As discussed in our first blog of this series, as Paycheck Protection Program (PPP) loans grow and become a material part of a lender’s financials, questions continue to arise around the appropriate treatment for these loans. Part one focused on the right processes to track and report on these loans to the SBA and to investors, as well as GAAP considerations as it relates to accounting for these loans. Here, we will focus on the reserving considerations for PPP loans
Initially, the thought was that the SBA guarantee will prevent any credit losses, but this thinking has changed as the clawback provision has raised questions. Ensuring that these loans are adequately considered within the allowance process will become ever more important for lenders. Some of these considerations are laid out in the following.
Reserving for Credit Losses
The allowance for credit losses around PPP is an area where the industry has been relatively silent. Likely, this is because the SBA guarantee is considered a significant embedded credit enhancement. Even if the loan is sold, the SBA guarantee transfers with it.
However, this ignores the possibility of credit losses in instances where the SBA determines that the lender did not fulfill its obligation. This possibility should be considered when estimating credit losses under ASC 326 or ASC450.
The allowance methodology will of course drive some of the key decisions around the calculation of the allowance. Under ASC450, lenders will need to record an allowance once it becomes probable that a loss will be incurred. Under ASC326, a life of loan loss will need to be recorded at origination and every period thereafter. Lenders will need to think about the type of historical loss rate and expected loss rates to use, whether by using the loss rates from another SBA program or assuming no losses until they are notified by the SBA that the guarantee will no longer apply and then assessing the risk of non-payment by the borrower. In the case of draws by the borrower, lenders will need to potentially use this information in estimating potential losses on other loans made to the same borrower.
Additionally, lenders must think about whether an allowance for the accrued fees will be required to account for a possible clawback of the fees that can occur if any of the following occurs:
- The PPP loan is canceled or voluntarily terminated and repaid after disbursement but before the borrower-certification safe harbor date.
- The PPP loan is canceled, terminated, or repaid after disbursement (and after the borrower-certification safe harbor date) because the SBA reviewed the loan and determined that the borrower was ineligible for the PPP loan.
- The creditor has not fulfilled its obligations under the PPP regulations.
These second and third points will likely require lender attention to ensure that appropriate loss rates are considered and that these policies work in tandem with the non-accrual policies established by the lender (see Part one for more information).
The Paycheck Protection Program has been helpful to borrowers and, in many ways, to lenders. However, it has also introduced complex accounting that many institutions have not traditionally had to worry about. The importance of having the right systems in place that can meet some of the more technical requirements of loan accounting under US GAAP continues to be magnified as the PPP loan portfolio grows for many lenders. Lenders will need to ensure that they have adequate allowance consideration of these loans that take into account the possibility of credit losses on the principal and the clawback of the processing fee. Lenders will also need to ensure that these policies are in line with the non-accrual policy that may be established separately.
To learn more about how we can help you solve the accounting, reserving and reporting challenges associated with PPP loans, contact us.
Commercial Lending, Regulation, Risk Management