Chapter 6 — Purchased Credit-Deteriorated Assets

6.2 Scope of the PCD Model

ASU 2016-13 adds the following definition of PCD assets to the ASC master glossary:

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.

ASC 326 does not specify either the cause of “more-than-insignificant deterioration” or the factors an entity should consider when assessing whether the deterioration in the credit quality of an asset (or a group of assets) has been more than insignificant since origination. Paragraph BC90 of ASU 2016-13 notes that the FASB did not want to identify which assets would meet the definition of a PCD asset:

Some stakeholders requested clarification on which purchased financial assets should be recognized through a gross-up approach. The Board discussed the definition of purchased assets with credit deterioration and did not intend for the gross-up approach to be limited to nonaccrual loans or other assets that may have been considered to be an “impaired” asset before the issuance of the amendments in this Update. The Board was concerned that stakeholders would misinterpret the guidance and apply the guidance to the same scope of assets as Subtopic 310-30. As a result, the Board clarified that a gross-up approach should be applied to purchased financial assets with a more-than-insignificant amount of credit deterioration since origination. This change in wording was recommended by user stakeholders. In addition, the Board concluded that this will expand the population of purchased financial assets that are eligible to be considered purchased financial assets with credit deterioration.

Although ASC 326 does not discuss what constitutes a more-than-insignificant deterioration in credit quality, it does provide an example illustrating one way in which an entity may evaluate the credit quality of PFAs.

ASC 326-20

Example 11: Identifying Purchased Financial Assets With Credit Deterioration

55-57 This Example illustrates factors that may be considered when assessing whether the purchased financial assets have more than an insignificant deterioration in credit quality since origination.

55-58 Entity N purchases a portfolio of financial assets subsequently measured at amortized cost basis with varying levels of credit quality. When determining which assets should be considered to be in the scope of the guidance for purchased financial assets with credit deterioration, Entity N considers the factors in paragraph 326-20-55-4 that are relevant for determining collectibility.

55-59 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.

55-60 Judgment is required when determining whether purchased financial assets should be recorded as purchased financial assets with credit deterioration. Entity N’s considerations represent only a few of the possible considerations. There may be other acceptable considerations and policies applied by an entity to identify purchased financial assets with credit deterioration.

Example 11 in ASC 326-20 illustrates that an entity could use the factors in ASC 326-20-55-4 to evaluate whether the deterioration of an asset’s credit quality has been more than insignificant. ASC 326-20-55-4 states, in part:

Examples of factors an entity may consider include any of the following, depending on the nature of the asset (not all of these may be relevant to every situation, and other factors not on the list may be relevant):

The borrower’s financial condition, credit rating, credit score, asset quality, or business prospects
The borrower’s ability to make scheduled interest or principal payments
The remaining payment terms of the financial asset(s)
The remaining time to maturity and the timing and extent of prepayments on the financial asset(s)
The nature and volume of the entity’s financial asset(s)
The volume and severity of past due financial asset(s) and the volume and severity of adversely classified or rated financial asset(s)
The value of underlying collateral on financial assets in which the collateral-dependent practical expedient has not been utilized
The entity’s lending policies and procedures, including changes in lending strategies, underwriting standards, collection, writeoff, and recovery practices, as well as knowledge of the borrower’s operations or the borrower’s standing in the community
The quality of the entity’s credit review system
The experience, ability, and depth of the entity’s management, lending staff, and other relevant staff
The environmental factors of a borrower and the areas in which the entity’s credit is concentrated, such as:
1. Regulatory, legal, or technological environment to which the entity has exposure
2. Changes and expected changes in the general market condition of either the geographical area or the industry to which the entity has exposure
3. Changes and expected changes in international, national, regional, and local economic and business conditions and developments in which the entity operates, including the condition and expected condition of various market segments.

These factors are provided in the context of how an entity might adjust historical loss information on the basis of certain conditions and characteristics that affect the asset’s collectibility. While the existence of these factors may signify that collectibility concerns are associated with a particular asset (or group of assets), it may not indicate that the asset (or group of assets) should be considered PCD because an entity can only conclude that an asset is PCD if the deterioration of its credit quality has been more than insignificant since origination.

Connecting the Dots

Considerations Related to AFS Debt Securities Under the PCD Model

The PCD model applies to an AFS debt security that meets the definition of a PCD asset. To determine whether this definition is met, an entity must consider the factors in ASC 326-30-55-1, which are the same factors that an investor uses to identify whether there is a credit loss on an AFS debt security. In addition, the subsequent-accounting guidance in ASC 326-30 on AFS debt securities that are considered PCD assets slightly differs from the PCD model for assets measured at amortized cost (e.g., loans and HTM debt securities). See Section 7.2.5 for further discussion of the accounting for AFS debt securities that are considered PCD assets.

Changing Lanes

Scope of the PCD Model Differs From That of the PCI Model

As noted previously, ASU 2016-13 defines a PCD asset as an acquired asset that has “experienced a more-than-insignificant deterioration in credit quality since origination.” Under previous U.S. GAAP, a purchased credit-impaired (PCI) asset accounted for under ASC 310-30 was considered credit-impaired if it was probable that the investor would be unable to collect all contractual cash flows because of deterioration in the asset’s credit quality since origination. Consequently, in determining whether the credit deterioration of an acquired asset has been more than insignificant, entities will most likely need to use greater judgment when applying the guidance in ASU 2016-13 than they did under previous guidance.

6.2.1 Application of PCD Model to BIs

The PCD model sometimes applies to BIs in securitized financial assets. The PCD model applies to assets that meet the definition of PCD assets as well as to certain BIs in debt securities that do not necessarily meet that definition (see Connecting the Dots below). ASC 325-40-30-1A (added by ASU 2016-13) states:

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.

For more information about BIs accounted for under ASC 325-40, see Section 6.4.

Connecting the Dots

PCD Model May Apply to a BI That Does Not Meet the Definition of a PCD Asset

Under ASC 325-40-30-1A (see the section above), an entity may need to account for a BI under the respective PCD model in ASC 326-20 or ASC 326-30, even if the BI does not meet the definition of a PCD asset. For example, the entity may be required to apply the PCD model to certain BIs in new securitizations (i.e., securitizations for which there is no deterioration in credit quality because they are new) since there may be a significant difference between contractual cash flows and expected cash flows on the recognition date.

6.2.2 Application of PCD Model to Assets Acquired in a Business Combination

Assets acquired in a business combination are within the scope of the PCD model. The PCD model applies to any acquired asset whose deterioration in credit quality has been more than insignificant since origination. Paragraph BC88 of ASU 2016-13 states that “the Board concluded that there is no inherent difference between assets acquired in a business combination and those that are purchased outside a business combination.”

An entity will still have to evaluate whether the individual financial assets (or groups of financial assets with similar risk characteristics) acquired in a business combination meet the definition of a PCD asset before applying the PCD model. This may differ from the previous practice in which an entity could elect to apply ASC 310-30 to a pool of acquired assets even if it could not assert that each individual asset acquired was within the scope of ASC 310-30.2

Note that while it may generally be relatively simple to determine whether the PCD model applies to acquired assets in a business combination, an entity may be required to perform an additional step if those acquired assets were previously written off by the seller. We believe that, in those instances, the acquirer would first need to evaluate whether it still has a contractual right to the cash flows of the asset at the time of acquisition and therefore has an asset to recognize. We believe that if the acquirer determines that it has a contractual right to the cash flows of a financial asset that was previously written off, it would then apply the PCD model to the acquired assets as of the acquisition date.

Changing Lanes

FASB Proposed ASU on Purchased Financial Assets

On June 27, 2023, the FASB issued a proposed ASU that would expand the model for PCD assets to include all financial assets acquired in a business combination, regardless of whether the credit quality of those assets has deteriorated since origination. In addition, the term PCD would be replaced with the term PFA.3 See Section 10.2.4 for more information.

6.2.3 Partially Funded Lines of Credit That Are PCD

Upon initially acquiring a partially drawn line of credit, an acquirer should account for the funded portion (that is considered to be PCD and noncancelable by the acquirer) in a manner similar to how it would account for any other PCD asset, as described in ASC 326-20-30-13. The accounting for the unfunded portion of the line of credit would be the same as that prescribed in ASC 326-20-30-11 for all unfunded loan commitments. That is, a liability for the expected credit losses should be recognized for the unfunded portion of the line of credit for which subsequent adjustments as of each reporting date are reported in net income as credit loss expense. In addition, adjustments to the allowance for expected credit losses on the funded portion of the line of credit are also reported in net income as credit loss expense.

As the entity continues to draw down on the line of credit, the acquirer would revise its estimate for credit losses recognized on the unfunded portion of the line of credit (i.e., potentially reducing its liability for off-balance-sheet credit exposure) while adjusting the allowance for expected credit losses on the funded loan amount (to reflect the newly funded amount).

6.2.4 Whether Pushdown Accounting Results in Applying PCD Accounting at the Subsidiary Level

Under ASC 805-50-30-10, if an acquiree elects to apply pushdown accounting, the carrying amounts of its assets and liabilities in its separate financial statements are adjusted to reflect the amounts recognized in the acquirer’s consolidated financial statements as of the date on which control was obtained. As a result, if the acquirer applies (or would have applied) PCD accounting at the consolidated level to assets acquired and the acquiree elects to apply pushdown accounting, the acquiree would need to adjust its assets to reflect the application of PCD accounting in its separate, stand-alone financial statements. Note that an acquiree that elects pushdown accounting must apply it in its entirety; the acquiree cannot pick and choose which assets or liabilities to recognize in its separate financial statements.

6.2.5 Accounting for a Net Investment in a Lease by Using the PCD Model

A lessor should consider a decline in the fair value of the residual asset in an acquired net investment in a sales-type or direct financing lease when evaluating whether the net investment in the lease meets the definition of a PCD asset. The unit of account used when the impairment model is applied from the lessor’s perspective is meant to encompass amounts related to the entire net investment in the lease, which would include the residual asset. Therefore, we believe that when evaluating whether the deterioration in the credit quality of an acquired net investment in a sales-type or direct financing lease has been more than insignificant since origination, the lessor should consider declines in the (1) lessee’s credit quality that are related to lease payments and (2) fair value of the underlying residual asset.

6.2.6 Unit of Account for PCD Assets

The unit of account used in the PCD model depends on the type of financial asset to which the entity is applying the PCD model. An entity is allowed to evaluate the applicability of the PCD model to loans, HTM debt securities, and other assets measured at amortized cost on a collective basis if they share similar risk characteristics (see Section 3.2). However, the entity is not permitted to determine whether PCD accounting applies to AFS debt securities on a collective or pool basis; instead, it must make that determination on the basis of each individual AFS debt security. For more information about the PCD assessment for AFS debt securities, see Section 7.2.5.

Connecting the Dots

Maintaining Integrity of Pool No Longer Required

ASC 310-30-40-1 states that, among other things, “once a pool of [PCI] loans is assembled, the integrity of the pool shall be maintained” and that a loan could only be removed if it met certain conditions. ASU 2016-13 removes that language. As a result, the general principles in ASC 326-20 that address the unit of account apply similarly to all assets measured at amortized cost. That is, an entity must evaluate financial assets within the scope of the model on a collective (i.e., pool) basis if they share similar risk characteristics. If a financial asset’s risk characteristics are not similar to those of any of the entity’s other financial assets, the entity would evaluate that financial asset individually. For more information about when to remove a financial asset from a pool of financial assets, including PCD assets, see Section 3.2.1.

However, note that the transition guidance in ASU 2016-13 allows an entity to continue to apply ASC 310-30 to pools of PCI assets if it elects to maintain those pools when adopting ASU 2016-13. As discussed in Section 9.2.1, entities have a choice of maintaining their existing pools accounted for under ASC 310-30 either at adoption only or on an ongoing basis after adoption. Furthermore, an entity’s approach to maintaining its existing pools should be determined on a pool-by-pool basis. As a result, while ASC 326-20 does not require an entity to maintain the integrity of a pool of PCD assets, an entity would be required to do so if it elected to maintain its pools of PCI assets upon adopting ASU 2016-13.

Footnotes

In a December 18, 2009, letter to the SEC staff, the AICPA documented the SEC staff’s position that after a purchase of loans in a business acquisition or an asset purchase, an entity is permitted to make an accounting policy election to accrete the discount on the basis of either contractual cash flows (by using an ASC 310-20 approach) or expected cash flows (by using an ASC 310-30 approach) for portfolios of acquired assets for which the entity does not individually evaluate each asset to determine whether it meets the scope requirements of ASC 310-30. Accordingly, some loans in the portfolio may individually meet the scope criteria while others may not.

AFS debt securities would be excluded from the PFA model. In addition, for financial assets acquired as a result of an asset acquisition or through consolidation of a VIE that is not a business, the asset acquirer would apply the gross-up approach to seasoned assets, which are acquired assets unless the asset is deemed akin to an in-substance origination. A seasoned asset is an asset (1) that is acquired more than 90 days after origination and (2) for which the asset acquirer was not involved with the origination.

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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.