1. What are the procedures related to the securitization of receivables using
SPEs? Describe all parties involved in this process.
In general, the securization of receivables involves the following procedure:
● A special purpose entity (SPE) is created by a third party which is independent of
the company (referred to as the transferor) with receivables.
● The transferor will first transfer its receivables to the SPE.
● The SPE issues securities (i.e. commercial papers) using these receivables as
● The cash received by the SPE from issuing securities will go back to the
transferor to pay off the receivables transferred.
● The SPE is served as a “pass through”.
● The ...view middle of the document...
● Second, the bank provides a credit enhancement: If a pool of assets held by the
conduit cannot be converted to cash, the bank will purchase the assets.
Accordingly, the conduit can continue to meet its obligations to commercial paper
2) The investment bank served as sponsors (or administrator) of the conduit, organizes
transaction and provides liquidity and credit enhancement, and charges the transferor
fees for creating and operating the SPE.
Sponsors that purchase assets to satisfy a credit enhancement generally recoup their
losses by obtaining recourse from the underlying originator. The losses were always
recouped unless there is outright fraud by the originator. However, despite the low risk
associated with liquidity and default guarantees, the party that provides these services
to the conduit qualifies as the primary beneficiary per FIN 46 (Gregory ). Hence,
sponsors are required to consolidate the conduits with their financial statements.
Because ABCP conduits are thinly capitalized, the consolidation of the conduit can have
a nontrivial impact on the sponsor’s leverage.
3a.Discuss the consolidation guidance under ARB 51.
The voting-interest-model is governed the consolidation, which is the party with more
than 50% of voting rights of an entity should consolidate the entity, according to ARB 51.
A general rule is that the usual condition for a controlling financial interest is ownership
of a majority voting interest. Ownership by one company, directly or indirectly, of over
50% of the outstanding voting shares of another company is a condition pointing toward
consolidation. An exception is that a majority-owned subsidiary shall not be
consolidated if control does not rest with the majority owner.
All entities in which a parent has a controlling financial interest, namely subsidiaries,
should be consolidated.
3b.Discuss the equity requirement of a qualifying SPE prior to FIN 46(R) and
under FIN 46 (R).
Prior to FIN 46(R), the equity requirement of a qualifying SPE is that the equity interest
of a third-party owner was at least 3% of the SPE’s total capitalization established by
the EITF90-15 non-consolidation rule of SPE. At the same time, the majority of equity
voting rights cannot reside with the beneficiary. Thus, the entity doesn’t need to
consolidate the SPE.
Under FIN 46(R), the equity requirement of a qualifying SPE is that an equity
investment shall be presumed insufficient to allow the entity to finance its activities
without relying on financial support from variable interest holders unless the investment
of the entity’s total assets is equal to at least 10%.
3c. Explain why many sponsors and transferors of SPEs created for securitization
purposes can avoid consolidation under ARB 51 and SFAS 140.
According to ARB 51, company is required to include in the consolidated financial
statements subsidiaries in which it has a controlling financial interest. The existing