How will financial institutions account for the more than $500 billion of PPP loans? How will they recognize the over $20 billion of fee income earned through the program? Financial institutions may have been hoping to take a deep breath after the scramble to keep up with demand for PPP loans — all while staying on top of guidance from the Treasury, SBA, and other regulators as they “build the plane while flying it.” Now, many institutions are working through the accounting implications of PPP loans on financial reporting, such as classification of PPP advances, consideration of allowances for credit losses, and recognition of PPP loan fee income.
Accounting standards under U.S. GAAP are issued by the Financial Accounting Standards Board (FASB), but they have provided no authoritative guidance on PPP loans. However, the American Institute of CPAs (AICPA) Depository Institution Expert Panel has issued three technical Q&As (TQAs) to help institutions apply existing accounting rules to PPP loans. Guidance from the AICPA is nonauthoritative, but can provide insights on industry-specific practical application of accounting rules.
A summary of the TQAs and Plante Moran’s perspective:
1. PPP advances should be classified as loans, not government grants.
2. The SBA guarantee should be considered when determining the allowance for credit losses on PPP loans, regardless of whether an institution is following CECL or incurred loss rules.
This is consistent with the FDIC’s FAQ document (page 7), which also says the guarantee should be considered in determining the allowance on PPP loans. Meanwhile, The Federal Reserve’s FAQs (Credit Issues Section, PPP questions) indicate that unless the bank has a reason to believe the SBA guarantee would be jeopardized, no reserve would be expected on an SBA-guaranteed PPP loan.
We believe many institutions will establish some level of allowance on PPP loans. While there may be no specific known problems with an institution’s underwriting or documentation which would jeopardize the SBA guarantee, forgiveness or collection are uncharted territory. Institutions may be uncertain as to the extent of forgiveness PPP borrowers have earned, what the SBA’s process will be to review forgiveness requests, borrowers’ ability and willingness to repay any remaining balances they thought would be forgiven, and what the process will be to collect on the SBA’s guarantee, if needed. All these items create an inherent uncertainty that the allowance is intended to address.
Without historical experience on which to base the estimated allowance, we expect it’ll be recorded through qualitative factors, and will align with management’s perspective on the various aspects of inherent uncertainty noted above.
If proposed legislation for automatic forgiveness of loans under a threshold of $150,000 is passed, institutions may disaggregate PPP loans under this amount and record little or no allowance on them.
3. Fees earned on PPP loans should be offset by direct origination costs, and the net amount should be deferred and recognized over the life of the loan like other origination fees. When prepayments are probable, and their timing and amounts can be reasonably estimated, accounting standards generally allow net fee deferrals to be recognized if the expected life of a loan is shorter than the contractual one.
Institutions may be grappling with whether to recognize the net fee of a PPP loan over its contractual life of two or five years, or the period over which forgiveness is expected to be earned. We believe many institutions will conclude their lack of history with PPP loans precludes them from being able to estimate reasonably the amount and timing of prepayment/forgiveness. Therefore, we expect these institutions to recognize the net fees over the contractual term of PPP loans without assuming forgiveness or prepayments. Thus, any remaining fee income would be recognized when the institution receives actual prepayments and/or affirmative forgiveness notification from the SBA.
Like the allowance considerations, management may conclude that fee recognition could be affected by proposals to automatically forgive loans under a certain threshold. If automatic forgiveness is available to certain loans, one might justify recognition of the fee income over the period of automatic forgiveness instead of the contractual term.
4. While not addressed in the original TQA, institutions have also inquired regarding classification of PPP loans once forgiveness is granted. For regulatory reporting purposes, the FDIC’s FAQs originally indicated that once an institution receives notification from the SBA of the amount to be forgiven, the institution should reclassify the amount from loans to a receivable from the SBA. However, updated guidance from the FDIC in August 2020 requires institutions to continue classifying PPP advances as loans until repaid in full by either the borrower or SBA. This revised guidance is consistent with an additional TQA released by the AICPA in August 2020, which indicates PPP advances should be accounted for as loans throughout the settlement process.
5. For bank regulatory capital purposes, PPP loans receive a 0% risk weight for risk-based capital requirements. These loans are generally included in average total consolidated assets for purposes of calculating the leverage capital ratio, but PPP loans funded through the Federal Reserve Board’s PPP lending facility are excluded when calculating a bank’s total leverage exposure, average total consolidated assets, total risk-weighted assets, and community bank leverage ratio.
If your institution needs help working through these or other accounting impacts of COVID-19 and the myriad response programs, we can assist you. Our team of industry specialists is uniquely qualified to see you through these challenging times.