Many securitization transactions involve the transfer of financial assets to a limited-purpose entity through one or multiple steps. Beneficial interests are formed when a special purpose entity issues various interests in security form (hence the term “securitization”) to third parties. The interests entitle the third parties to the cash flows generated by the securitization entity’s underlying financial assets.
Beneficial interests can involve cash flow and risk profiles that differ from other investments. As a result, certain beneficial interests are required to follow the more specialized accounting model in ASC 325-40
. Beneficial interest that do not fall within the scope of ASC 325-40
may be accounted for as:
, Transfers and servicing
, defines beneficial interests.
Definition from ASC 860-10-20
Beneficial Interests: Rights to receive all or portions of specified cash inflows received by a trust or other entity, including, but not limited to, all of the following:
- Senior and subordinated shares of interest, principal, or other cash inflows to be passed-through or paid-through
- Premiums due to guarantors
- Commercial paper obligations
- Residual interests, whether in the form of debt or equity
Beneficial interests can take many different forms, ranging from debt securities to equity interests issued by a limited partnership or LLC. Examples of beneficial interests in securitizations include mortgage-backed securities, asset-backed securities, credit-linked notes, collateralized debt obligations, and interest-only (IO) or principal-only (PO) strips. The primary investors in beneficial interests in securitizations are insurance companies, banks, broker-dealers, hedge funds, pension funds, and other individuals or companies that maintain a significant investment or trading portfolio. Corporate treasury groups may also invest in beneficial interests. For example, many corporations invest in mortgage-backed securities guaranteed by government-sponsored enterprises such as Freddie Mac or Fannie Mae.
Beneficial interests should be evaluated to determine whether they meet the definition of a derivative in ASC 815
. Beneficial interests that are not derivatives in their entirety should also be evaluated to determine whether they contain embedded derivatives that should be accounted for separately. See DH 4.4.6
for guidance on determining whether beneficial interests contain embedded derivatives that should be bifurcated from the host contract. ASC 815
provides an exception to derivative accounting for certain IO and PO strips, but the scope exception is limited to the most basic IO and PO instruments. See DH 3.2.12
for guidance on applying the scope exception for IO and PO instruments.
Certain beneficial interests in securitizations that are not derivatives within the scope of ASC 815
are accounted for like debt securities under ASC 320
, as detailed in ASC 860-20-35-2
Financial assets, except for instruments that are within the scope of Subtopic 815-10, that can contractually be prepaid or otherwise settled in such a way that the holder would not recover substantially all of its recorded investment shall be subsequently measured like investments in debt securities classified as available for sale or trading under Topic 320. Examples of such financial assets include, but are not limited to, interest-only strips, other beneficial interests, loans, or other receivables. Interest-only strips and similar interests that meet the definition of securities are included in the scope of that Topic. Therefore, all relevant provisions of that Topic (including the disclosure requirements) shall be applied. See related implementation guidance beginning in paragraph 860-20-55-33.
The term “substantially all” is not defined in ASC 860
. However, based on other accounting literature, “substantially all” is generally interpreted in practice to mean 90% of the investment. Financial assets that can be contractually prepaid or otherwise settled in a way that would prevent the holder from recovering substantially all of its recorded investment often contain embedded derivatives that should be accounted for separately in accordance with the guidance in ASC 815
. See DH 4
for additional information on embedded derivatives. When an embedded derivative is bifurcated, the applicable accounting guidance for beneficial interests would be applied to the host instrument.
requires accounting consistent with ASC 320
even if the financial instrument is not within the scope of that Topic (e.g., non-certificated beneficial interests). Subsequent changes in the fair value of these financial assets should also be recognized in accordance with ASC 320
(through OCI for available-for-sale securities and through net income for trading securities). Because these securities can be contractually prepaid or settled in a manner in which the investor would not recover substantially all of its recorded investment, they may not be classified as held to maturity.