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4.3 Re-recognition of financial assets previously sold
Publication date: 30 Sep 2020
us Transfers of financial assets guide
Events may occur that result in a transferor regaining control over a previously-derecognized financial asset. If so, ASC 860 requires that the transferor re-recognize the transferred financial asset on its balance sheet, with corresponding derecognition by the transferee.
4.3.1 Re-recognition of a financial asset
ASC 860-20-25-8 provides guidance on the re-recognition of a transferred financial asset.
Paragraph 860-10-40-41 explains that a change in law or other circumstance may result in a transferred portion of an entire financial asset no longer meeting the conditions of a participating interest (see paragraph 860-10-40-6A) or the transferor’s regaining control of transferred financial assets after a transfer that was previously accounted as a sale, because one or more of the conditions in paragraph 860-10-40-5 are no longer met.
A transferor is considered to have regained control over transferred financial assets if the transaction no longer satisfies all of the sale accounting conditions in ASC 860-10-40-5. A wide array of events can potentially trigger this outcome. For example:
- Amendments to the underlying transfer agreement obligate the transferor to provide additional recourse to the transferee. As a consequence, the transfer no longer satisfies the legal isolation criterion, based on counsel’s updated true sale analysis.
- Changes in law or regulations, or developments in case law, subsequent to the transfer lead to a conclusion that the legal isolation criterion is no longer met.
- Amendments to the underlying transfer agreement impose various constraints on the transferee’s ability to pledge or exchange the acquired asset to the extent that the condition in ASC 860-10-40-5(b) is no longer satisfied.
- A contingent event has occurred, thereby allowing a transferor to re-acquire a transferred asset in accordance with a removal-of-accounts provision in the underlying transfer agreement (see TS 4.3.3 for information on ROAPs).
In addition, ASC 860-10-40-41 states that a transferred portion of a financial asset that no longer meets the conditions of a participating interest is also subject to ASC 860’s re-recognition provisions. A transferred participating interest may subsequently fail to meet the criteria in ASC 860-10-40-6A as a consequence of the transferor selling, at a later date, another portion that does not satisfy the participating interest rules. Example TS 4-5 illustrates this guidance.
EXAMPLE TS 4-5
Re-recognition of a transferred financial asset
Re-recognition of a transferred financial asset
In 20X1, Bank Co transfers a 50% interest in a commercial loan to Investor A. The transferred interest meets both the participating interest criteria and the conditions for derecognition under ASC 860. Accordingly, Bank Co reports the transfer as a sale in its 20X1 financial statements.
In 20X2, Bank Co transfers a 30% interest in the same loan to Investor B. The participation agreement executed between the parties provides that, in the event of a payment default by the loan obligor, Bank Co and Investor B will share all subsequent cash collections disproportionately. Thus the interest sold to Investor B and the portion retained by Bank Co each do not qualify as participating interests. Investor A’s pro rata entitlement to 50% of the underlying loan’s cash flows remains unchanged in accordance with the previously-executed participation agreement.
What implications, if any, does Bank Co’s transaction with Investor B have on Bank Co’s accounting for the interest previously sold to Investor A?
Analysis
In accordance with ASC 860-10-40-6A(a) and ASC 860-10-40-6A(b), as long as a transferred portion of an entire financial asset remains outstanding, each portion (including the portion retained by the transferor) must continue to meet the characteristics of a participating interest for the transferred interest to qualify for derecognition. If at any time a transferred portion no longer satisfies the participating interest rules, the transfer must be re-characterized as a secured borrowing transaction.
In this example, prior to Bank Co’s transfer of the 30% interest to Investor B, the participation sold to Investor A, and the portion retained by Bank Co, each qualified as participating interests. However, neither the participation sold to Investor B nor the interest retained by Bank Co qualify as participating interests, as the two parties will not share cash inflows from the loan on a proportionate basis if the loan obligor defaults. Thus, the condition in ASC 860-10-40-6A(b) is no longer met. As a consequence, the participation held by Investor A no longer qualifies as a participating interest (as its interest is, effectively, now senior to the interest retained by Bank Co in the event of the loan obligor’s default). As a result, Bank Co must re-recognize on its balance sheet the interest previously transferred to Investor A.
4.3.2 Re-recognition accounting–measurement principles
ASC 860-20-25-9 stipulates that changes cited in ASC 860-20-25-8 have accounting implications for a transferor and transferee.
Such changes shall be accounted for in the same manner as a purchase of the transferred financial assets from the former transferee(s) in exchange for liabilities assumed unless they arise solely from either:
- Consolidation of an entity involved in the transfer at a subsequent date (see paragraph 860-20-25-10)
- A change in market prices (for example, an increase in price that moves into the money a freestanding call option on a non-readily-obtainable, transferred financial asset that was originally sufficiently out of the money that it was judged not to constrain the transferee).
If an event occurs that results in a transferor regaining control over a transferred financial asset (or, if a transferred portion no longer qualifies as a participating interest), the transferor is required to record the asset (or portion) on its balance sheet at its current fair value, along with a corresponding liability to the transferee. ASC 860-20-25-10 provides guidance for the transferor’s re-recognition accounting, both at initial recognition and thereafter. The transferor is required to:
- Recognize on its balance sheet the transferred financial assets together with the liabilities to the former transferee (or beneficial interest holders of the former transferee).
- Introduce no changes in the accounting for any servicing asset related to the now re-recognized financial assets. Although the transferor may have re-recognized all or certain of the serviced financial assets for financial reporting purposes, the transferor remains contractually obligated to service the assets on behalf of the transferee and its beneficial interest holders in exchange for a fee. The servicing asset should continue to be measured and reported separately.
- Continue to account for any other interests in the transferred financial assets separate and apart from the re-recognized assets. Any such interests in the transferred assets should continue to be measured and reported in accordance with applicable GAAP. Those interests, and the rerecognized financial assets, represent separate units of account.
This guidance also applies if the re-recognized asset consists of a transferred portion of an entire financial asset that no longer qualifies as a participating interest.
In addition, the transferor should measure an allowance for credit losses in accordance with ASC 326, if applicable. ASC 860-20-25-13 explains that for assets that are not purchased credit deteriorated (PCD) financial assets, the transferor recognizes the allowance for credit losses with a corresponding charge to credit loss expense. For assets that are PCD assets within the scope of ASC 326, the transferor recognizes an allowance with a corresponding increase to the amortized cost basis of the asset (see LI 9).
4.3.3 Re-recognition accounting–ROAPs
In many instances, re-recognition is attributable to a removal-of-account-provision (ROAP) becoming exercisable. Commonly seen in securitization transactions involving credit card receivables or mortgage loans, ROAPs allow a transferor to reclaim previously-transferred financial assets under certain circumstances. As discussed in TS 3.7.2.4, if the transferor’s right to reclaim is contingent upon a third-party action outside the control of the transferor that has yet to occur – for example, default by a transferred loan’s obligor – a ROAP would not preclude a transferor’s accounting for the transfer as a sale. However, if the third-party action or contingent event subsequently occurs that, in turn, permits the transferor to exercise the ROAP, the transferor has regained control over the transferred asset – a re-recognition event.
Given the prevalence of ROAPs, ASC 860 provides tailored guidance on how to apply its re-recognition provisions to these arrangements.
Whether the removal-of-accounts provision is exercised or not, the transferor shall recognize any financial assets subject to the removal-of-accounts provision if all of the following conditions are met:
- A third party’s action (such as default or cancellation) or decision not to act (expiration) occurs.
- The occurrence allows removal of assets to be initiated solely by the transferor.
- The provision provides a more-than-trivial benefit to the transferor.
For example, once a contingency is met (such as when a given loan goes into default), the call option on that asset (loan) is no longer contingent.
In our view, to conclude that a now-exercisable ROAP provides no more than a trivial benefit to a transferor would be rare.
As indicated in ASC 860-20-25-11, when a transferor can first exercise a ROAP, re-recognition of the underlying financial assets is required because the transferor has regained effective control over the previously-transferred financial assets. Under ASC 860’s control-based derecognition framework, whether the transferor intends to exercise the ROAP is irrelevant. In these circumstances, the transferor should record the financial assets at their current fair value, with a corresponding liability to the transferee.
ASC 860 does not address how a transferor should subsequently account for a re-recognized financial asset subject to a ROAP that has yet to be exercised. The transferor should account for the asset in accordance with GAAP and its accounting policies. For example, if re-recognition is triggered by a credit event (e.g., the underlying transferred loan goes into payment default), the transferor should consider whether the re-recognized loan is subject to the guidance in ASC 326 regarding purchased financial assets with credit deterioration (PCD assets – see LI 9). However, upon exercise of the ROAP (subsequent to recognizing the underlying financial asset), the consideration paid to reacquire the financial asset may differ from its current fair value. ASC 860-20-25-12 acknowledges that the transferor may record a gain or loss if the ROAP or similar contingent right is not accounted for as a derivative under ASC 815-10, and is not at the money when exercised. In these instances, the fair value of the repurchased asset will likely differ from the outlay required to settle the related obligation to the transferee.
Figure TS 4-1 summarizes the principal accounting guidance that a transferor may need to consider upon the occurrence of a re-recognition event.
Figure TS 4-1
Accounting for re-recognition events
Accounting for re-recognition events
Issue
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Guidance
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At re-recognition date (no contemporaneous re-acquisition of underlying financial asset) |
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How should a re-recognized financial asset and the corresponding liability be measured?
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Upon re-recognition, the financial asset should be measured at fair value, along with a corresponding liability. No gain or loss should be recognized.
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Upon re-recognition, should a loan-loss allowance be recognized for loans that do not meet the definition of a security?
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Yes. An allowance for credit losses should be recognized based on the requirements of ASC 326.
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What impact does re-recognition of a transferred financial asset have on a transferor’s accounting for any beneficial interests in the re-recognized asset?
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There is no change in the transferor’s separate accounting for its beneficial interests, including measurement of income and periodic assessments for impairment.
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How does re-recognition impact the accounting for any servicing asset or liability related to the re-recognized financial assets?
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There is no change in the accounting for the servicing asset or liability. Any such amounts should continue to be reported and remeasured separately.
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Re-acquisition of the underlying financial asset (subsequent to asset’s re-recognition) |
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When a ROAP or contingent call is exercised, should a gain or loss be recognized upon the reacquisition of the transferred financial assets?
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Yes, assuming the fair value of the repurchased asset differs from the consideration paid to settle the related obligation to the transferee. If the ROAP or contingent call is accounted for at fair value or is otherwise at-the-money, a gain or loss may not arise.
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What impact does re-acquisition of a transferred financial asset have on a transferor’s accounting for any beneficial interests in the re-recognized asset?
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It depends. If the beneficial interest consists entirely of an interest in the re-acquired financial asset, it should be re-combined with it. On the other hand, if the beneficial interest entitles the transferor to cash flows from assets that the transferee continues to hold, the beneficial interest should not be extinguished (recombined); rather, in that instance, the transferor should evaluate the impact that re-acquisition may have on the carrying amount of the beneficial interest and its estimated future cash flows.
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How does re-reacquisition impact the accounting for any servicing asset or liability related to the re-acquired financial assets?
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It depends. If re-acquisition results in cancellation of the servicing contract, the servicing asset or liability should be written off. On the other hand, if the servicing contract remains in effect, the transferor should continue to report and re-measure separately any servicing asset or liability. The impact that re-acquisition may have on estimated future servicing cash flows should also be evaluated when re-measuring the servicing asset or liability.
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Question TS 4-3 discusses the accounting if the transferor buys back the asset.
Question TS 4-3
If, subsequent to a transfer when the sale criteria were considered satisfied, the transferor buys the transferred financial assets from the transferee or from a third party, should the initial sale be reversed?
If, subsequent to a transfer when the sale criteria were considered satisfied, the transferor buys the transferred financial assets from the transferee or from a third party, should the initial sale be reversed?
PwC response
No, assuming the subsequent acquisition does not stem from an arrangement made contemporaneous with, or in contemplation of, the initial transfer. If so, the purchase may have been executed in accordance with a contract or understanding constituting a form of continuing involvement that should have been considered in connection with the transferor’s derecognition analysis, as required by ASC 860-10-40-4.
ASC 860-10-55-57 clarifies that these so-called wash sales should be accounted for as sales under ASC 860-10. The transferor is not considered to maintain effective control over transferred financial assets in the absence of a concurrent contract to repurchase or redeem the transferred financial assets, that is, in the absence of the transferor’s continuing involvement with the transferred financial assets that allows it to maintain effective control over them.
ASC 860-20-55-83 through ASC 860-20-55-92 contains an example that illustrates the application of certain of the re-recognition provisions in ASC 860-20-25.
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