Old fashioned loan accounting

[Guest tmills]

We are taking over an old PSP that includes a mandatory after tax component. Prior to our involvement, recordkeeping has been done in-house. No participant direction. Balance forward annual statements. Plan is audited. Plan has loans that are accounted for in total as a trust asset, as things used to be 15-20 years ago, not as assets of the account of the participant taking the loan.

The trustee bank is accounting for the loans in a separate account under a master promissory note. The balance is increased when a new loan is issued, decreased to reflect principal payments. Not sure how frequently the decreases happen, but as long as everything balances at the end of the year, it shouldn't matter.

Participant statements for those who have a loan will have a note at the bottom indicating their loan balance. The participant's share of the total loan account will not be shown separately, nor wil there be any other indication of loan activity.

Loan interest is allocated to all participants as earnings, whether or not they have a loan.

There is a $100 loan fee taken from loan proceeds, but included as part of the loan amortization.

If a participant defaults (which has supposedly never happened except for terms) and offsets, at that point the outstanding balance is removed the master loan account and deducted from their balance prior to payment.

I need to know if all this sounds reasonable, is there anything to be on the lookout for, have we missed anything, etc? It's been too long since I've had to deal with loan accounting like this. Help is always appreciated.

[ESOP Guy]

It has been a few years but that sounds right.

If this bothers you we used to run plenty of balance forward plans with common investments except for the loan. You could see if the plan sponsor is interest in that change with new loans.

In that case the person get all their loan interest and you treat loan payments the same as deferrals for earnings allocations. It seemed like we gave the deferrals a 50% weight when computing the basis of the earnings allocation and we gave the loan repayments the same 50% weight.

[shERPA]

Agree with ESOP guy, that sounds about right. However I think DOL back in the '90s indicated a pretty strong preference for treating loans as a segregated investment to the specific participant borrowing. I remember we changed our balance forward plans to this method at that time and have done it this way ever since. I can't give you the cite as I don't recall it now.

I don't know what percentage of the plan's total assets is in loans, but from an investment management perspective this represents a fixed income investment. In these days of fiduciary this and fiduciary that, the investment mix and management should consider this and allocate the remaining assets accordingly if they are really convinced they want to keep it the way it is. There isn't really a risk of loss to the plan because the loans are fully secured by account balances, but there is a potential opportunity cost to the plan on investment returns if the plan is overweighted in fixed income including the loans.

Personally, I'd recommend changing the loans to be segregated investments of the borrowers.

[Guest tmills]

Thanks for the responses. Believe me we have tried to get them to change. No luck. Their counsel understands the issues but thinks they have made as many changes this year as they possible can. We'll have to bring it up again next year. We did get them to agree that they likely have had hundreds of defaulted loans in the past b/c most participants miss an average of 10 weekly payments a year due to no pay plant shutdowns, and the missed payments were never caught up until the end of the loan.

I'm still trying to get my head around the fact that there are essentially no individual accounts so everyone fund the loans, everyone shares in the repayments and the interest, yet if a participant terminates w/ an outstanding loan, that loan balance is subtracted from his vested balance to determine his distributable amount. I guess it would have to be b/c he did get the money, but it's a different way of looking at things.