined fair value of $210,000. The non-revolving loan facility has a maximum borrowing capacity of $500,000, of which $300,000 in principal is outstanding as of the acquisition date. The loan is currently in default and matures in six months. The Bank estimates that, if it forecloses on the property, it would collect approximately $225,000. However, the Bank further estimates that, if it allows the borrower to draw the remaining commitment so that the construction project may continue to completion, it would collect approximately $490,000, thus reducing the loan's expected loss. As a result, the Bank decides to allow the borrower to draw the remaining $200,000 and complete the construction.

As described in Question 1 above, the Bank must recognize the $300,000 outstanding principal component of the loan facility (i.e., the $300,000 drawn amount) in accordance with ASC 310-30, and separately recognize the loan commitment component. In recognizing the $300,000 principal component and the loan commitment component, the Bank should determine a systematic and rational approach for determining which portion of the loan facility's total expected cash flows are allocable to the $300,000 in principal already outstanding. This allocation is necessary both to allocate the loan facility's total fair value to the outstanding loan and the undrawn commitment, and to determine the effective yield on the outstanding loans in accordance with ASC 310-30.

PwC Response: While there are multiple allocation methods that could be utilized, one reasonable allocation method is a "waterfall" approach to the loan facility's two components. Underlying this approach is an assumption that the Bank would only lend additional money that it expects to collect in full.

Overall, the estimated total cash flows of the loan are sufficient to at least pay the anticipated subsequent advances at their contractual terms. In essence, the future advances are considered "good" loans and the outstanding $300,000 is considered a "bad" loan. In applying a waterfall approach, the good loans are considered senior to the bad loan. Therefore, as the loan's principal and interest payments are estimated (and subsequently received), the payment amounts would first be applied to the most recent advances under the loan facility with any residual amounts applied to the original loan advances.

In applying this methodology to the above fact pattern, the Bank determines, in accordance with ASC 820, that the portion of the total fair value of the loan facility allocable to the commitment liability is $5,000.

The $5,000 amount would adjust the contractual yield on the new advances to an interest rate similar to other "good" construction loans. Accordingly, the portion of the total fair value allocable to the acquired loan is $215,000, which is the construction loan facility's total fair value of $210,000 plus the $5,000 allocated to the commitment liability.

The loan commitment value of $5,000 should be deferred and recognized as a discount to the remaining construction advances. The discounts are recognized over the life of the additional advances as an adjustment of yield as described in ASC 310-20, Receivables, Nonrefundable Fees and Other Costs.

Interest income on the $215,000 allocated to the original loan should be recognized using the accretable yield calculated in accordance with ASC 310-30. The accretable yield would be the internal rate of return that would cause the present value of the excess of the total expected cash flows over the amount necessary to satisfy the contractual terms of the new construction advances to equal the initial investment of $215,000.

While other reasonable allocation methods could be devised, we believe the waterfall approach is consistent with the economics of the transaction, straightforward in its application and results in reported amounts that are consistent with the various detailed reporting requirements for loans under ASC 310-20 and ASC 310-30.

PwC Response: Yes. We believe that the decision to use either a single best estimate or a probability-weighted measure is a policy election. The term "expected future cash flows" is not necessarily an "expected cash flow measure" as defined in CON 7, Using Cash Flow Information and Present Value in Accounting Measurements (CON 7) or as described in ASC 820 (ASC 820-10-55-4 through 55-20). CON 7 defines expected cash flow as the "sum of probability weighted amounts in a range of possible estimated amounts; the estimated mean or average." Although some believe ASC 310-10 implies that a single best estimate should be used, CON 7, paragraph 59 notes that cash flows under ASC 310-10 can be determined using an expected cash flow approach. Thus, while a single "best estimate" measure may be used, an approach that determines a probability-weighted measure would also be appropriate for ASC 310-10 purposes. Management should document and disclose its policy decision in this regard. In practice, a best estimate approach is typically used for purposes of applying ASC 310-10 to investments in impaired loans.