Accounting for Deferred Loan Fees and Costs with Recent Current Expected Credit Losses (CECL) Considerations

By Michael Bailey September 11, 2024

Accounting for deferred loan fees and costs continues to be an area of inquiry for our clients. The recent implementation of the Current Expected Credit Losses (CECL) standard has raised additional questions surrounding deferred loan fees and costs and their relation to the amortized cost basis of loan portfolios and the allowance for credit losses calculation.  This article covers the accounting treatment for such items prior to and after the adoption of CECL. 

The Financial Accounting Standards Board (FASB) within Topic 310-20, Receivables—Nonrefundable Fees and Other Costs, requires that loan origination fees and costs be deferred and (generally) amortized as a component of interest income over the life of the loan. The period used for amortization can be the contractual life of the loan, or an estimated life for a group of similar loans that contemplates anticipated prepayments.  Exceptions to this treatment would be loans placed on nonaccrual where the amortization of deferred fees and costs no longer occurs, and loans held-for-sale where amortization does not occur and instead is factored into the gain or loss amount recognized when the loans are eventually sold in the secondary market.  Common origination fees are known as “points” on a loan that serve to reduce the lender’s interest rate. These can also be amounts to reimburse a lender for costs that are associated with a specific loan. The possible origination costs are more variable and include items such as attorney fees, the portion of internal salaries related to loan closings, and the costs of activities to determine a borrower’s credit worthiness, among other items. At a high level, these are the costs associated with originating a specific loan. In practice, a standard amount is typically used based on loan type. These standard amounts should be evaluated regularly. 

On the balance sheet, deferred fees and costs should be netted and presented as a component of the amortized cost basis of loans. For loans held for investment, the net deferred fees or costs should be amortized using the effective interest rate (EIR) method (or amortized on a straight-line method if the difference between the two methods is immaterial). 

CECL requires that an allowance for credit losses be determined for assets measured at amortized cost. One common methodology used to do so is the Discounted Cash Flow (DCF) methodology. This methodology involves comparing the present value of the expected cash flows, calculated using the financial asset’s EIR, with the carrying value of the loan at amortized cost. ASC 326-20-20 defines the EIR, in part, as the rate of return implicit in the financial asset, that is, the contractual interest rate adjusted for any deferred fees or costs, premium, or discount existing at the origination or acquisition of the financial asset.  However, there is a difference inherent in the DCF methodology. CECL requires that prepayments be considered in the estimate for credit losses while the accounting for net deferred fees and costs generally assumes that the loans will be held to maturity with no prepayments. The different loan terms result in assumptions used to recognize income that are inconsistent with the assumptions used to estimate credit losses. The FASB addressed this inconsistency with Accounting Standards Update (ASU) 2019-04, which states that an entity may make a policy election to use a prepayment-adjusted EIR when applying a DCF method under CECL. For entities using methods other than the DCF method to estimate expected credit losses, the accretion of the net deferred fees and discounts should not offset the expectation of credit losses. In addition, the entity may measure the components of amortized cost basis (including net deferred fees and costs) on a combined basis or by separately measuring each of the components, that is, amortized cost basis, premiums or discounts, and applicable accrued interest. 

Under CECL, the concept of troubled debt restructurings (TDRs) went away, but the need to track and analyze loan modifications remains, using the general loan modification guidance within Subtopic 310-20. If the terms of a loan modification are at least as favorable to the lender as the terms for comparable loans to other customers with similar credit risk and the modifications are more than minor, the modification represents a new loan. If the modification is treated as a new loan, the existing net deferred fees and costs applicable to the original loan are recognized into earnings at the origination of the new modified loan. If those criteria are not met, the modification is treated as a continuation of the old loan and the net deferred fees or costs will continue to be amortized over the life of the loan.  

The adoption of CECL has raised fresh questions related to the treatment of deferred fees and costs, particularly regarding the amortized cost basis and the allowance for credit losses estimates. The CECL standard allows for significant flexibility in methodologies and while these different methodologies can lead to different options for incorporating deferred fees and costs into your allowance for credit loss estimate, the underlying accounting remains generally the same. Deferred fees and costs remain on the balance sheet as a component of the amortized cost basis of loans and the related income is recognized over the life of the loan to prevent financial institutions from front-loading income at loan origination.