2.4 Transfers Not Subject to ASC 860-10

2.4.1 Custody of Financial Assets for Safekeeping

Financial assets may be transferred to a third party for safekeeping or custody. In these situations, ASC 860-10 does not apply (see ASC 860-10-15-4(c)). In practice, the financial assets continue to be carried as assets by the transferor and no secured borrowing is recognized because no proceeds are received. The only consideration that may be exchanged in these transfers is the payment of a fee by the transferor to the custodian. The custodian does not control the assets but must follow the transferor’s instructions. Therefore, the custodian (transferee) also does not recognize the financial assets held.

2.4.2 Contributions

Some transfers of financial assets are nonreciprocal and therefore represent contributions. ASC 720-25 addresses contributions made, and ASC 958-605 addresses contributions received by not-for-profit entities. ASC 860-10 does not apply to contributions made or received (see ASC 860-10-15-4(d)).

2.4.3 Ownership Interests in Consolidated Subsidiaries

2.4.3.1 General

ASC 810-10

Deconsolidation of a Subsidiary or Derecognition of a Group of Assets

40-3A The deconsolidation and derecognition guidance in this Section applies to the following:

A subsidiary that is a nonprofit activity or a business, except for . . .
A group of assets that is a nonprofit activity or a business, except for . . .
A subsidiary that is not a nonprofit activity or a business if the substance of the transaction is not addressed directly by guidance in other Topics that include, but are not limited to . . .

3. Topic 860 on transferring and servicing financial assets . . .

ASC 860-10

Ownership Interest in a Consolidated Subsidiary by Its Parent if the Subsidiary Holds Nonfinancial Assets

55-13 An ownership interest in a consolidated subsidiary is evidence of control of the entity’s individual assets and liabilities, not all of which are financial assets, and this guidance only applies to transfers of financial assets. (Note that in the parent’s [transferor’s] consolidated financial statements, the subsidiary’s holdings are reported as individual assets and liabilities instead of as a single investment.) The guidance in this Subtopic does not apply to a transfer of an ownership interest in a consolidated subsidiary by its parent if that consolidated subsidiary holds nonfinancial assets.

A parent entity controls the assets held by a subsidiary, regardless of whether the subsidiary is consolidated under the voting interest entity or VIE model in ASC 810. ASC 860-10-55-13 indicates that ASC 860-10 does not apply to a parent’s transfer of an ownership interest in a consolidated subsidiary if that subsidiary holds nonfinancial assets (i.e., ASC 610-20 or ASC 810 applies). ASC 810-10-40-3A further clarifies that ASC 860-10 does not apply when a parent transfers (1) an ownership interest in a consolidated subsidiary that meets the definition of a business or (2) a group of assets that meets the definition of a business. In these two situations, ASC 860-10 does not apply regardless of the quantity or amount of financial assets involved in the transfer.

In summary, ASC 860-10 does not apply to a parent’s transfer of any of the following:

An ownership interest in a consolidated subsidiary that meets the definition of a business.
A group of assets that meets the definition of a business.11
An ownership interest in a consolidated subsidiary that is not a business but does not represent a transfer of financial assets in substance (i.e., the subsidiary holds a substantive amount of nonfinancial assets, regardless of whether these assets are recognized).

In the above three situations, ASC 810 applies to the deconsolidation (ASC 610-20 may also apply to the nonfinancial assets involved in the transaction). However, if an entity transfers an ownership interest in a consolidated subsidiary that is not a business, ASC 860-10 may apply to the financial assets involved in the transfer. Specifically, an entity should apply ASC 860-10 when it transfers an investment in a consolidated subsidiary that is not a business if (1) the subsidiary holds only financial assets or (2) the nonfinancial assets of the subsidiary are not substantive. In these situations, an entity must analyze the economic characteristics and risks of the legal form of equity being transferred or sold to determine whether derecognition is appropriate under ASC 860-10.

The above view regarding transfers of ownership interests in subsidiaries that represent a transfer of financial assets in substance is consistent with views previously expressed by the SEC staff. For example, at the 1997 AICPA Conference on Current SEC Developments, Armando Pimentel, then a professional accounting fellow in the SEC’s Office of the Chief Accountant, stated the following:

The FASB has indicated that a parent company’s investment in its consolidated subsidiary is not a financial asset, and the Staff agrees with this position because any sale of the equity securities of the subsidiary represents the sale of an interest in subsidiary’s individual assets and liabilities, which are not necessarily financial assets under the definition in SFAS 125.

The Staff recently responded to an inquiry from a registrant regarding the proper accounting guidance to follow in recording a sale of all of the equity securities of a consolidated subsidiary whose only asset was a cost-method investment, which is considered a financial asset under SFAS 125. The Staff concluded that the provisions of SFAS 125 should apply when an entity sells the equity securities of its consolidated subsidiary if all of the assets in the consolidated subsidiary are financial assets.

This conclusion arose from the Staff’s concern that, otherwise, a company whose transfer of assets would not qualify as a sale under SFAS 125 criteria could sidestep those requirements by simply first transferring the assets to a newly created wholly owned subsidiary and selling the equity securities of that subsidiary. The company might then assert that SFAS 125 did not apply, because the transaction involved the sale of equity securities of the subsidiary, and account for the transfer as a sale under other GAAP that addresses the sale of assets and liabilities.

Similar views were expressed in a speech by Brian Fields at the 2009 AICPA Conference on Current SEC and PCAOB Developments. Mr. Fields stated:

Beginning with transfers, we’ve recently heard of efforts to structure certain sales of beneficial interests in a manner that some believe falls outside the scope of Codification Topic 860 on transfers of financial assets. Those efforts involved selling preferred interests in a subsidiary that holds only financial assets rather than selling senior interests in the financial assets themselves. The idea seems to be that by describing the beneficial interests sold as equity in a consolidated subsidiary it may be possible to classify the proceeds received as noncontrolling equity interests rather than collateralized debt in the financial statements of the parent sponsor.

For some companies this may be appealing as a kind of “back up” plan. That is, if derecognition is not possible for whatever reason, presentation of the proceeds received on a failed sale within shareholders’ equity rather than as debt may be the next best thing, or perhaps even better if those proceeds increase third party measures of capital for a distressed institution. Such strategies may raise concerns if they become more common under new FASB standards that make derecognition more difficult, so now seems like a good time to share information about how to grapple with the issues they raise.

In a typical example, a bank transfers loans to a consolidated special purpose entity [(SPE)] in exchange for all senior and subordinated interests in the newly formed entity. The senior interests, which pay a prescribed rate of return each period, are then sold to outside investors, while the junior interests are retained by the bank. The activities of the SPE are significantly limited, primarily relating to servicing and, in some cases, rolling over assets as they mature. In this and other ways, these structures may be similar to QSPE’s and other asset-backed financing structures that will more often be consolidated by their sponsors under the revised model of control in FASB Statements 166 and 167 [ASC 860 and ASC 810].

While these structures contain only financial assets and do not have the breadth and scope of activities of a business, some believe that by describing the beneficial interests sold as legal form equity and not including an explicit maturity date they can classify securitization proceeds received as noncontrolling equity interests in the consolidated financial statements of the parent sponsor. We have reached a different view in these circumstances. Beneficial interests in such entities are essentially transfers of interests in financial asset cash flows dressed up in legal entity form, and we believe the proceeds received on such transfers should be presented as collateralized borrowings pursuant to transfer accounting requirements to the extent the underlying financial assets themselves do not qualify for derecognition.

To say it again in another way, when a subsidiary is created simply to issue beneficial interests backed by financial assets rather than to engage in substantive business activities, we’ve concluded that sales of interests in the subsidiary should be viewed as transfers of interests in the financial assets themselves.1 The objective of an asset-backed financing is to provide the beneficial interest holders with rights to a portion of financial asset cash flows and the guiding literature is contained in Codification Topic 860 on transfers of financial assets. That literature requires a transfer to be reflected either as a sale or collateralized borrowing, depending on its specific characteristics-presentation as an equity interest in the reporting entity is not a possible outcome.

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1 Relevant technical references include FASB ASC subparagraph 860-10-15-4(f), which notes that investments by owners in a business are not in scope of Topic 860, and paragraph 860-10-55-13, which notes that the guidance in Subtopic 860-10 “does not apply to a transfer of an ownership interest in a consolidated subsidiary by its parent if that consolidated subsidiary holds nonfinancial assets.”

As discussed in Mr. Fields’s speech, an entity whose transfer of financial assets would not qualify as a sale under ASC 860-10-40-5 might attempt to structure a transaction in a manner that sidesteps the sale accounting guidance. In such a structure, the entity would first transfer the financial assets to a newly created subsidiary (e.g., SPE) in exchange for all senior and subordinated interests in the subsidiary. All interests are in legal-form equity and do not contain a maturity date. The entity then sells the senior interests to outside investors. The activities of the subsidiary are significantly limited and do not have the breadth and scope of activities of a business. Because it may seem that the sale of the senior interests represented an equity transaction involving owners, the entity might assert that the guidance in ASC 860-10 does not apply and account for the sale of the senior interests as the issuance of a noncontrolling equity interest rather than as collateralized debt. However, Mr. Fields cautioned that “when a subsidiary is created simply to issue beneficial interests backed by financial assets rather than to engage in substantive business activities,” the sales of beneficial interests in the subsidiary “should be viewed as transfers of interests in the financial assets themselves” and ASC 860-10 would apply.

The above SEC staff speeches focus on attempts to structure transactions in a manner that sidesteps the criteria for sale accounting in ASC 860-10-40-5. In these situations, entities must “look through” the legal form of the transfer and account for the transfer on the basis of its substance (i.e., by focusing the accounting analysis on the financial assets held by the consolidated subsidiary).12 However, the principles in these speeches apply more broadly because they are examples of an overarching principle in ASC 860 (see ASC 810-10-40-3A(c)(3)). That is, on the basis of consultations and discussions with the SEC staff, we believe that these principles apply broadly to legal entities that hold only financial instruments. The accounting model should not change by virtue of the inclusion of an inconsequential amount of nonfinancial assets in the entity whose ownership interests are being transferred. Otherwise, an entity whose transfer of financial assets did not qualify as a sale under ASC 860-10-40-5 could sidestep those requirements by simply (1) transferring the financial assets to a newly created wholly owned subsidiary and including a trivial amount of nonfinancial assets in that entity and (2) selling those equity securities.

If an entity (1) determines that a transfer of ownership interests in a consolidated subsidiary represents a transfer of financial assets in substance and (2) applies ASC 860-10, there are only two potential outcomes: either the transfer meets the conditions for sale accounting in ASC 860-10-40-5 and the transferred financial assets are derecognized or the transfer is accounted for as a secured borrowing. If the transaction must be accounted for as a secured borrowing, any beneficial interests in the transferred financial assets must be accounted for by the transferor as liabilities even if those interests represent equity in legal form.

Note that while the SEC staff speeches above focus on transactions in which an entity creates a consolidated subsidiary in contemplation of a transfer of financial assets, ASC 860-10 also applies to the following transactions involving the transfer of ownership interests in a consolidated subsidiary that represents a transfer of financial assets in substance:

A parent entity transferred financial assets to the consolidated subsidiary in a period before the transfer of the ownership interests in the consolidated subsidiary (i.e., the subsidiary was not created contemporaneously with the transfer of the ownership interests in the subsidiary).
A parent entity never transferred the financial assets to the consolidated subsidiary (i.e., the parent consolidated an entity that held financial assets as of the date of initial consolidation).

If the breadth and scope of a subsidiary’s activities are such that the subsidiary is considered to meet the definition of a business (e.g., active management of the assets owned by the entity), the transfer of ownership interests in the subsidiary would not be within the scope of ASC 860-10. When the consolidated subsidiary is not a business, an entity may need to use judgment to determine whether the transfer of the ownership interest in the subsidiary represents a transfer of financial assets in substance. This evaluation depends on the specific facts and circumstances, including the nature of the financial instruments owned by the subsidiary and the circumstances giving rise to a potential deconsolidation of the consolidated entity. We believe that if the consolidated subsidiary represents a form of asset-backed financing rather than a business, ASC 860-10 applies to the derecognition of the entity’s financial assets.

Connecting the Dots

If a parent transfers financial assets to a newly created subsidiary and then transfers the ownership interests in that subsidiary to a third party, to derecognize the financial assets from its consolidated financial statements, the parent must conclude that (1) both transfers qualify for sale accounting (i.e., the transfer of financial assets from the parent to the subsidiary and the parent’s sale of the ownership interests in the subsidiary) and (2) it is no longer required to consolidate the newly created subsidiary under ASC 810 (see ASC 860-10-40-4(a)).

If a parent transfers ownership interests in an existing consolidated subsidiary that holds financial assets and that transaction is considered a transfer of financial assets in substance, to derecognize the financial assets owned by the subsidiary from the consolidated financial statements, the parent must conclude that (1) its transfer of the ownership interests in the subsidiary qualifies for sale accounting and (2) it is no longer required to consolidate the subsidiary under ASC 810 (see ASC 860-10-40-4(a)).

2.4.3.2 Broker-Dealers and Investment Companies With Investments in Subsidiaries

ASC 860-10

Investment in an Nonconsolidated Investee

55-14 An entity (for example, a broker-dealer or an investment company) that carries an investment in a subsidiary at fair value will realize its investment by disposing of it rather than by realizing the values of the underlying assets through operations. Therefore, a transfer of an investment in a subsidiary by that entity is a transfer of the investment (a financial asset), not the underlying assets and liabilities (which might include nonfinancial assets). Generally, the guidance in this Subtopic applies to a transfer of an investment in a controlled entity that has not been consolidated by an entity because that entity accounts for its investment in the controlled entity at fair value.

Broker-dealers in securities and investment companies account for investments in subsidiaries in which they have a controlling financial interest at fair value through earnings in accordance with ASC 940 and ASC 946, respectively (i.e., such investments are exempt from consolidation under ASC 810). ASC 860-10-55-14 indicates that transfers of such investments by broker-dealers in securities and investment companies are within the scope of ASC 860-10.

2.4.3.3 Exchange of One Form of Beneficial Interest for Another

ASC 860-10

Exchange of One Form of Beneficial Interest for Another

55-16 A transferor’s exchange of one form of beneficial interests in financial assets that have been transferred into a trust that is consolidated by the transferor for an equivalent, but different, form of beneficial interests in the same transferred financial assets would not be a transfer under this Subtopic if the exchange is with the trust that initially issued the beneficial interests. If the exchange is not a transfer, then the provisions of paragraph 860-20-40-1B would not be applied to the transaction.

ASC 860-10-55-16 addresses an exchange of one form of beneficial interests in financial assets for another form by an entity that consolidates the securitization entity that issued the beneficial interests. That guidance indicates that such a transaction is not within the scope of ASC 860-10.

2.4.4 Investments by Owners or Distributions to Owners of a Business Entity

2.4.4.1 General

ASC 860-10

Reacquisition by an Entity of Its Own Securities

55-15 A reacquisition by an entity of its own securities by exchanging noncash financial assets (for example, U.S. Treasury bonds or shares of an unconsolidated investee) for its common shares constitutes a distribution by an entity to its owners, as defined in FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, is excluded from the scope of this Subtopic.

ASC 860-10-15-4(f) states that “[i]nvestments by owners or distributions to owners of a business entity” are not within the scope of ASC 860-10. That exception applies to both the transferor and the transferee. Examples of such transactions that are outside the scope of ASC 860-10 include:

A business entity reacquires its own common stock or debt securities by transferring a noncash financial asset (see ASC 860-10-55-15).
A business entity exchanges its outstanding debt held by a third party for its own equity securities.
A business entity distributes noncash financial assets to its owners.
A business entity sells its own securities to a third party in return for noncash financial assets.
A business entity sells or reacquires ownership interests in a consolidated subsidiary.

The exception in ASC 860-10-15-4(f) generally only applies to transactions involving investments by or distributions to an entity that meets the definition of a business. Therefore, not all transfers of financial assets in return for legal-form equity interests in the transferee are outside the scope of ASC 860-10. For example, ASC 860-10 applies to transfers of financial assets in return for beneficial interests in those transferred financial assets (regardless of the legal form of the beneficial interests) because the securitization entity that issued the beneficial interests is not a business. If, however, the interest received by a transferor in a transfer of financial assets represents equity issued by a transferee that meets the definition of a business (i.e., the interest received does not represent solely an interest in the transferred financial assets), the transfer is not within the scope of ASC 860-10.

The examples below illustrate the application of the scope exception in ASC 860-10-15-4(f).

Example 2-3

Transfer of Mortgage Loans to a Securitization Trust

Entity D transfers a portfolio of mortgage loans to Entity E, which is a securitization trust that only owns the mortgage loans transferred. In return, D receives cash and a residual equity interest in E. This transfer is within the scope of ASC 860-10 for both the transferor and the transferee. The residual interest issued by E, although equity in legal form, represents a beneficial interest in the transferred financial assets. This conclusion would not change if D received only beneficial interests in the transferred financial assets. However, if D transfers a portfolio of mortgage loans to an operating entity that meets the definition of a business in return for equity issued by the transferee, the transaction would not be within the scope of ASC 860-10 because it represents a transaction that is subject to the scope exception in ASC 860-10-15-4(f).

Example 2-4

Transfer of Loans Receivable in Return for Common Stock of the Transferee

Entity F transfers a portfolio of loan receivables to Entity G, a business entity that manufactures, sells, leases, and finances equipment. In return, F receives common shares of G, which are publicly traded equity securities. This transfer is not within the scope of ASC 860-10 for F, as transferor, or G, as transferee. See ASC 860-10-15-4(f).

Example 2-5

Transfer of a Receivable From the Sale of Stock

Entity H, a business entity, issues its common stock to I, a third party, in return for a note receivable. In accordance with ASC 505-10-45-2, the note receivable is recognized as an offset to stockholders’ equity. Entity H subsequently transfers the note receivable to a third party. This transfer is not within the scope of ASC 860-10. The exception in ASC 860-10-15-4(f) applies because H classifies the note receivable within equity.

If the note receivable met the conditions to be classified as an asset, the transfer would be within the scope of ASC 860-10.

Example 2-6

Resale of Treasury Stock

Entity J holds its own common shares in treasury. If J sells those treasury sales to third-party investors, those sales would not be within the scope of ASC 860-10. Rather, they should be treated in the same manner as an original issuance of stock.

Example 2-7

Investee Acquires Another Entity in a Business Combination

Entity L owns an investment in Investee A that is accounted for at fair value in accordance with ASC 321. Investee A acquires Investee B in a business combination in which A exchanges its common shares for all the equity of B. After this exchange, the shareholders of A now own all the shares of the combined entity (i.e., A and B). This transaction is outside the scope of ASC 860-10 in accordance with the scope exception in ASC 860-10-15-4(f) for investments by owners and distributions to owners of a business entity. Entity L would continue to recognize its investment in A at fair value through earnings.

2.4.4.2 Transfers Between a Parent and Its Subsidiary

As discussed in Section 3.1.3.5.1, ASC 860-10-55-78 indicates that transfers of financial assets between subsidiaries of a common parent are within the scope of ASC 860-10. However, this guidance does not necessarily apply to transfers of financial assets between a parent entity and its subsidiaries. Such transfers are generally subject to the scope exception in ASC 860-10-15-4(f).

2.4.4.3 Certain Transfers of Nonperforming Assets

SEC Staff Accounting Bulletins

SAB Topic 5.V, Certain Transfers of Nonperforming Assets [Reproduced in ASC 942-810-S99-1]

Facts: A financial institution desires to reduce its nonaccrual or reduced rate loans and other nonearning assets, including foreclosed real estate (collectively, “nonperforming assets”). Some or all of such nonperforming assets are transferred to a newly-formed entity (the “new entity”). The financial institution, as consideration for transferring the nonperforming assets, may receive (a) the cash proceeds of debt issued by the new entity to third parties, (b) a note or other redeemable instrument issued by the new entity, or (c) a combination of (a) and (b). The residual equity interests in the new entity, which carry voting rights, initially owned by the financial institution, are transferred to outsiders (for example, via distribution to the financial institution’s shareholders or sale or contribution to an unrelated third party).

The financial institution typically will manage the assets for a fee, providing necessary services to liquidate the assets, but otherwise does not have the right to appoint directors or legally control the operations of the new entity.

FASB ASC Topic 860, Transfers and Servicing, provides guidance for determining when a transfer of financial assets can be recognized as a sale. The interpretive guidance provided in response to Questions 1 and 2 of this SAB does not apply to transfers of financial assets falling within the scope of FASB ASC Topic 860. Because FASB ASC Topic 860 does not apply to distributions of financial assets to shareholders or a contribution of such assets to unrelated third parties, the interpretive guidance provided in response to Questions 1 and 2 of this SAB would apply to such conveyances.

Further, registrants should consider the guidance contained in FASB ASC Topic 810, Consolidation, in determining whether it should consolidate the newly-formed entity.

Question 1: What factors should be considered in determining whether such transfer of nonperforming assets can be accounted for as a disposition by the financial institution?

Interpretive Response: The staff believes that determining whether nonperforming assets have been disposed of in substance requires an assessment as to whether the risks and rewards of ownership have been transferred.38 The staff believes that the transfer described should not be accounted for as a sale or disposition if (a) the transfer of nonperforming assets to the new entity provides for recourse by the new entity to the transferor financial institution, (b) the financial institution directly or indirectly guarantees debt of the new entity in whole or in part, (c) the financial institution retains a participation in the rewards of ownership of the transferred assets, for example through a higher than normal incentive or other management fee arrangement,39 or (d) the fair value of any material non-cash consideration received by the financial institution (for example, a note or other redeemable instrument) cannot be reasonably estimated. Additionally, the staff believes that the accounting for the transfer as a sale or disposition generally is not appropriate where the financial institution retains rewards of ownership through the holding of significant residual equity interests or where third party holders of such interests do not have a significant amount of capital at risk.

Where accounting for the transfer as a sale or disposition is not appropriate, the nonperforming assets should remain on the financial institution’s balance sheet and should continue to be disclosed as nonaccrual, past due, restructured or foreclosed, as appropriate, and the debt of the new entity should be recorded by the financial institution.

Question 2: If the transaction is accounted for as a sale to an unconsolidated party, at what value should the transfer be recorded by the financial institution?

Interpretive Response: The staff believes that the transfer should be recorded by the financial institution at the fair value of assets transferred (or, if more clearly evident, the fair value of assets received) and a loss recognized by the financial institution for any excess of the net carrying value40 over the fair value.41 Fair value is the amount that would be realizable in an outright sale to an unrelated third party for cash.42 The same concepts should be applied in determining fair value of the transferred assets, i.e., if an active market exists for the assets transferred, then fair value is equal to the market value. If no active market exists, but one exists for similar assets, the selling prices in that market may be helpful in estimating the fair value. If no such market price is available, a forecast of expected cash flows, discounted at a rate commensurate with the risks involved, may be used to aid in estimating the fair value. In situations where discounted cash flows are used to estimate fair value of nonperforming assets, the staff would expect that the interest rate used in such computations will be substantially higher than the cost of funds of the financial institution and appropriately reflect the risk of holding these nonperforming assets. Therefore, the fair value determined in such a way will be lower than the amount at which the assets would have been carried by the financial institution had the transfer not occurred, unless the financial institution had been required under GAAP to carry such assets at market value or the lower of cost or market value.

Question 3: Where the transaction may appropriately be accounted for as a sale to an unconsolidated party and the financial institution receives a note receivable or other redeemable instrument from the new entity, how should such asset be disclosed pursuant to Item III C, “Risk Elements,” of Industry Guide 3? What factors should be considered related to the subsequent accounting for such instruments received?

Interpretive Response: The staff believes that the financial institution may exclude the note receivable or other asset from its Risk Elements disclosures under Guide 3 provided that: (a) the receivable itself does not constitute a nonaccrual, past due, restructured, or potential problem loan that would require disclosure under Guide 3, and (b) the underlying collateral is described in sufficient detail to enable investors to understand the nature of the note receivable or other asset, if material, including the extent of any over-collateralization. The description of the collateral normally would include material information similar to that which would be provided if such assets were owned by the financial institution, including pertinent Risk Element disclosures.

The staff notes that, in situations in which the transaction is accounted for as a sale to an unconsolidated party and a portion of the consideration received by the registrant is debt or another redeemable instrument, careful consideration must be given to the appropriateness of recording profits on the management fee arrangement, or interest or dividends on the instrument received, including consideration of whether it is necessary to defer such amounts or to treat such payments on a cost recovery basis. Further, if the new entity incurs losses to the point that its permanent equity based on GAAP is eliminated, it would ordinarily be necessary for the financial institution, at a minimum, to record further operating losses as its best estimate of the loss in realizable value of its investment.43

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38 [Original footnote removed by SAB 114.]

39 The staff recognizes that the determination of whether the financial institution retains a participation in the rewards of ownership will require an analysis of the facts and circumstances of each individual transaction. Generally, the staff believes that, in order to conclude that the financial institution has disposed of the assets in substance, the management fee arrangement should not enable the financial institution to participate to any significant extent in the potential increases in cash flows or value of the assets, and the terms of the arrangement, including provisions for discontinuance of services, must be substantially similar to management arrangements with third parties.

40 The carrying value should be reduced by any allocable allowance for credit losses or other valuation allowances. The staff believes that the loss recognized for the excess of the net carrying value over the fair value should be considered a credit loss and this should not be included by the financial institution as loss on disposition.

41 The staff notes that FASB ASC paragraph 942-810-45-2 (Financial Services — Depository and Lending Topic) provides guidance that the newly created “liquidating bank” should continue to report its assets and liabilities at fair values at the date of the financial statements.

42 FASB ASC paragraph 845-10-30-14 (Nonmonetary Transactions Topic) provides guidance that an enterprise that distributes loans to its owners should report such distribution at fair value.

43 Typically, the financial institution’s claim on the new entity is subordinate to other debt instruments and thus the financial institution will incur any losses beyond those incurred by the permanent equity holders.

SAB Topic 5.V addresses transfers of nonperforming assets, including foreclosed real estate. While SAB Topic 5.V discusses a transfer of nonperforming assets by a financial institution that is an SEC registrant, we believe that this guidance is relevant for all entities, including nonregistrants. It should also be considered for transfers of performing financial assets that are not within the scope of ASC 860-10. However, SAB Topic 5.V does not apply to a transfer of real estate that is within the scope of other guidance (e.g., ASC 610-20).

SAB Topic 5.V is intended to prevent an entity from derecognizing financial assets in certain situations not addressed by ASC 860-10. Without SAB Topic 5.V, entities could potentially conclude that in the absence of specific U.S. GAAP applying to a particular transaction, derecognition may be achieved even though the transferor has retained substantial risks and rewards related to the transferred financial assets. Unlike the control model in ASC 860-10, the model in SAB Topic 5.V is a risks-and-rewards derecognition model.

To determine whether SAB Topic 5.V applies, entities should perform the following steps:

Step 1 — Determine whether the transfer is within the scope of ASC 860-10 or other U.S. GAAP.

SAB Topic 5.V does not override ASC 860-10 but only applies if a transfer is not within the scope of ASC 860-10. As discussed in SAB Topic 5.V, ASC 860-10 does not apply to (1) “distributions of financial assets to shareholders” (see Section 2.4.4.1) or (2) “a contribution of [financial] assets to unrelated third parties” (see Section 2.4.2). Thus, SAB Topic 5.V does not apply to a transfer of financial assets in which the transferor receives a beneficial interest in the transferred financial assets and the only other investors in the transferred financial assets are third parties. SAB Topic 5.V also does not apply if an entity transfers nonperforming loans to an SPE, receives the residual interest in the SPE, and then transfers that interest to a third party. SAB Topic 5.V only applies in limited situations. For example, SAB Topic 5.V would apply if an entity transfers financial assets to an SPE, distributes all the beneficial interests in the SPE to its shareholders (or contributes those beneficial interests to a third party), and has continuing involvement with the SPE such as a guarantee or a profit participation interest.

If a transfer of financial assets is within the scope of ASC 860-10, an entity should apply ASC 860-10-40-5 to determine whether the transfer qualifies for sale accounting.13 If a transfer includes foreclosed real estate, an entity applies ASC 610-20 to determine whether those assets qualify for derecognition. If a transfer involves a contract for which substantially all of the assets being transferred are nonfinancial assets (i.e., real estate), any loan receivables included in the transfer are considered in-substance nonfinancial assets and the guidance in ASC 610-20 applies.

Connecting the Dots

A transfer of financial assets that would qualify for derecognition under SAB Topic 5.V should not be accounted for as a sale on the basis of that guidance if the transfer is within the scope of ASC 860-10. That is, SAB Topic 5.V does not override the application of ASC 860-10. However, even when ASC 860-10 applies, an entity may find the disclosure guidance in Question 3 of SAB Topic 5.V relevant.
Step 2 — If the transaction is not within the scope of ASC 860-10 or other U.S. GAAP, apply SAB Topic 5.V.
The transferor would apply SAB Topic 5.V (to determine whether derecognition of the transferred financial assets is appropriate) only if the transfer is not within the scope of ASC 860-10 or other U.S. GAAP. For transactions within the scope of SAB Topic 5.V, the transferor should consider the following five factors related to the risks and rewards of ownership of the transferred financial assets:
- The transferee has recourse to the transferor.
- The transferor directly or indirectly guarantees the debt of the transferee in whole or in part.
- The transferor retains a participation in the rewards of ownership of the transferred financial assets (e.g., higher than normal incentive, management, or servicing fees).
- The fair value of any noncash consideration received by the transferor in return for the transferred financial assets is not reasonably estimable.
- The transferor retains ownership through holding a significant residual equity interest in the transferred financial assets, or third-party holders of such interests do not have a significant amount of capital at risk.
The existence of any of these factors creates a rebuttable presumption that the risks and rewards of ownership have not been transferred and therefore that the transferred financial assets should not be derecognized.
Step 3 — If the transaction qualifies for derecognition under SAB Topic 5.V, apply ASC 810.

When SAB Topic 5.V is applicable, the transferor must still consider whether it is required to consolidate the transferee under ASC 810. Many of the “risks and rewards” considerations in SAB Topic 5.V are also relevant under the VIE consolidation accounting model in ASC 810. If consolidation is required, the transferor may not derecognize the transferred financial assets. Note that steps 2 and 3 can be evaluated in reverse order since the conditions in both steps must be met for an entity to derecognize transferred financial assets subject to SAB Topic 5.V.

Note that SAB Topic 5.V is intended to prevent derecognition of certain transactions involving financial assets that are not specifically addressed by ASC 860-10. SAB Topic 5.V is not intended to allow for derecognition in transactions that are within the scope of ASC 860-10 and that must be accounted for as a secured borrowing.

Example 2-8

Transfer of Nonperforming Loans to a Liquidating Bank

Entity K has a substantial amount of nonperforming loan receivables. As a result, K transfers those receivables to a newly created bank, L, whose stock will be distributed to K’s common stockholders. Entity L is a liquidating bank that will manage the loan receivables received and collect cash from loan repayments or disposition of assets, including any collateral securing the loan receivables. All cash remaining after expenses are paid and liabilities are serviced will be distributed to K’s common stockholders.

In addition to transferring the nonperforming loan receivables to L, K (1) makes a cash contribution to L so that it has initial capital to pay any expenses that are incurred in servicing the transferred financial assets and (2) provides a line of credit to L, which L can use if it needs additional cash to service the loan receivables. In return for the transfer of the loan receivables, cash contribution, and extension of credit, K retains a 20 percent profits interest in L.

The transfer of the loan receivables by K to L is not within the scope of ASC 860-10 because it involves a distribution of noncash financial assets to K’s owners. Since ASC 860-10 does not apply, K must consider the guidance in SAB Topic 5.V. In accordance with that guidance, K has retained significant risks and rewards of ownership of the transferred financial assets. Entity K has retained a risk of ownership through the extension of credit to L. Entity K has retained a reward of ownership through the profits interest in L. As a result of the retention of significant risks and rewards of ownership of the transferred financial assets, K may not derecognize those assets in accordance with SAB Topic 5.V.

2.4.5 Employee Benefit Plans

ASC 860-10-15-4(g) states that “[e]mployee benefits subject to the provisions of Topic 712” are not within the scope of ASC 860-10.

2.4.6 Certain Lease Transactions

ASC 860-10-15-4(h) and (i) indicate that ASC 860-10 does not apply to leveraged leases and money-over-money leases that are accounted for under ASC 842 (or ASC 840 for entities that have not adopted ASC 842).

Footnotes

ASC 860-10 does apply to the financial assets transferred as part of a transfer of a portfolio of financial assets and liabilities that does not meet the definition of a business.

Although the definition of a transfer may not seem applicable to a transfer of an ownership interest in a consolidated subsidiary because that ownership interest is not a financial asset, the guidance in ASC 860-10 on transfers of financial assets applies because the transfer is viewed from the perspective of the financial assets within the consolidated subsidiary as opposed to the transfer of the consolidated subsidiary itself.

In accordance with ASC 860-10-40-4(a), a transferor must first consider whether the transferee must be consolidated by the transferor.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.