by Martin Rosenblatt
End Sept., 2000, the FASB released FASB Statement 140 which replaces FASB 125 in its entirety, but carries forward most of its provisions without reconsideration. The major changes to FASB 125 affecting securitizations are summarized below. FASB 140 is generally effective for transactions occurring after March 31, 2001; however, the additional disclosures of securitization activities are required in audited financial statements beginning this December year-end. Those required disclosures are quite extensive and are described further in this bulletin.
New Requirements to be a Qualifying Special-Purpose Entity
Remember that Qualifying Special-Purpose Entities (QSPEs) do not get consolidated by the transferor even if the so-called equity class is wholly-owned by the transferor.
A QSPE is a trust or other legal vehicle that meets all of the following conditions:
a. It is demonstrably distinct from the transferor, meaning it cannot be unilaterally dissolved by the transferor (throughout this document, transferor includes its affiliates and its agents) and either (a) at least 10 percent of the fair value of its beneficial interests (all debt and equity securities issued by the SPE) is held by parties other than the transferor or (b) the transfer is a guaranteed mortgage securitization (either Ginnie, Fannie, Freddie or a monoline). An ability to unilaterally dissolve an SPE can take many forms, including holding sufficient beneficial interests to demand that the trustee dissolve the SPE, the right to call all the assets transferred to the SPE, and a right to call the beneficial interests held by other parties.
b. Its permitted activities (1) are significantly limited, (2) were entirely specified in the legal documents that established the SPE or created the beneficial interests in the transferred assets that it holds, and (3) may be significantly changed only with the approval of the holders of at least a majority of the beneficial interests held by entities other than the transferor.
c. It may hold only:
(1) Financial assets transferred to it that are passive in nature
(2) Passive derivative financial instruments that pertain to beneficial interests issued or sold to parties other than the transferor
(3) Financial assets (for example, guarantees or rights to collateral) that would reimburse it if others were to fail to adequately service financial assets transferred to it or to timely pay obligations due to it and that it entered into when it was established, when assets were transferred to it, or when beneficial interests were issued by the SPE
(4) Servicing rights related to financial assets that it holds
(5) Temporarily, nonfinancial assets obtained in connection with the collection of financial assets that it holds
(6) Cash collected from assets that it holds and investments purchased with that cash pending distribution to holders of beneficial interests that are appropriate such as money-market or other relatively risk-free instruments.
d. If it can sell or otherwise dispose of noncash financial assets, it can do so only in AUTOMATIC response (consistent with the notion of being brain-dead or on auto pilot) to one of the following conditions:
(1) Occurrence of an event or circumstance that (a) is specified in the legal documents that established the SPE or created the beneficial interests in the transferred assets that it holds; (b) is outside the control of the transferor; and (c) causes, or is expected at the date of transfer to cause, the fair value of those financial assets to decline by a specified degree below the fair value of those assets when the SPE obtained them
(2) Exercise by a beneficial interest holder (other than the transferor) of a right to put that holder's beneficial interest back to the SPE
(3) Exercise by the transferor of a call or ROAP specified in the legal documents that established the SPE, transferred assets to the SPE, or created the beneficial interests in the transferred assets that it holds
(4) Termination of the SPE or maturity of the beneficial interests in those financial assets on a fixed or determinable date that is specified at inception; but the transferor can not bid on the asset at auction if it holds the residual.
Removal-of-Accounts Provisions(ROAPs)
Whether a ROAP precludes sale accounting depends on whether the ROAP results in the transferor's maintaining effective control over specific transferred assets. The following are examples of ROAPs that preclude transfers from being accounted for as sales:
a. An unconditional ROAP or repurchase agreement that allows the transferor to specify the assets that may be removed, because such a provision allows the transferor unilaterally to remove specific assets
b. A ROAP conditioned on a transferor's decision to exit some portion of its business, because whether it can be triggered by canceling an affinity relationship, spinning off a business segment, or accepting a third party's bid to purchase a specified (for example, geographic) portion of the transferor's business, such a provision allows the transferor unilaterally to remove specific assets.
The following are examples of ROAPs that do not preclude transfers from being accounted for as sales:
a. A ROAP for random removal of excess assets, if the ROAP is sufficiently limited so that the transferor cannot remove specific transferred assets, for example, by limiting removals to the amount of the transferor's retained interest and to one removal per month
b. A ROAP for defaulted receivables, because the removal would be allowed only after a third party's action (default) and could not be caused unilaterally by the transferor
c. A ROAP conditioned on a third-party cancellation, or expiration without renewal, of an affinity or private-label arrangement, because the removal would be allowed only after a third party's action (cancellation) or decision not to act (expiration) and could not be caused unilaterally by the transferor.
Lease Securitizations
Residual values meet the definition of financial assets to the extent that they are guaranteed at the inception of the lease by either the lessee or an unrelated third party . Thus, transfers of residual values guaranteed at inception are covered by Statement 140. Unguaranteed residual values do not meet the definition of financial assets, nor do residual values guaranteed after inception, and transfers of them are not covered by Statement 140.
Securitizations by Banks
In July 2000, the FDIC adopted a final rule, Treatment by the Federal Deposit Insurance Corporation as Conservator or Receiver of Financial Assets Transferred by an Insured Depository Institution in Connection with a Securitization or Participation. That rule modifies the FDIC's powers so that, subject to certain conditions, it shall not recover, reclaim, or recharacterize as property of the institution or the receivership any financial assets transferred by an insured depository institution in connection with a securitization or participation. The final rule also states that the FDIC may repeal or amend that final rule but that any such repeal or amendment would not apply to any transfers of financial assets made in connection with a securitization or participation that was in effect before such repeal or amendment. In view of that final rule and after consultation with other affected parties, the FASB concluded that specific guidance about the effect of the FDIC's powers as receiver on the isolation of transferred assets would no longer be needed. Therefore, Statement 140 removes that specific guidance. It is anticipated that auditors will now seek legal letters from attorneys concerning isolation of assets when banks enter into securitization transactions.
Required Disclosures
Appendix C to FASB 140 provides specific examples that illustrate the disclosures that are required. The formats in the illustrations are not required by the Statement. The FASB encourages entities to use a format that displays the information in the most understandable manner in the specific circumstances. The disclosures are not required to be shown for periods ending before December 2000, when prior year financial statements are presented for comparative purposes.
If securitizations are accounted for as sales (but not if they are accounted for as debt), the securitizer must disclose for each major type (e.g. mortgage loans, auto loans, credit card accounts):
- Its accounting policies for initially measuring the retained interests including the methodology used to determine their fair value
- A description of the continuing involvement with the transferred assets, including servicing, recourse and restrictions on retained interests and the gain or loss on sale
- Quantitative information on the key assumptions used in measuring fair value of the retained interests including discount rates, expected prepayments including expected weighted average life of the underlying assets, and anticipated credit losses both (a) at the time of the securitization and (b) at the date of the latest balance sheet. Ranges of assumptions can be disclosed if the entity has entered into multiple securitizations of the same major asset type during the year.
- Cash flows between the securitization SPE and the transferor including proceeds from new securitizations, amounts reinvested during revolving periods, purchases of delinquent or foreclosed loans, servicing fees and advances, and cash flows received on retained interests, including releases of overcollateralization amounts.
- Static pool actual and projected losses as a percentage of the original balance securitized for each year of origination.
- A stress test showing the hypothetical effect on the fair value of retained interests which would result from two or more unfavorable variations (e.g. 10% and 20% increases) from the expected levels for each key assumption, calculated without changing any other assumption.
- For both off-balance sheet assets (i.e. securitized assets) and on-balance sheet assets of the same type that the entity manages:
- delinquencies at the end of the period
- credit losses, net of recoveries, during the period
- principal amounts outstanding of securitized loans accounted for as sales and on-balance sheet loans held for sale or securitization, separately from those held in portfolio.
The FASB staff is working on a draft Special Report of answers to questions that arose in implementing FASB 125, updated to reflect FASB 140. The draft will be available on FASB's website at www.fasb.org
The changes described above are only some of the changes adopted in FASB 140, some of which are more subtle. Copies of the full Statement can be purchased through the FASB Order Department.