5.4 Examples

Transfer of Loan Receivables for Cash in a Secured Borrowing — Transferor’s and Transferee’s Accounting

On February 1, 20X2, Entity A transfers a portfolio of consumer loan receivables, carried at amortized cost, to Entity B, a third party, on a nonrecourse basis. The transfer does not qualify for sale accounting because A has a unilateral right to repurchase any of the transferred consumer loans at a purchase price equal to 105 percent of the unpaid principal amount. Therefore, the transfer is accounted for as a secured borrowing. The following are key details of the transfer:

• Carrying amount of loans: $25 million.
• Principal amount of loans: $25 million.
• Proceeds from transfer: $26 million.

Entity A should recognize the transfer as follows:

No gain or loss is recognized by A as of the transfer date. Entity A continues to recognize the transferred consumer loans and should not change the subsequent accounting for them (i.e., the loans would continue to be subsequently measured at amortized cost). Interest income and an allowance for credit losses should continue to be recognized on the consumer loans. Entity A should separately account for the liability for the secured borrowing. If A does not elect the FVO, it should apply ASC 835-30 and amortize the premium on the initial recorded amount (i.e., $1 million) so that the liability equals its principal amount on maturity of the consumer loans. Entity A should also recognize interest expense on the liability on the basis of the stated interest on the consumer loans. This liability should only be derecognized when one of the conditions in ASC 405-20-40-1 is met (e.g., A may not derecognize the liability upon the occurrence of a default or write-off of the consumer loans).

Entity B should recognize the transfer as follows:

Entity B should not recognize the consumer loans as assets because the transfer is not accounted for as a sale. Rather, B recognizes a receivable from A and should apply other applicable U.S. GAAP to subsequently account for this receivable. For example, B could elect the FVO for the receivable or account for it at amortized cost. If the FVO is not elected, B should recognize interest income on the receivable by using the interest method and should record an appropriate allowance for credit losses.

On April 15, 20X2, Entity C transfers a portfolio of mortgage loan receivables, carried at amortized cost, to a securitization entity on a nonrecourse basis. The transfer does not qualify for sale accounting because C has a unilateral right to repurchase any of the transferred loans at a purchase price equal to 105 percent of the unpaid principal amount. As a result, C accounts for the transfer as a secured borrowing with a pledge of collateral. The following are key details of the transfer:

• Carrying amount of loans: $100 million.
• Principal amount of loans: $100 million.
• Proceeds from transfer: $75 million in cash and a $25 million subordinated beneficial interest in the transferred mortgage loan receivables.

Entity C should recognize the transfer as follows:

No gain or loss is recognized by C as of the transfer date. Entity C should not recognize the beneficial interest in the transferred mortgage loans as an asset. Under ASC 860-30, the $100 million of transferred mortgage loans represents the collateral pledged in a secured borrowing. It would be inappropriate for C to recognize a beneficial interest in the transferred mortgage loans as an asset because this instrument represents an interest in the $100 million mortgage loans that remain on C’s balance sheet. If C recognized the beneficial interest as an asset, it would count the same asset twice because the source of cash flows on the beneficial interest is the cash collections on the mortgage loans that remain recognized by C.

Entity C should not change the subsequent accounting for the transferred mortgage loans (i.e., they would continue to be subsequently measured at amortized cost). Interest income and an allowance for credit losses should continue to be recognized on the loans. Entity C should separately account for the liability for the secured borrowing and should recognize interest expense on the liability on the basis of the stated interest on the mortgage loans. Entity C should only derecognize this liability when one of the conditions in ASC 405-20-40-1 is met (e.g., C may not derecognize the liability upon the occurrence of a default or write-off of the mortgage loans).

Entity D transfers mortgage loan receivables, carried at amortized cost, to a consolidated securitization entity. The transfer does not meet the conditions for sale accounting because the transferee is consolidated by D. Entity D should continue to recognize the mortgage loan receivables at amortized cost along with an appropriate allowance for credit losses. Entity D cannot consider the existence of the secured borrowing in estimating the allowance for credit losses (i.e., the secured borrowing is not a form of collateral on the mortgage loan receivables).

Entity D is not eligible to apply the FVO as of the transfer date. Furthermore, D cannot recharacterize the mortgage loan receivables as securities because the transfer is not accounted for as a sale. That is, D continues to recognize the mortgage loan receivables; it does not recognize a beneficial interest issued by the securitization entity as an asset. Entity D should not change the carrying amount of the mortgage loans or the subsequent accounting for them as a result of the transfer.

Note that ASC 820-10-15-3(ee) contains a practicability exception related to the initial and subsequent measurement of “[f]inancial assets or financial liabilities of a consolidated [VIE] that is a collateralized financing entity [(CFE)] when the financial assets or financial liabilities are measured using the measurement alternative in paragraphs 810-10-30-10 through 30-15 and 810-10-35-6 through 35-8.” When a CFE meets the scope requirements in ASC 810-10-15-17D and this measurement alternative is elected, the entity measures both the financial assets and the financial liabilities of the CFE by using the more observable of the fair value of the financial assets or the fair value of the financial liabilities. The fair value measurement guidance in ASC 820 applies to the more observable of the fair value of the financial assets or the fair value of the financial liabilities. This use of the FVO applies only to the financial assets and financial liabilities of a consolidated CFE. It does not apply to secured borrowings that do not reflect transfers to CFEs. Furthermore, an entity may apply this practicability exception to financial assets transferred to a CFE only if they were measured at fair value, with changes in fair value recognized in earnings, before the transfer to the CFE.

Subsequent Accounting for Mortgage Loan Receivables Transferred in a Secured Borrowing — Transferee’s Accounting

On August 31, 20X4, Entity E enters into a loan purchase agreement to acquire $115 million of residential mortgage loans from Entity F, a third party. A sister company of F services the mortgage loans in addition to providing E with a guarantee of the timely payment of principal and interest on the loans. Entity F further agrees to repurchase any transferred mortgage loans upon the occurrence of a breach of certain representations and warranties made by F as part of the sale.

Because of the credit loss protection provided by F and its sister entity, the transfer does not meet the legal isolation condition in ASC 860-10-40-5(a). That is, E does not absorb credit risk on the transferred mortgage loans as a result of the guarantees provided in the transaction. (Note that since the sister company of F is an affiliate of F, its involvement in the transfer must be included in the accounting analysis.) Since the transfer does not meet the conditions to be accounted for as a sale by F, E is not allowed to recognize the mortgage loan receivables. Rather, E must recognize a loan receivable from F as the offsetting entry for the amount paid to F. As discussed in Section 5.1, ASC 860-10’s sale accounting requirements are symmetrical. If the transferor does not meet the conditions for sale accounting, it cannot derecognize the transferred financial assets and the transferee therefore cannot recognize those assets.

Subsequent Accounting for Undivided Interests in Defaulted Credit Card Loan Receivables — Transferee’s Accounting

Entity G acquires from Entity H undivided interests in delinquent credit card receivables for which the customer’s ability to draw additional amounts has been terminated. The purchase price paid represents 10 percent of the stated amounts due because significant credit losses are expected. The transfer of the subordinated undivided interests from H to G does not meet the conditions for sale accounting because the interests transferred are not participating interests. As a result, G recognizes a receivable from H rather than recognizing an interest in the credit card receivables.

Entity G should not recognize interest income on its receivable from H in accordance with ASC 310-30’s guidance on purchased credit-impaired assets (or ASC 326-20’s guidance on purchased deteriorated assets, for entities that have adopted ASU 2016-13) because the receivable recognized is not a purchased asset. Rather, G’s asset is considered to have been a receivable originated with H. Entity G also should not apply ASC 325-40 to recognize interest income since its recognized receivable is not a beneficial interest in securitized financial assets.

Entity G determines that ASC 310-20 applies to its receivable from H. In applying ASC 310-20, G determines that it is not appropriate to recognize interest income on the basis of contractual cash flows (i.e., the contractual amounts due on the underlying credit card receivables) because those amounts are not expected to be collected. As a result, G applies the cost recovery method to subsequently account for its receivable. Entity G also periodically assesses the carrying amount of the receivable for credit losses and recognizes an appropriate allowance for them.

Entity B transfers an equity security to a third party as collateral for a loan that must be repaid in 10 years. In accordance with the sale agreement, the transferee is unable to pledge or exchange the equity security received without B’s consent, which may be withheld for any reason. As a result, B does not meet the conditions for sale accounting. In conjunction with the transfer of the equity security, B grants the transferee an option that allows it to put the transferred equity security back to B at a fixed price at any time for the next 10 years. The put option must be net-cash-settled. The settlement of the put option does not affect B’s obligation to repay the loan.

Entity B should recognize a derivative liability for the put option. The scope exception in ASC 815-10-15-63 does not apply because the recognition of the transferred equity security and the put option whose underlying is the transferred equity security does not cause the same asset to be counted twice. Recognizing a liability for the put option does not result in counting the same market risk exposure arising from the equity security twice because B is exposed to changes in the fair value of the equity security from both its continued holding of the equity security and its obligation to net-cash-settle the written put option. That is, if the transferee decides to exercise the put option, B is still required to repay the loan.

Note that ASC 860-10-15-63 would also not apply in similar situations if, in lieu of writing a net-cash-settleable put option on transferred financial assets, an entity wrote a net-cash-settleable total return swap on transferred financial assets or entered into a net-cash-settleable call option on transferred financial assets. In these cases, the settlement of the derivatives over the transferred financial assets does not result in the settlement of the secured borrowing related to the loan that is secured by the transferred financial assets.

Securities Lending Transaction With Noncash Collateral — Transferor and Transferee Accounting

On June 1, 20X1, Entity A lends ABC securities, classified as trading, to Entity B for 60 days. In return for borrowing the ABC securities, B pledges U.S. Treasury securities, classified as trading, to A. Entity A has the right to sell the U.S. Treasury securities, and Entity B has the right to sell the ABC securities. In 60 days, B must return the ABC securities to A and can redeem the U.S. Treasury securities from A. Entity B must also pay $30,000 to A as a fee for borrowing the ABC securities. On June 1, 20X1, the fair values are as follows:

• ABC securities: $10,000,000.
• U.S. Treasury securities: $10,500,000.

On June 1, 20X1, A sells the U.S. Treasury securities to a third party for $10.5 million and incurs a transaction cost of $25,000. In addition, B sells the ABC securities for $10 million and incurs a transaction cost of $25,000. On June 30, 20X1, the fair values are as follows:

• ABC securities: $10,500,000.
• U.S. Treasury securities: $10,600,000.

For simplicity, it is assumed that no additional collateral postings are required for this securities lending transaction.

On July 31, 20X1, the fair values are as follows:

• ABC securities: $10,600,000.
• U.S. Treasury securities: $10,400,000.

Entity A incurs a transaction cost of $25,000 to repurchase the U.S. Treasury securities, and B incurs a transaction cost of $25,000 to repurchase the ABC securities.

Entity A should account for the above transaction as follows (note that, for simplicity, this example does not show the periodic accrual of fee income or expense):

Note that in this example, A sold the U.S. Treasury securities received as collateral. If A had not sold the U.S. Treasury securities, it would have recognized them as an asset and reflected interest income on these securities.

Entity B should account for the above securities lending transaction as follows:

Customer Securities Loaned to a Third Party

On March 1, 20X2, Entity C, a broker-dealer, executes the following trades for a customer:

• DEF stock — 500,000 shares at $20 per share ($10,000,000 total purchase price).
• XYZ stock — 200,000 shares at $100 per share ($20,000,000 total purchase price).

Of the total $30 million purchase price, $10 million is purchased on margin. For simplicity, assume that no commissions are charged on the stock purchase transactions.

Entity C recognizes the following for the margin loan made:

On March 15, 20X2, C lends 100,000 shares of XYZ stock to a third party. In return, C receives cash collateral of $10.5 million. Entity C should recognize the following entries:

When an entity lends an owned security, it does not derecognize the security unless the borrower defaults on the terms of the secured contract. However, when the security loaned is not owned, a receivable is recognized along with an offsetting obligation to return the security to the customer. In this transaction, C has recognized a receivable from and a payable to the borrower. Since the transaction will be settled on a gross basis, the conditions in ASC 210-20 for offsetting would not be met.

Entity D, a broker-dealer, maintains custody of securities for a customer that has an outstanding margin loan with D. The securities include U.S. Treasury securities. On May 15, 20X4, D enters into a securities lending transaction with a third party. In this transaction, D borrows a publicly traded stock that has a fair value of $25 million. As collateral, D pledges U.S. Treasury securities owned by the customer that have a fair value of $26 million.

Entity D should recognize the following entry:

Typically, when an entity borrows securities in return for pledging noncash collateral, the borrower does not recognize an entry at inception of the securities lending arrangement. However, when an entity pledges a customer’s security as collateral in a securities lending transaction, it must recognize an obligation to return the customer’s security. An offsetting entry is recognized to reflect the lender’s obligation to return that pledged security (i.e., a receivable from the lender). Entity D would not recognize the security itself as an asset because the security is owned by the customer and is not considered the proceeds in the lending arrangement.