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Transcript of Christopher Bianucci Partner [email protected] (312) 879-2040 Ernst & Young LLP 233 South...
Christopher Bianucci
Partner
(312) 879-2040
Ernst & Young LLP
233 South Wacker Drive
Chicago, IL 60606
2003 Interagency Accounting Seminar
Asset Securitization
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FASB Interpretation 46
Consolidation of VariableInterest Entities (“VIEs”)
March 20, 2003
Christopher BianucciPartner
(312) [email protected]
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Accounting OverviewAccounting Overview
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Statement of Accounting Standard No. 125 (issued in 1996) revised criteria for accounting for sales of financial assets and securitizations.
• SFAS 125 introduced financial components approach and based balance sheet treatment on a control basis.
Adoption of SFAS 125 gave rise to need for 2-step transfers and “Qualifying” SPEs in order to achieve true sale criteria
SFAS 140 retained the fundamental concepts of SFAS 125 and clarified certain QSPE issues. Also expanded the disclosure requirements.
FIN 46, released in 2003, revised the framework for determining consolidation of variable interest entities.
Accounting for Securitizations… The Saga Continues
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Sales Criteria
Surrender of control critical criteria. Paragraph 9 of SFAS 140 provides guidance on how to interpret a transaction for purposes of determining whether sales treatment is appropriate.\
Must meet all of the following:
9(a) Transferred assets have been isolated from the transferor -- put presumptively beyond the reach of the transferor and its creditors even in bankruptcy or other receivership
Generally, legal opinions will be required
9(b) Transferee obtains the right -- free of conditions -- to pledge or exchange the transferred assets or the transferee is a qualifying SPE and the holders of beneficial interests in that entity have the right -- free of conditions --- to pledge or exchange those interests and such pledge or exchange does not provide more than a trivial benefit to the transferor.
Effect: Seller cannot restrict buyer’s ability to sell the transferred assets
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Sales Criteria (continued)
9 c The transferor does not maintain effective control over the transferred assets through:
• An agreement that both entitles and obligates the transferor to repurchase or redeem transferred assets before their maturity, or
• The ability to unilaterally cause the holder to return specific assets, other than through a cleanup call (this could have a significant impact on deals with a revolving structure due to removal of accounts provisions (ROAPs)
Limited randomly selected accounts Response to third party-controlled event Defaulted contracts
Effect: No Call options on unique assets
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Consolidation Considerations
Deconsolidation achieved in 2 ways:
• QSPE
• FIN 46 – applies to special purpose entities which do not meet the criteria of QSPE.
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
QSPE
Qualified Special Purpose Entity (QSPE): QSPE can be corporation, partnership, or trust.
QSPE’s can only hold• Passive financial assets transferred to it• Passive derivative financial instruments• Servicing rights related to the assets it holds
Activities of QSPE must be limited, specified in the documents that create it, and can only be changed by a majority of the 3rd party beneficial interest holders
Must be “demonstrably distinct”• At least 10% of its beneficial interests held by parties other
than the transferor, its affiliates or agents
QSPE can only sell or dispose of noncash financial assets as an automatic response to a restricted list of conditions (servicing becomes very restricted)
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Entity that by design has:
• Equity investment at risk not sufficient to finance its activities without additional financial support (5(a)), or
• Equity investors do not have either-
Direct or indirect ability to make decisions through voting or similar rights (5(b)(1)),
Obligation to absorb expected losses (5(b)(2)), or
Right to receive residual returns (5(b)(3))
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
What is a Variable Interest Entity?
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Is the total equity investment at risk sufficient?
Do equity investors have the ability to make decisions about theentity’s activities through voting or similar rights?
Do equity investors have the obligation to absorb expected losses ?
Do equity investors have the right to receive the expected residual returns if they occur?
VIE Decision Tree
yes
yes
yes
yes
Apply consolidation guidance of FAS 94 Entity is a VIE
No
No
No
No
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At least equal to expected losses
At least 10% of assets, unless:
• Entity can finance activities without additional subordinated financial support (9(a)),
• Entity has at least as much equity as other entities that hold similar amounts of similar quality assets, and operate with no additional subordinated financial support (9(b)), or
• Investment exceeds expected entity losses based on reasonable quantitative evidence (9(c))
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
How Much is Enough?
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Contractual, ownership, or other pecuniary interests that change with changes in VIE net assets (paragraph 2(c))
Includes:
Equity and subordinated debt instruments issued by VIE
Senior Debt instruments
Loss guarantees
Servicing/Management contracts
other
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
What Constitutes a Variable Interest?
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The Primary Beneficiary of a VIE is the entity that is deemed to be the accounting parent and consolidates the VIE.
Entitled to more than 50% of expected VIE: • Losses, or • Residual returns
If different parties meet criteria, losses take precedence
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
How do I know if I have to consolidate something?
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Does the entity absorb a majority of VIE’s expected losses?
Does entity receive a majority of residual returns and no other entity absorbs a majority of expected losses?
No
No
Entity is not PB – Do not consolidate VIE Entity is PB – Consolidate VIE
Yes
Yes
Primary Beneficiary Decision Tree
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Derived from expected cash flows, discounted and adjusted for market factors and assumptions (paragraph 2(b))
Includes:
• Expected variability in: Net income or loss, Fair value of assets if not included in prior item, and
• Fees to: Decision makers, and Guarantors of substantially all VIE assets or liabilities (paragraph 8)
Decision maker directly or indirectly makes decisions that significantly affect VIE results (paragraph 14)
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Expected Losses Defined
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How about an Example….
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
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VIE Variable Interest: Purch. Price ComputedPrincipal (Fair Value) Yield
Senior (zero coupon) 750,000$ 675,000$ 7.26%
Subordinate (zero coupon) 210,000 28,000 10.71%960,000 703,000 7.40%
Management Fee (annual) 40,000 40,000 0.00%1,000,000$ 743,000$ 7.00%
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Assumptions:
Assume a pool of assets with a maturity of 1 year, funded by the following structure:
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Assumptions:
The pool of financial assets, with a contractual cash flow of $1.0, have expected cash flows as follows:
Outflow To Net VIE Outflow, ExcludingProbability In Flow Management Fee Senior VI Subordinate VI Cash Flow Management Fee
(a) (b) (c) (d) (e) (f)=(b)-(c)-(d)-(e) (g)=(d)+(e)5% 650,000$ 40,000$ 610,000$ -$ -$ 610,000$
10% 700,000 40,000 660,000 - - 660,000 25% 750,000 40,000 710,000 - - 710,000 25% 800,000 40,000 750,000 10,000 - 760,000 20% 850,000 40,000 750,000 60,000 - 810,000 15% 900,000 40,000 750,000 110,000 - 860,000
Present Value at 6.00% 37,736$
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Computed Variability of Senior Interest
Cash Flow Computations Variability in ExpectedCash Flow Probability Profit and Loss
Amount Probability Weighted Fair Value Present Value (Loss) Profit(a) (b) (c)=(a)*(b) (d)=Purchase Price (e)=(a)/(1+yield) (f)=((e)-FV)*(b))
610,000$ 5% 30,500$ 568,715$ (5,314)$ - 660,000 10% 66,000 615,331 (5,967) - 710,000 25% 177,500 661,948 (3,263) - 750,000 25% 187,500 699,240 - 6,060 750,000 20% 150,000 699,240 - 4,848 750,000 15% 112,500 699,240 - 3,636
100% 724,000$ 675,000$ (14,544)$ 14,544$
Computed Yield 7.26%
(675,000)$ 724,000$
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Variability of Subordinated Interest
Cash Flow Computations Variability in ExpectedCash Flow Probability Profit and Loss
Amount Probability Weighted Fair Value Present Value (Loss) Profit(a) (b) (c)=(a)*(b) (d)=Purchase Price (e)=(a)/(1+yield) (f)=((e)-FV)*(b))
-$ 5% -$ -$ (1,400) - - 10% - - (2,800) - - 25% - - (7,000) -
10,000 25% 2,500 9,032 (4,742) - 60,000 20% 12,000 54,194 - 5,239
110,000 15% 16,500 99,355 - 10,703 100% 31,000 28,000$ (15,942)$ 15,942$
Computed Yield 10.71%
(28,000)$ 31,000$
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Variable Interest Decision MakerLosses Profit
Dollars % Dollars %
Manager -$ 0% 37,736$ 55%
Senior (14,544) 48% 14,544 21%
Subordinate (15,942) 52% 15,942 23%
Total (30,486)$ 100% 68,222$ 100%
Total - Computed Yield (26,072)$ 63,807$
Determination of Primary Beneficiary
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
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Only if:
• Governing documents or contractual arrangements change,
• Part or all of equity investment is returned, and parties other than equity holders become exposed to expected losses, or
• Entity undertakes additional activities or acquires additional assets that increase expected losses
Not if losses exceed expected losses and reduce equity investment
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Reconsideration of VIE Status paragraph 7
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Non-primary beneficiary reconsiders if it’s primary beneficiary only if:
• Governing documents or contractual arrangements change,• Contractual arrangements among parties change,• Acquires newly issued variable interests, or• A portion of former primary beneficiary’s interest
Primary beneficiary reconsiders if it is primary beneficiary only when it sells or disposes of all or part of its variable interest
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Reconsideration of Primary Beneficiary Status paragraph 15
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
If consolidation of a VIE is required:
• Record assets of VIE at Fair Value (other than those transferred by the PB)• Record assets transferred by the PB at Book Value• Record Fair Value of liabilities assumed• Record Fair Value of minority interests in the VIE
If debit balance, record as extraordinary loss If credit balance, reallocate to basis of assets
If Consolidation is required
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If reasonably possible a VIE will be consolidated or disclosed upon full implementation:
• Nature, purpose, size, and activities of VIE, and• Maximum loss exposure from involvement
VIEs can be aggregated if separate reporting would not add material information
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Pre-Implementation Disclosure paragraph 26
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Pre-Implementation Disclosure:• Financials issued after January 31, 2003
VIEs created after January 31, 2003:• Immediately
VIEs created before February 1, 2003 whose primary beneficiary is a public company:• Quarters beginning after June 15, 2003
Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Timing
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Accounting OverviewAccounting OverviewAccounting OverviewAccounting Overview
Measure assets, liabilities and non-controlling equity in VIE at carrying amounts as if the Interpretation had been in effect as of the date enterprise first met the requirements to be the PB – if practicable to do so. If not practical to determine previous carrying value, record at fair value as of effective date.
Any difference between the net assets of the VIE and the previously recognized interest shall be recognized as a cumulative effect of an accounting change. Restatement of previous financial statements is encouraged but not required.
Transition Provisions – existing transactions