views March 2016 SBA 7(a) Loan Origination and Sale Accounting: A Simplified Look at Frequent Accounting “Surprises” Often Encountered by Community Banks Jesse Respess, Partner | DHG Financial Services It seems that virtually all community banks are looking for ways to stabilize and enhance revenue streams during this environment of compressed interest rate margins. To that end, many community banks have considered an originate and sell model for loans under the SBA 7(a) program, which can serve to not only bolster profitability, but can also provide a much needed lending platform to the bank’s small business owner customers, stimulating job growth in their local communities and potentially accumulating CRA benefits along the way. Demand for the sale of guaranteed loans is strong, with investors willing to pay meaningful premiums as the primary risk associated with these loans is simply that of prepayment. Sounds great, right? Not so fast…let’s take a look at a few of the accounting and financial reporting implications that all too often result in a “surprise” for many banks after this business model is up and running. Sale Accounting In order to remove the sold loan balance from your financial statements, the sales transaction must qualify for such under ASC Topic 860, Transfers and Servicing.

Under this guidance, in order for the transfer of a portion of an entire financial asset Assurance | Tax | Advisory | dhgllp.com Demand for the sale of guaranteed loans is strong, with investors willing to pay meaningful premiums as the primary risk is simply that of prepayment. to qualify for sale accounting, the portion must first meet the definition of a “participating interest” and then must meet the applicable sale conditions as set forth in this guidance. Common pitfalls here include a servicing fee significantly above market, interest rate differentials between the retained and transferred portions and limited recourse provisions. It is important to adequately document your participating interest . views analysis, as well as the conditions that must be met, in order to qualify for sale accounting. Don’t overlook these important considerations as you rush to determine your anticipated journal entries. Benefits of SBA Loan Origination • Bolster profitability • Create lending platform for small business owner customers Recording the Transaction • Stimulate community job growth After concluding that sale accounting treatment under ASC Topic 860 is proper, it’s time to record the appropriate accounting entries. In summary, this will include: • Accumulate CRA benefits 1. Based on the relative fair value method, allocate the previous carrying amount of the entire financial asset between the participating interest retained and that which was sold. Conclusion As you consider the risks and rewards of deploying an SBA 7(a) lending platform at your financial institution, be thorough with your understanding of the accounting and financial reporting mechanics. In addition to the credit and compliance requirements that you will likely evaluate, the operational accounting processes are somewhat unique.

Performing accounting due diligence in this area early may save you a few “surprises” down the road. 2. Measure and separately recognize the servicing right. 3. Derecognize the participating interest that has been sold. 4. Record the respective gain (or loss) on the sale. 5. Report the retained participating interest at the difference between the previous carrying amount and the derecognized balance. Many are surprised to find that there is typically a discount to be recorded relative to the retained participating interest. About DHG Financial Services DHG Financial Services, a national practice of Dixon Hughes Goodman, focuses on publicly traded and privately-held financial services companies across the U.S. Our 30 financial services partners and more than 300 dedicated professionals provide you with in-depth, specialized industry knowledge and a wide range of assurance, tax and advisory services to address issues facing your industry in today’s challenging environment.

For more information, visit dhgllp.com/financial-services. These steps can present challenges to those who are unfamiliar with the accounting intricacies and the need to determine relative fair values. As a result, most community banks find it beneficial and cost effective to engage a thirdparty provider, many of which provide a turn-key accounting product to properly record the respective transaction, as well as the necessary ongoing servicing asset valuation. Allowance for Loan Losses Lastly, it is important to establish a process to identify and track any newly originated loans or portions thereof that have met the criteria for classification as held for sale (HFS). HFS loans are subject to lower of cost or market accounting and should not be subject to allowance for loan loss (ALL) modeling, as is the case with loans held for investment. Traditional loan accounting systems may not be structured to facilitate simple, automated identification of these respective balances in order to determine which balances are subject to an ALL. About the Author Jesse Respess is a partner in the DHG Financial Services practice. He has more than 18 years’ experience in public accounting and auditing with the majority of his time focusing on financial services organizations.

He possesses a diverse knowledge of accounting, auditing, financial and SEC reporting for financial services organizations. Jesse Respess Partner DHG Financial Services jesse.respess@dhgllp.com Assurance | Tax | Advisory | dhgllp.com 2 .