Securitisation – revolving structure

This is an illustration of how derecognition is applied in practice. The objective is to present the mechanics of applying the IFRS 9 requirements for derecognition of financial assets, starting with an analysis of the transaction using the flowchart [IFRS 9 B3.2.1], and culminating with the initial and subsequent accounting entries for both the transferor and transferee.

Background and assumptions

Bank N assigns €100 million of its credit card receivables to a Special Purpose Vehicle (SPV) on a revolving basis for five years. The SPV is formed for the purpose of this securitisation; its activities are limited to holding the credit card receivables, issuing notes to investors and associated activities. To fund the assignment of receivables, the SPV issues both senior (€90 million) and subordinated (€10 million) floating-rate notes. Third-party investors purchase the senior notes from the SPV. N purchases the subordinated notes from the SPV. Each month when cash is collected from the receivables, the interest element collected is used to pay interest on the notes, and any principal collected is reinvested in new receivables. At the end of five years, the notes mature and the principal is repaid from the collections on the receivables. The senior notes are paid first, and only if there is sufficient collections will the subordinated note be repaid.

During the five years, the SPV cannot sell or pledge the credit card receivables.

The average level of default on the revolving pool of the credit card receivables over the five years is 5%.

Additional information:

  • Fair value of credit card receivables on date of transfer – €100 million
  • Carrying value of portfolio of receivables on date of transfer – €100 million
  • Credit card receivables are not considered cash and cash equivalents and are accounted for as assets at fair value through profit or loss under IFRS 9

Analysis using the flowchart [IFRS 9 B3.2.1]

Step 1 Consolidate all subsidiaries

For the purposes if this illustration, it is assumed the SPV is consolidated because in substance bank N controls the SPV. The activities of the SPV are conducted on behalf of N according to its specific business needs, and N retains the majority of the residual or ownership risks of the SPV through holding the subordinated note.

Step 2 Determine whether the derecognition model should be applied to part of a financial asset (or a group of similar financial assets) or a financial asset (or a group of similar financial assets) in its entirety.

The financial instruments being transferred have similar characteristics. They are all credit card receivables. They should be assessed as a group of similar financial assets in their entirety.

Step 3 Have the rights to the cash flows expired?

No, the portfolio of receivables has not yet matured so the rights to the cash flows still exist.

Step 4 Is there a transfer?

As the SPV is consolidated by bank N, there is no outright transfer of the contractual rights to the cash flows under IFRS 9 3.2.4 (a). Hence N Group (including the SPV) should assess whether it meets the pass-through requirements.

  • Test (a) passed – N Group has no obligation to pay amounts to the eventual recipients (investors in the notes) unless it collects equivalent amounts from the credit card receivables.
  • Test (b) passed – N Group is prohibited by the terms of the transfer contract from selling or pledging the receivables other than as security to the investors for the obligation to pay them cash flows.
  • Test (c) failed – N Group does not have an obligation to remit any cash flows it collects on behalf of the investors without material delay, as the principal is not repaid until year five. In addition, N Group is entitled to reinvest such cash flows in future credit card receivables and not just in cash or cash equivalents.

N therefore fails the pass-through requirements and should continue to recognise the receivables.

Transferor’s accounting

On the date of the transfer

As bank N failed the pass-through tests, it cannot derecognise the receivables. It will recognise the notes issued by the SPV as collateralised borrowings. It does not recognise the subordinated notes issued by the SPE that it has purchased, as from the consolidated entity’s perspective those notes are inter-company and hence are eliminated.

Accounting entries on the date of the transfer

(in € millions)

DR

CR

Cash Securitisation – revolving structure

90

Senior notes issued Securitisation – revolving structure

90

To recognise the notes issued to third-party investors.

Subsequently, bank N will account for the credit card receivables as it did prior to the transfer, at amortised cost using the effective interest method. N will account for the issued note also at amortised cost using the effective interest method.

Transferee’s accounting

On the date of the transfer

As the transfer did not meet the derecognition requirements, the investors cannot recognise the credit card receivables. They will instead recognise an asset for the asset-backed (collateralised) notes issued from the SPV.

Accounting entries on the date of the transfer

(in € millions) Securitisation – revolving structure

DR

CR

Cash Securitisation – revolving structure

90

Asset backed securities Securitisation – revolving structure

90

To record the purchase of the asset backed securities issued by the SPV.

Subsequently, the investors will account for the securities as either assets at amortised costs (if they are not quoted in an active market) or at fair value through profit or loss depending on the facts and circumstances and chosen classification.

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