Understand the valuation of your loan portfolios

The fair value of a loan portfolio may need to be measured for many reasons, including two common purposes:

• Recording the fair value of an acquired loan portfolio under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 805 — Business Combinations
• Making a quarterly disclosure of the fair value of financial assets and liabilities under FASB Accounting Standards Update (ASU) 2016-01 — Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities

Understanding how to define fair value along with the valuation methods applicable to your loan portfolio can help you be prepared for either purpose.

Defining fair value

Under ASC 805, Business Combinations, and ASC 820, Fair Value Measurements and Disclosures, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement  date.

ASC 820 overview

As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between observable and unobservable inputs:

• Observable inputs are based on market data obtained from sources independent of the reporting entity.
• Unobservable inputs are derived from market-participant assumptions and rely on the best information available under the circumstances.

The fair value hierarchy prioritizes inputs to valuation techniques used to measure fair value into three broad levels, giving the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities at Level one and the lowest priority to unobservable inputs at Level three.

Inputs used to measure fair value may sometimes fall into more than one level of the fair value hierarchy. In such cases, the fair-value level should be assigned based on the lowest level input that’s significant to the fair value measurement. Assessing the significance of a particular input requires consideration of the factors specific to the asset or liability.