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9.2 Scope of PCD asset model
Publication date: 31 May 2022
us Loans & investments guide
PCD assets can be loans or debt securities, and if debt securities, could be classified as either HTM or AFS. Under prior GAAP, receivables and debt securities acquired with deteriorated credit quality that met the scope of ASC 310-30 (or when ASC 310-30 was applied by analogy) were generally referred to as purchased credit-impaired (PCI) assets. ASC 326 uses the term “purchased financial assets with credit deterioration” and the definition of PCD assets is broader than the definition of PCI assets. Therefore, some assets that are considered PCD assets under the guidance in ASC 326 may not have been considered PCI assets under prior GAAP. Although the definition of PCD is generally broader than PCI, there may be some instances where PCI assets do not meet the definition of PCD assets under the new guidance.
To provide some relief upon transition, those assets that were accounted for as PCI under prior GAAP are required to be accounted for as PCD under the new guidance. Upon transition, entities should not reassess other previously purchased assets to determine whether those assets, which were not deemed to be PCI under prior GAAP, would meet the definition of PCD assets. See LI 13 for more information on transition.
For financial assets subject to CECL, ASC 326-20-20 provides guidance on identifying PCD assets.
Definition from ASC 326-20-20
Purchased Financial Assets with Credit Deterioration: Acquired individual financial assets (or acquired groups of financial assets with similar risk characteristics) that as of the date of acquisition have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by an acquirer’s assessment. See paragraph 326-20-55-5 for more information on the meaning of similar risk characteristics for assets measured on an amortized cost basis.
ASC 326 does not define “a more-than-insignificant deterioration in credit since origination.” Therefore, a reporting entity will need to apply judgment to determine whether a purchased financial asset meets the definition of a PCD asset. ASC 326-20-55-59 provides an example that includes factors that may indicate there has been more-than-insignificant deterioration in credit since origination. The listing is not all inclusive.
Entity N assesses what is more-than-insignificant credit deterioration since origination and considers the purchased assets with the following characteristics to be consistent with the factors that affect collectibility in paragraph 326-20-55-4. Entity N records the allowance for credit losses in accordance with paragraph 326-20-30-13 for the following assets:
- Financial assets that are delinquent as of the acquisition date
- Financial assets that have been downgraded since origination
- Financial assets that have been placed on nonaccrual status
- Financial assets for which, after origination, credit spreads have widened beyond the threshold specified in its policy.
For AFS debt securities, ASC 326-30-30-2 provides guidance on identifying PCD assets and refers to ASC 326-30-55-1.
A purchased debt security classified as available-for-sale shall be considered to be a purchased financial asset with credit deterioration when the indicators of a credit loss in paragraph 326-30-55-1 have been met. The allowance for credit losses for purchased financial assets with credit deterioration shall be measured at the individual security level in accordance with paragraphs 326-30-35-3 through 35-10. The amortized cost basis for purchased financial assets with credit deterioration shall be considered to be the purchase price plus any allowance for credit losses. See paragraphs 326-30-55-1 through 55-7 for implementation guidance.
There are numerous factors to be considered in determining whether a credit loss exists. The length of time a security has been in an unrealized loss position should not be a factor, by itself or in combination with others, that an entity would use to conclude that a credit loss does not exist. The following list is not meant to be all inclusive. All of the following factors should be considered:
- The extent to which the fair value is less than the amortized cost basis
- Adverse conditions specifically related to the security, an industry, or geographic area; for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, changes in the financial condition of the underlying loan obligors. Examples of those changes include any of the following:
- Changes in technology
- The discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security
- Changes in the quality of the credit enhancement.
- The payment structure of the debt security (for example, nontraditional loan terms as described in paragraphs 825-10-55-1 through 55-2) and the likelihood of the issuer being able to make payments that increase in the future.
- Failure of the issuer of the security to make scheduled interest or principal payments
- Any changes to the rating of the security by a rating agency.
When assessing whether the credit quality of the asset has deteriorated, an entity should compare the credit quality of the asset at the time of origination with the credit quality at the time of acquisition. An asset that was originated with low credit quality should not be considered to be PCD if there has not been a more-than-insignificant deterioration in credit since origination. For example, assume a loan is acquired shortly after its origination. Despite the fact that the loan may have a low credit quality at acquisition, it would not be considered PCD if there had not been a credit deterioration since the loan was originated.
The PCD asset guidance should only be applied to instruments that meet the definition of PCD assets and that are within the scope of either the CECL model (i.e., instruments accounted for at amortized cost) or the AFS debt security impairment model (i.e., instruments accounted for at fair value through OCI). It should be applied to financial assets that are acquired individually, as part of an acquisition of a pool of loans, or in a business combination.
It is important to note that when a group of loans, HTM debt securities, or other assets measured at amortized cost is acquired, an entity may, but is not required to, individually assess each financial asset within the pool to determine if it should be classified as PCD. However, for AFS debt securities, an entity should determine whether the acquired asset is deemed to be PCD at the individual asset level.
Entities are allowed to perform the assessment on a group level basis for assets measured at amortized cost because it may be practically unrealistic to individually assess each asset to determine if there was a more-than-insignificant deterioration in credit quality since origination. To evaluate a group of acquired financial assets, the financial assets must first be grouped based on similar risk characteristics before assessing the pool to determine if they would be considered PCD under ASC 326. The criteria used for grouping should be designed to distinguish assets that have experienced more-than-insignificant deterioration in credit quality since origination from those that have not. A determination that the pool is PCD would not be expected to capture a significant number of individual assets that would not qualify as PCD on their own. While the PCD assessment can be done at the group level, any amortized cost basis adjustment resulting from acquiring a pool of PCD assets and the allowance for credit losses must be allocated to the individual assets within the pool.
The determination of whether there has been a more-than-insignificant deterioration in credit quality is an important step in determining the appropriate accounting for a purchased financial asset. When a reporting entity purchases financial assets that do not meet the definition of a PCD asset, it is prohibited from applying the PCD asset guidance, with the exception of certain beneficial interests (see LI 9.2.1).
Question LI 9-1 addresses whether an entity can account for all loans that are purchased at a discount to par as PCD assets.
Question LI 9-1
Can an entity account for all loans that are purchased at a discount to par as PCD assets?
Can an entity account for all loans that are purchased at a discount to par as PCD assets?
PwC response
No. An entity cannot automatically consider all financial assets purchased at a discount to be PCD assets. An entity needs to determine whether the purchased financial assets meet the definition of a PCD asset (i.e., has experienced more-than-insignificant deterioration in credit quality since origination) or in the case of certain beneficial interests, there is a significant difference between contractual and estimated cash flows. The purchase of a financial asset at a discount may be a factor to consider in determining if the asset is PCD, but it is not determinative.
Entities often purchase loans, debt securities, and other instruments at amounts less than the amount contractually due from the borrower. However, not all financial assets purchased at a discount are due to an other-than-insignificant deterioration in credit quality since origination. Loans may be purchased at a discount due to changes in interest rates, prepayment estimates, credit spreads, or other market factors since origination.
The PCD asset guidance is not applicable to purchased unfunded commitments giving the borrower the right, but not the obligation to borrow. In order to fall within the scope of the PCD model, there must be a financial asset and an unfunded commitment that gives the borrower the right to borrow does not meet the definition of a financial asset. In these agreements, the lender does not have a right to receive cash or another financial asset or exchange other financial instruments; they have an obligation if the borrower exercises their right.
However, an entity should still consider the guidance related to off-balance sheet credit exposures under the CECL model in ASC 326-20, which requires an entity to estimate the expected credit losses on off-balance sheet loan commitments unless the commitment is unconditionally cancellable by the issuer. See LI 7 for more information.
Question LI 9-2 addresses whether there is a scope exception from the PCD model for revolving lines of credit.
Question LI 9-2
Is there a scope exception from the PCD model for loans drawn under revolving lines of credit under ASC 326?
Is there a scope exception from the PCD model for loans drawn under revolving lines of credit under ASC 326?
PwC response
No. Unlike prior GAAP under ASC 310-30, there is no scope exception from the PCD model for revolving lines of credit if the borrower still has revolving privileges. Therefore, the PCD asset guidance applies to purchased loans drawn under revolving credit agreements (e.g., credit cards, home equity loans) that have experienced a more-than-insignificant deterioration in credit quality since origination, as of the date of acquisition.
Question LI 9-3 addresses how the definition of a PCD asset differs from the definition of a PCI asset under prior GAAP.
Question LI 9-3
Are the requirements for classifying an asset within the scope of ASC 326-20 (CECL model) and ASC 326-30 (AFS impairment model) as PCD different than the requirements for classifying an asset as PCI under the previous guidance in ASC 310-30?
Are the requirements for classifying an asset within the scope of ASC 326-20 (CECL model) and ASC 326-30 (AFS impairment model) as PCD different than the requirements for classifying an asset as PCI under the previous guidance in ASC 310-30?
PwC response
Yes. The PCI guidance applied to purchased loans and securities with evidence of credit quality deterioration since origination for which it was probable, at acquisition, that all contractual cash flows would not be collected. The new PCD guidance does not include a probability threshold regarding collection. The PCD guidance only requires there to be more-than-insignificant deterioration in an asset’s credit quality since origination for an asset to be classified as PCD. In the basis of conclusions of ASU 2016-13, the FASB acknowledged that the definition of PCD is expected to apply to more assets than what would have been considered PCI.
9.2.1 PCD: beneficial interests subject to ASC 325-40
The guidance in ASC 325-40-30-1A, Beneficial Interests in Securitized Financial Assets, requires that the PCD asset guidance be applied to certain beneficial interests classified as either HTM or AFS if it meets certain criteria.
An entity shall apply the initial measurement guidance for purchased financial assets with credit deterioration in Subtopic 326-20 to a beneficial interest classified as held-to-maturity and in Subtopic 326-30 to a beneficial interest classified as available for sale, if it meets either of the following conditions:
- There is a significant difference between contractual cash flows and expected cash flows at the date of recognition.
- The beneficial interests meet the definition of purchased financial assets with credit deterioration.
Beneficial interests subject to ASC 325-40 are considered to be PCD if they meet the definition of PCD assets or if there is a significant difference between expected cash flows and "contractual" cash flows as of the acquisition date. See LI 14 for the definition of a beneficial interest (BI) and for further information on the scope and application of PCD for beneficial interests subject to ASC 325-40.
9.2.2 PCD assets in a variable interest entity (VIE)
When an entity becomes the primary beneficiary of a VIE, the assets of the VIE are recognized in the consolidated financial statements of the entity upon consolidation of the VIE. Therefore, an entity should determine if the financial assets within the VIE that are required to be consolidated are within the scope of ASC 326 and meet the PCD criteria.
If the entity was the transferor of the financial assets to the VIE and the transfer was not recognized as a sale, then the consolidation of the VIE would not result in initial recognition of these financial assets as of the date of consolidation. Since the transfer of financial assets did not qualify as a sale, the financial assets were always recognized in the financial statements of the entity. Therefore, an entity would not be permitted to apply the PCD criteria as a result of the VIE’s consolidation.
If the entity previously transferred financial assets within the scope of ASC 326 that were accounted for as a sale, and then subsequently regains effective control over the assets as a result of the occurrence of an event, ASC 860-20-25-8 and ASC 860-20-25-9 require an entity to account for the re-recognition of the assets in the same manner as if the assets were purchased from the transferee. This would include an assessment for PCD accounting.
9.2.3 Assessing net investments in leases as potential PCD assets
For leases that will be accounted for as sales-type or direct financing leases acquired either though a business combination or an asset purchase, we believe an entity should assess whether the acquired leases would be considered PCD assets. To the extent a lease is not considered a PCD asset, the initial measurement of the allowance for credit losses would be reported in current earnings (similar to an originated lease). Refer to LI 7 for further information. If a lease is considered a PCD asset, the initial measurement of the allowance for credit losses will create a basis adjustment to the amortized cost basis of the net investment in lease, as discussed in LI 9.3.
The PCD model is an integral part of the new credit impairment guidance. Since the FASB concluded that the impairment of sales-type and direct financing leases should follow the CECL model (of which the PCD guidance is a component), we believe that the PCD guidance is applicable to these leases as well.
Since a net investment in a lease balance includes non-financial elements, these elements will impact the determination of whether the net investment is considered a PCD asset. For example, the estimated residual value of the leased asset will impact the net investment in a lease. If there has been a decline in the estimated residual value, this decline in value is considered a credit loss and therefore could impact whether the net investment in the acquired lease is considered a PCD asset. In addition, declines in the estimated residual value of the leased asset since the lease’s origination could impact the amount of the “day one” allowance for credit losses for a lease. To estimate the allowance for credit losses upon acquisition of a lease, the purchaser will need to estimate what the residual value of the asset at the end of the lease was forecasted to be at the inception of the lease.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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