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  • Securitization Accounting

    Ninth edition January 2014

  • Contents

    Chapter 1: Whats new since the last edition? 3

    Chapter 2: Who has to consolidate the special purpose entity? 5

    Chapter 3: Does my securitization meet the sale criteria under GAAP? 21

    Chapter 4: How do securitizations fare under IFRS? 31

    Chapter 5: How about some examples? 45

    Chapter 6: How do you determine gain or loss on a sale? 55

    Chapter 7: What should I know about mortgage servicing rights? 61

    Chapter 8: What about the investors? 66

    Chapter 9: How do I measure and report fair value information? 75

    Chapter 10: So where is the transparency? 81

    Chapter 11: How will taxes impact my transaction? 92

    Chapter 12: How does securitization impact banks regulatory capital? 105

    Chapter 13: What's on the horizon? 117

    Appendix: Contacts 124

    For your convenience, this document contains links to external sources, some of which may require registration and/or subscription.

  • Securitization Accounting Copyright 2014 Deloitte Development LLC. All rights reserved. 3

    Since the financial crisis, the securitization market continues to be faced with uncertainty. Even as market participants are able to start putting some of the puzzle pieces together, many are still not sure of what the final picture will look like or even how all the pieces will fit.

    Yet, the pace of market clarity continues to accelerate. Over the past few months, we have seen the Consumer Finance Protection Bureau finalize the ability to repay rule along with the qualified mortgage provisions, the enactment of new risk-based capital regulations (commonly referred to as Basel III), the passing of the Volcker Rule and the re-proposal of risk retention rules. This year promises to be just as exciting with new proposals and the implementations of final rulings.

    As the securitization market continues to recover and evolve, we remain strong in our belief that accounting issues will play a significant role in securitization and in many ways remain embedded in the foundation of various changes in the regulatory environment.

    The earliest editions of this book were small pamphlets focused on major accounting changes impacting how securitizations were reported on the financial statements. Over the years we have transformed the book to become a roadmap covering accounting, tax, and various regulatory changes impacting securitization accounting and the overall markets. We continue that trend in this edition by adding new topics while continuing to robustly update previously covered topics.

    In this edition, we have addressed the new issues facing the market resulting from the Financial Accounting Standards Boards (FASB) and the International Accounting Standards Boards (IASB) continued convergence work on accounting for financial instruments. We also provide an in-depth International Financial Reporting Standards (IFRS) accounting analysis for securitizations as an increasing number of market participants report under this standard as well as U.S. Generally Accepted Accounting Principles (GAAP).

    Whats new since the last edition?1

  • 4Copyright 2014 Deloitte Development LLC. All rights reserved. Securitization Accounting

    For those following GAAP, much remains the same, with incremental additions to required disclosures on securitization transactions and additional clarity on treatment of consolidated securitizations.

    Yet, accounting issues continue to change and market participants may face major challenges in the FASBs and the IASBs proposals for the classification and measurements of financial instruments, as well as impairment of financial assets. These changes are due to be finalized in the near term. Also coming, changes to the consolidation paradigm that could force deconsolidation of many previously consolidated securitizations under GAAP.

    Further, U.S. and European banks continue to experience the enactment of new risk based capital rules under Basel III. This new regime impacts the role banks will play in the securitization market and what risk based capital they must maintain for their structured finance assets.

    Certainly, there will be much more to write about and share in valued dialogue with all market constituents in the coming months and years; and the new electronic version of this edition will make it easier to send out periodic updates. It also makes it possible to electronically link additional information for further reference.

    For now, we hope you find this edition illuminates a bit, the ever evolving, complex world of securitization accounting.

    Enjoy!

    Chapter 1

  • 5 Securitization Accounting Copyright 2014 Deloitte Development LLC. All rights reserved.

    2 Who has to consolidate the special purpose entity?

    In accounting for securitizations, there are two baseline questions to be answered: Do I have to consolidate the special purpose entity(ies) involved?

    Have I sold the transferred assets for accounting purposes?

    Both U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) require a reporting entity, as part of the derecognition assessment, to consider whether the transfer includes a transfer to a consolidated subsidiary. Therefore, logically, the first step in determining whether sale accounting has occurred is to determine if a securitization entity requires consolidation by the transferor.

    Because many securitizations involve more than one transfer, and consolidated affiliates often prepare their own separate company financial statements, the consolidation and sale questions will often need to be considered more than once for a transaction. As one might expect, different answers may be appropriate at different stages in the securitization or for different financial reporting purposes.

    What accounting guidance applies?For companies applying GAAP, the consolidation guidance is included in ASC 810, Consolidation in particular, the variable interest entity (VIE) subsections otherwise formerly known as Statement of Financial Accounting Standards No. 167, Amendments to FASB Interpretation No. 46(R) (FAS 167). Not all special purpose entities (SPEs) are VIEs, but generally, all securitization SPEs are VIEs. A VIE does not usually issue equity instruments with voting rights (or other interests with similar rights) with the power to direct the activities of the entity, and often the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional forms of credit enhancement or other financial support. If an entity does not issue voting or similar interests or if the equity investment is insufficient, that entity's activities probably are predetermined or decision-making ability is determined contractually. Because securitization entities are typically insufficiently capitalized, with little or no true equity for accounting purposes, and are rarely designed to have a voting equity class possessing the power to direct the activities of the entity, they are generally VIEs. The investments or other interests that will absorb portions of a VIEs expected losses or receive portions of its expected residual returns are called variable interests.

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  • 6Copyright 2014 Deloitte Development LLC. All rights reserved. Securitization Accounting

    Chapter 2

    After the issuance of FAS 167 in 2009, the Financial Accounting Standards Board (FASB) deferred the amended consolidation model for certain investment funds choosing to retain, for these entities, the prior risk and rewards consolidation model commonly known as FASB Interpretation No. 46R, Consolidation of Variable Interest Entities (FIN 46R). However, securitization entities and asset-backed financing entities, such as collateralized loan obligations (CLOs), were specifically excluded from the scope of the deferral and therefore apply the hybrid consolidation model discussed further on in this chapter.

    For companies applying IFRS, gone is the previous control-based consolidation model under International Accounting Standard (IAS) 27, Consolidated and Separate Financial Statements (IAS 27), and the risk-and-rewards overlay for structured entities under Standing Interpretations Committee (SIC)-12, Consolidation Special Purpose Entities (SIC-12). IFRS now includes a single consolidation model for all types of entities. In May 2011, the IASB issued IFRS 10, Consolidated Financial Statements (IFRS 10) which replaced the previous consolidation guidance in IAS 27 and SIC-12.

    Who must consolidate the securitization entity?The first step in determining who should consolidate the securitization entity is, logically enough, identifying all the parties to the deal and identifying which ones have a variable interest. While there is no requirement for the transaction parties to compare their accounting conclusions (but, theoretically, only one entity should conclude that it controls), each participant needs to understand the various rights and obligations granted to each party in order to conclude as to its own accounting for its interest in the issuer.

    Because they are both based on control, the consolidation decision trees under both GAAP and IFRS are largely similar, with each framework considering both power and variable interests. ASC 810 requires identifyin