Chapter 4 — Measurement of Expected Credit Losses

4.10 Transfers Between Classification Categories

Financial assets reported at amortized cost are within the scope of ASC 326-20. By contrast, HFS loans and AFS debt securities are not within the scope of the guidance on expected credit losses in ASC 326-20 since (1) HFS loans are reported at the lower of amortized cost basis or fair value as of the balance sheet date and (2) AFS debt securities are reported at fair value as of the balance sheet date. However, upon either (1) the transfer of an HFS loan to an HFI loan or (2) the transfer of an AFS debt security to an HTM debt security, the transferred loan (i.e., HFI loan or HTM debt security) then becomes subject to ASC 326-20.

ASU 2016-13 does not provide guidance on how an entity should apply the CECL model when a loan that is HFS is transferred into an HFI classification (or vice versa) or when a debt security is transferred from AFS to HTM (or vice versa).17 As a result, in ASU 2019-04, the FASB provided guidance on transfers between classification categories. The table below summarizes this guidance.

HFS Loan to HFI Loan	HFI Loan to HFS Loan
On the transfer date, reverse any previous valuation allowance that was recorded in the income statement for the HFS loan. Transfer the loan to HFI at its amortized cost reduced by any previous write-offs (but excluding any valuation allowance). Evaluate the HFI loan for expected credit losses in accordance with ASC 326-20. The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.	On the transfer date, reverse any previous valuation allowance that was recorded in the income statement for the HFI loan. Transfer the loan to HFS at its amortized cost reduced by any previous write-offs (but excluding any valuation allowance). Evaluate the HFS loan for any valuation allowance in accordance with ASC 310-10. The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

HFS Loan to HFI Loan

HFI Loan to HFS Loan

On the transfer date, reverse any previous valuation allowance that was recorded in the income statement for the HFS loan.
Transfer the loan to HFI at its amortized cost reduced by any previous write-offs (but excluding any valuation allowance).
Evaluate the HFI loan for expected credit losses in accordance with ASC 326-20.
The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

On the transfer date, reverse any previous valuation allowance that was recorded in the income statement for the HFI loan.
Transfer the loan to HFS at its amortized cost reduced by any previous write-offs (but excluding any valuation allowance).
Evaluate the HFS loan for any valuation allowance in accordance with ASC 310-10.
The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

HTM Debt Security to AFS Debt Security	AFS Debt Security to HTM Debt Security
On the transfer date, reverse into earnings any allowance for credit losses that was previously recorded. Transfer the debt security to the AFS category at the security’s amortized cost basis reduced by any previous write-offs (but excluding any valuation allowance). Evaluate the AFS debt security for expected credit losses in accordance with ASC 326-30. Report in other comprehensive income (OCI) any unrealized gains or losses on the transfer date. Consider whether the transfer between classification categories affects the entity’s intent and ability to hold HTM debt securities. The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.	On the transfer date, reverse into earnings any allowance for credit losses that was previously recorded. Transfer the debt security to the HTM category at the security’s amortized cost basis reduced by any previous write-offs (but excluding any valuation allowance) plus or minus the amount of the remaining unrealized gains or losses reported in accumulated OCI. Evaluate the HTM debt security for expected credit losses in accordance with ASC 326-20. Continue to report any unrealized gains or losses that exist on the transfer date in a separate component of equity. The gains or losses should be amortized over the remaining life of the security as an adjustment to the security’s yield. The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

HTM Debt Security to AFS Debt Security

AFS Debt Security to HTM Debt Security

On the transfer date, reverse into earnings any allowance for credit losses that was previously recorded.
Transfer the debt security to the AFS category at the security’s amortized cost basis reduced by any previous write-offs (but excluding any valuation allowance).
Evaluate the AFS debt security for expected credit losses in accordance with ASC 326-30.
Report in other comprehensive income (OCI) any unrealized gains or losses on the transfer date.
Consider whether the transfer between classification categories affects the entity’s intent and ability to hold HTM debt securities.
The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

On the transfer date, reverse into earnings any allowance for credit losses that was previously recorded.
Transfer the debt security to the HTM category at the security’s amortized cost basis reduced by any previous write-offs (but excluding any valuation allowance) plus or minus the amount of the remaining unrealized gains or losses reported in accumulated OCI.
Evaluate the HTM debt security for expected credit losses in accordance with ASC 326-20.
Continue to report any unrealized gains or losses that exist on the transfer date in a separate component of equity. The gains or losses should be amortized over the remaining life of the security as an adjustment to the security’s yield.
The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

ASC 320-10-35-10 through 35-16 provide guidance on transfers between the classifications of investments in debt and equity securities (i.e., trading, AFS, and HTM). Transfers involving the trading classification are expected to be rare. Transfers out of the HTM classification may call into question the entity’s ability to use that classification for a period. Transfers from AFS to HTM are not restricted, provided that the entity has the positive intent and ability to hold the transferred security to its maturity.

Example 4-3

Transfer From HTM to AFS

Company X has an investment in a bond that is classified as HTM. The bond was acquired for $1,000 with a par value of $1,000. Upon initial recognition of the bond, X recognized an allowance of $70 for credit losses. During the following year, X transfers the bond from HTM to AFS. As of the transfer date, the bond’s amortized cost and fair value are $1,000 and $900, respectively. In addition, as of the transfer date, because the bond is now classified as AFS, X determines, in accordance with ASC 326-30, that $90 of the unrealized loss is related to credit and $10 is related to interest rate changes.

As of the transfer date, X would record the following journal entries:

Example 4-4

Transfer From AFS to HTM

Company Z purchases a security and classifies it as AFS. The security is acquired at its par value of $4,000. Immediately before the transfer date, the security’s fair value is $3,500 and its allowance for credit losses is $300 (accordingly, Z recognizes in OCI an unrealized loss of $200 that is due to non-credit-related factors). Once Z transfers the security from AFS to HTM, it estimates the allowance for credit losses on the security to be $350 in accordance with ASC 326-20.

As of the transfer date, X would record the following journal entries:

Keep in mind that the unrealized loss of $200 as of the transfer date will continue to be recorded in AOCI; however, it should be amortized prospectively over the remaining life of the security from AOCI. The amortization should be performed in a manner consistent with the recognition of a premium or discount (e.g., the effective interest method). In addition, the transfer will create a discount of $200 on the carrying amount of the security that should be amortized prospectively over the remaining life of the security. Typically, this amortization will have no net impact on the reported yield of the security because the amortization of the amount in AOCI and the amortization of the discount will offset each other. Effectively, the amortization of the unrealized loss in AOCI will reduce the debt discount, thereby increasing the carrying amount of the investment.

Footnotes

This issue was initially addressed by the TRG at its June 2018 meeting and led to the FASB’s issuance of ASU 2019-04.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.