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FASB, Changes to CECL: PCD Gross Up

 

On October 12th, the Financial Accounting Standards Board (FASB) continued discussions from the February 2022 Meeting related to Purchased Credit Deteriorated (“PCD”) assets accounting outlined in Accounting Standards Codification (ASC) Topic 326, commonly referred to as “CECL”. In addition to the infamous double count, which results in a provision expense in the first period post acquisition to fund the allowance on non-PCD assets that are already at fair value, the “bad accounting” on non-PCD assets also distorts interest income as the credit portion of fair value marks are being accreted into interest income as a non-cash, non-core interest income that creates the need for non-GAAP measures to understand the underlying economics. In the February meeting, it was decided that PCD accounting be expanded to a broader population of acquired assets. Questions around scoping and implementation remained.

 

Five topics were discussed in this recent meeting and the following tentative decisions were made:

1. Amending the Terminology

Amending the terminology from PCD to Purchased Financial Assets (PFA) provides clarity to financial statement preparers and users as credit quality is no longer a consideration in the ongoing purchase accounting.

2. Defining the Seasoning Period

Defining the Seasoning period for which acquired assets would receive the PFA designation vs being “In-Substance Originations”. Decided upon a Principles based approach that considers the acquirer’s involvement prior to the acquisition and if they had any exposure to credit risk Bright line/safe harbor period of 90 days. All assets acquired in a business combination would receive PFA treatment regardless of the above items

3. PFA Active Revolving Privileges 

Credit Cards, Home Equity Lines of Credit, Commercial Lines of Credit, and other assets with active revolving privileges should be within the scope of the PFA model. While some operational concerns need to be further explored and understood, the elimination of the “double-count” is needed.

4. Trade Accounts Receivable

Trade Accounts Receivable (AR) should be included within the scope of the PFA model. Similar to No. 3 above, operational concerns do not outweigh the “bad” accounting that accompanies the “double-count” issue currently present.

5. Assets Not Recognized at Fair Value

Assets not recognized at fair value in a business combination (mainly contract assets and a lessor’s net investment in leases) should be included within the scope of the PFA model. As with items 3 and 4, the consensus was preference around use of a single model of all seasoned assets receiving PFA treatment.

 

This topic is significant to financial services companies involved in business combinations and asset acquisitions. Based on some board members’ feedback, the current PCD provisions results in lower than expected populations. However, it is well understood why that is given the naming convention of “PCD” and the hurdle to pass for “more than insignificant deterioration”. While it is unlikely that this improvement will be made prior to final cohort of CECL adopters as of 1/1/2023, removal of the Non-PCD “double-count” is moving towards completion. This timing likely eliminates concerns over whether the PFA model would be applied to existing acquired assets as well as assets acquired after the codification changes.

 

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As part of an annual study that began in 2020, Valuant conducts analysis on ASC 326, commonly referred to as “CECL”. The study contains key data statistics and insights around the US Regional and Community Banking sectors and the impact CECL has on their Allowance for Credit Loss (ACL) Coverage Ratios.

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