Financial Accounting Standards Board Moving Forward with Changes to Merger Accounting Standards

If you’re pondering the best timing for a potential merger acquisition, then one of the issues you should consider is the Federal Accounting Standards Board’s ongoing consideration of changes to how delinquent loans and investments have to be reflected in the ALLL reserves. These changes are particularly important now that all financial institutions, including most credit unions, have to comply with CECL.

One of the many changes CECL ushered in was a new way of accounting for poorly performing loans that are being held to maturity at the time they are acquired by a surviving merger partner. The Comptroller’s accounting handbook explains the scenario this way:

Facts A bank pays $750,000 for a loan with an unpaid principal balance of $1 million. The loan will be HFI and measured on an amortized cost basis. The acquired loan has experienced more-than-insignificant deterioration in credit quality since origination. At the time of purchase, the bank estimates the ACL on the unpaid principal to be $175,000. Should the bank recognize a provision for credit losses (expense) as of the acquisition date for this loan?

No. Because the loan has experienced more-than-insignificant deterioration in credit quality since origination, it should be accounted for as PCD. For PCD loans, the ACL recorded at the acquisition date is established by adding it to the loan’s purchase price, rather than through a provision for credit losses. The acquisition date journal entry is as follows: Loan (HFI) – unpaid principal balance $1,000,000 Loan (HFI) – non-credit discount $75,000 ACL $175,000 Cash $750,000.

Similar guidance has been issued by the NCUA: Frequently Asked Questions on the New Accounting Standard on Financial Instruments – Credit Losses | NCUA

With the caveat that yours truly is not an accountant, the key point to keep in mind is that, by “grossing up” the purchase price to reflect the amount of the expected credit loss, the acquiring institution does not have to account for the asset in its reserves.

In contrast, a credit union which acquires a healthy batch of well-performing loans and investments being held to maturity has nothing to “gross up” in the purchase price.  Since these newly acquired well performing loans are subject to CECL, however, the credit union has to  anticipate the expected credit loss over the lifetime of these loans, and to account for them in its loss reserves. Critics of this approach correctly argue that this results in an anomaly where loans that are poorly performing so-called purchase credit deteriorated (PCD) loans are overvalued and well-performing loans are undervalued.

At its March 29th meeting, the FASB voted to put out a proposed change to standardize the day one treatment of all loans acquired in a merger. The next step is to seek public input on an “exposure draft.” Financial Instruments ─ Credit Losses (Topic 326) ─ Acquired Financial Assets ( To put it nicely, the board is methodical in how it goes about making such changes. Nevertheless, it is not too early to start discussing how these changes could impact merger plans with your accounting team. I want to stress, however, that, contrary to some of the information I have seen recently on the Internet, these changes are nothing more than proposals, at this point.