In today’s banking landscape, the acquisition of loan portfolios can present healthy banks and credit unions with unique opportunities to rapidly expand their footprints, enhance their deposit bases and provide value to shareholders, often at significant discounts.
While acquisitions offer many positives for an institution, the associated GAAP purchase accounting standards can be complex for the banker or credit union professional responsible for calculating the ALLL.
Of the loans considered “credit impaired” at the time of purchase, the standard requires that institutions recognize income based on expected cash flows. If loans have a deterioration in credit quality after origination and it is probable that the acquiring institution will be unable to collect all contractually obligated payments from the borrower, then these loans are to be accounted for under the ASC 310-30 (SOP 03-3) method.
ASC 310-30 (SOP 03-3) uses the acquirer’s “cash flow expected at acquisition” as the benchmark for calculating the yield (interest income) on the investment in the loan, as well as for purposes of determining whether the loan is impaired and how that impairment should be measured.
One of the primary complexities of accounting for purchased loans is the additional required calculation of Accretable Yield vs. Non-Accretable Difference. As with all acquired loans, a loan accounted for under ASC 310-30 is initially recorded at its purchase price (fair value). The amount of expected cash flows that exceed the initial investment in the loan represent the Accretable Yield, which is recognized as interest income on a level yield basis over the life of the loan. The excess of total contractual cash flows over the cash flows expected to be received at origination is deemed the Non-Accretable Difference.
For more information on the calculation of the ASC 310-30 for an institution’s ALLL, download the whitepaper, “Accounting for Purchased Loans Easier Said Than Done.”