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4.3 Classification and accounting for loans
Publication date: 31 May 2022
us Loans & investments guide
Loan receivables may be classified as held for investment or held for sale, or accounted for under the fair value option (FVO) method of accounting. They may be accounted for under ASC 310 (nonmortgage loans, commonly referred to as “not held for sale) or under ASC 948-310 (mortgage loans, commonly referred to held for long term investment). The following sections discuss how to determine the appropriate classification and accounting for various loan types.
An entity may elect to apply the FVO to originated or purchased loans in accordance with ASC 825-10-15-4. The irrevocable election can be made on an instrument-by-instrument basis (i.e., only select loans will be reported at fair value) with changes in fair value recorded in earnings. As a result of the election, loans accounted for under the FVO will not be subject to an allowance for credit losses under the CECL impairment model as ASC 326-20-15-3 scopes out financial assets measured at fair value through earnings. See LI 7 for more information regarding the allowance for credit losses and FV 5 for more information on the FVO election.
4.3.1 Classification and accounting: loans held for investment (HFI)
When a reporting entity holds an originated or purchased loan for which it has the intent and ability to hold for the foreseeable future or to maturity or payoff, the loan should be classified as held-for-investment. If a reporting entity intends to sell a loan, the loan should be classified as held for sale (see LI 4.3.2). Management should make a positive assertion regarding its ability and intent to hold or sell loan receivables.
As discussed in ASC 310-10-35-47A and ASC 948-310-30-4, loans held for investment are reported on the balance sheet at their amortized cost basis. The amortized cost basis is the amount at which a financing receivable or investment is originated or acquired, adjusted for applicable accrued interest, accretion, or amortization of premium, discount, and net deferred fees or costs, collection of cash, writeoffs, foreign exchange, and fair value hedge accounting adjustments. See LI 7 for information on determining the allowance for credit losses for a loan held for investment. See DH 6.5 for information on loans that are in an active portfolio layer method hedging relationship.
4.3.2 Classification and accounting: loans held for sale (HFS)
When a reporting entity originates or purchases a loan with the intent to sell the loan to another entity (e.g., a government-sponsored enterprise), the loan should be classified as held for sale. Management should make a positive assertion regarding its ability and intent to hold or sell loan receivables. Loans should be classified as held for sale once a decision has been made to sell the loans. It is possible to designate only a portion of a loan as held for sale.
If a reporting entity is unsuccessful in selling a loan classified as held for sale, it should remain in held for sale until the reporting entity decides not to sell the loan (and the intent and ability criteria for classifying the loan as HFI are met), at which point the loan should be transferred to the HFI portfolio.
Both mortgage and nonmortgage loans classified as held for sale should be carried at the lower of amortized cost basis or fair value. If the amortized cost basis of a loan exceeds fair value, a valuation allowance should be established for the difference. However, if the loan is hedged in an active portfolio layer method hedge, the loan’s amortized cost basis (used in applying the lower of amortized cost or fair value model) should not reflect any basis adjustments associated with the portfolio layer method hedge. See DH 6.5 for information on portfolio layer method hedging relationships. The accounting for mortgage loans should be based on the guidance in ASC 948, Mortgage Banking, while the accounting for nonmortgage loans should be based on the guidance in ASC 310.
Question LI 4-1
Should a lender include a loan premium when measuring the lower of amortized cost basis or fair value of an HFS loan?
Should a lender include a loan premium when measuring the lower of amortized cost basis or fair value of an HFS loan?
PwC response
Yes, with one exception. In accordance with ASC 310-10-20, unamortized loan premium is part of the amortized cost basis and should be considered when measuring the lower of amortized cost basis or fair value of an HFS loan. However, if the loan is hedged in an active portfolio layer method hedge, the loan’s amortized cost basis (used in applying the lower of amortized cost or fair value model) should not reflect any basis adjustments associated with the portfolio layer method hedge. See DH 6.5 for information on portfolio layer method hedging relationships.
4.3.2.1 Accounting for mortgage loans held for sale
Mortgage loans that are classified as held for sale are accounted for in accordance with the guidance in ASC 948-310-35.
Mortgage loans held for sale shall be reported at the lower of amortized cost or fair value, determined as of the balance sheet date. If a mortgage loan has been the hedged item in a fair value hedge that is not a portfolio layer method hedge (as addressed in Topic 815), the loan’s amortized cost basis used in lower-of-amortized-cost-or-fair value accounting shall reflect the effect of the adjustments of its carrying amount made pursuant to paragraph 815-25-35-1(b).
If a mortgage loan that is held for sale is included in a closed portfolio hedged in an existing portfolio layer method hedge, the loan’s amortized cost basis used in the lower-of-amortized-cost-basis-or-fair-value accounting shall not reflect the effect of the adjustments made pursuant to paragraph 815-25-35-1(c). If that portfolio layer method hedge is discontinued pursuant to paragraphs 815-25-40-7A though 40-8, the loan’s amortized cost basis used in lower-of-amortized-basis-or-fair-value accounting shall reflect the effect of the adjustments of its carrying amount made pursuant to paragraphs 815-25-35-1(b) and 815-25-40-9 through 40-9A.
The amount by which amortized cost exceeds fair value shall be accounted for as a valuation allowance. Changes in the valuation allowances shall be included in the determination of net income of the period in which the change occurs. Purchase discounts on mortgage loans shall not be amortized as interest revenue during the period the loans or securities are held for sale.
Capitalized costs of acquiring rights to service mortgage loans, associated with the purchase or origination of mortgage loans (see paragraph 860-50-25-1), shall be excluded from the cost of mortgage loans for the purpose of determining the lower of cost or fair value.
ASC 948 requires that the fair value of mortgage loans held for sale be determined by loan type. At a minimum, the fair value of residential and commercial mortgage loans should be determined separately. Either the aggregate or individual loan basis may be used to determine the lower of amortized cost or fair value for each loan type. However, the granularity of the analysis should not be inconsistent with the way the underlying loans are valued and ultimately sold by the reporting entity.
Because the net deferred fees or costs associated with a loan held for sale are deferred (i.e., not amortized or accreted in interest income) until the related loan is sold, they should be included in the amortized cost basis of an HFS mortgage loan when evaluating the need for a valuation allowance. See LI 4.4 for information on loan origination fees and costs.
4.3.3 Loans: transfers between categories
A reporting entity may decide to sell a loan classified as held for investment or to retain a loan previously classified as held for sale. The loan should be reclassified at the point the criteria for changing classification is met (e.g., when the reporting entity intends to sell loans that were originally classified as held for investment).
4.3.3.1 Transfer from held for investment to held for sale
As discussed in ASC 310-10-35-48A and ASC 948-310-35-2A, a loan classified as held for investment should be reclassified to held for sale if the reporting entity decides to sell the loan. On the date a loan is transferred into the held-for-sale category, any previously recorded allowance for credit losses is reversed in earnings and the loan is recorded at its amortized cost basis. Prior to the transfer, a reporting entity should apply its writeoff policy to the amortized cost basis. The amortized cost at the date of transfer should be reduced by any writeoffs recognized just prior to the transfer. If the amortized cost basis exceeds the loan’s fair value at the date of transfer, the reporting entity should establish a valuation allowance equal to the difference between amortized cost basis and fair value. However, if the loan is hedged in an active portfolio layer method hedge, the loan’s amortized cost basis (used in applying the lower of amortized cost or fair value model) should not reflect any basis adjustments associated with the portfolio layer method hedge. The previously recorded allowance for credit losses associated with the transferred loans (after applying the writeoff policy) should generally be released and an offsetting entry recorded to the provision. This will typically occur when the reporting entity determines its overall allowance for credit losses at the next reporting date. This could have the effect of reversing the pre-transfer held for investment allowance for credit losses through the provision and establishing a new held for sale valuation allowance through earnings in the same reporting period. For loans with credit deterioration, applying the writeoff policy should eliminate much of the pre-transfer allowance.
Question LI 4-2
If a bank has not made a final decision, but is considering the sale of one or more loans that have been previously designated as held for investment at origination, what should the bank consider in determining how those loans be classified in the bank’s financial statements?
If a bank has not made a final decision, but is considering the sale of one or more loans that have been previously designated as held for investment at origination, what should the bank consider in determining how those loans be classified in the bank’s financial statements?
PwC response
The bank should consider the following factors to determine how to classify the loans it is considering selling:
- Is there a formal marketing strategy?
- Are there potential buyers?
- Have the loans to be sold been specifically identified?
- Has a potential sale been approved by the banks’ Board of Directors or by those in management having authority over such decisions?
Positive answers to these questions may indicate that the bank has decided to sell the loans, and as a result they should be classified as held for sale. A bank should consider all relevant facts to determine the appropriate classification of loans.
4.3.3.2 Transfer from held for sale to held for investment
A loan classified as held for sale should be reclassified to held for investment if a reporting entity no longer plans to sell it but will instead hold the loan as a long-term investment (i.e., it has the intent and ability to hold the investment for the foreseeable future or until its maturity or payoff).
As discussed in ASC 310-10-35-48B and ASC 948-310-35-5A, when a loan is reclassified to held for investment, any previously recorded valuation allowance is reversed in earnings and the loan recorded at its amortized cost basis. Upon transfer to held for investment, the reporting entity should calculate an allowance for credit losses using the CECL impairment model. See LI 7 for information on the CECL impairment model. Fair value hedge accounting basis adjustments on active portfolio layer method hedges should not be considered when measuring the allowance for credit losses.
If the basis of a loan transferred to held for investment had been adjusted due to the application of hedge accounting while it was classified as held for sale, such adjustment would be part of the loan’s amortized cost basis upon transfer similar to any deferred fees or costs.
Example LI 4-1 illustrates a loan transfer from held for sale to held for long-term investment/not held for sale.
EXAMPLE LI 4-1
Transfer of loans from held for sale to held for investment
Transfer of loans from held for sale to held for investment
Bank Corp holds a loan with an amortized cost basis of $100,000 and a fair value of $80,000 in its loans held for sale portfolio. Since the fair value is $20,000 lower than the amortized cost basis, Bank Corp has recognized a valuation allowance of $20,000 on the loan.
On December 31, 20X7, Bank Corp makes the decision to hold the loan for long-term investment and transfers the loan to held for investment. Upon transfer, Bank Corp determined that it should record a $10,000 allowance for credit losses associated with the transferred loan.
How should Bank Corp account for the transfer of the loan from held for sale to held for investment?
Analysis
Bank Corp would account for the transfer of the loan from held for sale to held for investment by recording the following journal entries.
Dr. Loans held for investment |
$100,000 |
|
Dr. HFS valuation allowance |
$20,000 |
|
Cr. Loans held-for-sale |
$100,000 |
|
Cr. Lower of cost or market adjustment on loans held for sale |
$20,000 |
|
To record the loan transfer and reverse the valuation allowance in net income |
||
Dr. Provision for credit losses |
$10,000 |
|
Cr. Allowance for credit losses |
$10,000 |
|
To record the allowance for credit losses associated with the loan on the transfer date |
||
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