Balance sheet recognition of ABS transactions

Asset-backed securities (ABS) programs are an attractive instrument for many companies to raise liquidity as part of their debt financing. In short, the idea is to sell bundled payment claims from receivables to a specially established special purpose entity and then securitize them. The special purpose entity finances the purchase of the receivables by placing securities (e.g. commercial paper) backed by the receivables on the capital or money market. The receivables sold are typically operating trade receivables, credit card receivables or lease receivables. Often, the collection or management of the receivables is continued by the seller as a service agent for a fee and the incoming payments from the debtors are passed on to the special purpose entity or the investors in the securities. 

From an economic point of view, financing via ABS programs affords the seller an immediate inflow of liquidity without burdening existing credit lines. The cost of the financing does not depend on the company's credit rating, but on the creditworthiness of the receivables portfolio, which is assessed by external rating agencies as part of the program. By derecognizing the receivables sold and using the additional liquidity to reduce liabilities, an optimization of the balance sheet structure is achieved. In practice, the question repeatedly arises as to how an ABS program must be designed in order to meet the derecognition requirements and achieve the desired balance sheet effect. 

The derecognition decision under IFRS for financial assets is generally based on the requirements of IFRS 9, supplemented by the issuing of IDW RS HFA 48 – Einzelfragen der Bilanzierung von Finanzinstrumenten nach IFRS 9 (Specific issues relating to accounting for financial instruments in accordance with IFRS 9), also against the background of the special features of ABS transactions. Under IFRS 9.B3.21, the standard setter supplies the seller with a flowchart to help decide when to derecognize an asset. Along the branches, three possible types of accounting can be derived as a result: The sold receivable is to be derecognized in full, the sold receivable continues to be recognized in full, or the receivable is recognized proportionately in the amount of the so-called continuing involvement. The individual criteria, which build on one another, are examined below specifically for ABS transactions from the seller's perspective.

First, the transaction to be assessed is delimited. According to IFRS 10, a consolidation review of the acquiring special purpose entity must be performed. The decision on derecognition under IFRS is made from the perspective of the Group, and an actual disposal of the receivable can only occur if the receivable is transferred to an external third party. If the special purpose entity is not a consolidated company, the transaction between the seller and the special purpose entity is the subject of the audit. If this is not the case, the transaction with non-consolidated investors in the issued securities constitutes the external transaction to be examined. The consolidation issue depends on the structure of the special purpose entity (e.g. single-purpose entity vs. multi-purpose entity or conduit structure) and is often very complex, so that a detailed case-by-case examination is essential. If only shares in cash flows or tranches of receivables are sold, the examination of the disposal is carried out individually for the delimitable part.

The second step is to examine the previously defined transaction with regard to the type of transfer. This involves assessing whether the transferor's payment claims are irrevocably and directly transferred to the transferee (pass-through arrangement or true sale). This is generally the case in the case of an open assignment or an undisclosed assignment that is linked to a right of conversion into an open assignment by the acquirer. If the seller is acting as a service agent under the ABS program, this is not critical after the assignment as long as there is no possibility to substantially change the collection without objection by the buyer. If there is no direct transfer of rights to the receivables, it is necessary to consider whether this is done indirectly through a pay through arrangement. Such an arrangement exists if there is only an obligation to pass on incoming payments without significant delay and the seller may not sell or pledge the receivables to third parties. Derecognition may not be performed if there exists neither an effective transfer of the receivables nor a pay-through arrangement.

The third step is to assess the risk/reward profile of the seller of the receivables before and after the transaction. In the case of operational receivables within the scope of ABS transactions, relevant risks are in particular credit risks, but possibly also late payment risks and currency risks, which have an influence on the amount of the expected cash flows. The costs of the ABS program are essentially determined by the credit rating of the securitized receivables. Depending on the structure of the programs, additional collateralization techniques are used to increase the credit rating of the receivables to be sold. One form of collateralization that is widely used in practice is overcollateralization. This involves a purchase price discount on the volume of receivables. This is intended to cover possible defaults on receivables on the basis of historical default rates. The discount is retained in a guarantee account. It is available to the buyer in the event of actual defaults. Any unused balance is available to the seller and determines the final purchase price of the receivables. It is also conceivable to provide cash collateral or to form tranches depending on creditworthiness with subordination. Ultimately, these measures leave portions of the credit risk with the seller.

Derecognition may only take place if substantially all risks and rewards have been transferred in full. As a rule, a quantitative analysis of the receivables portfolio before and after the transfer is required to prove this. The variability in the amount and timing of the expected cash flows must be used as a benchmark. The standard does not provide any specific requirements for the calculation. However, paragraph 81 et seq. of HFA 48 contains a calculation example that illustrates such proof on the basis of present values for probability-weighted cash flows. If the analysis shows that substantially all the risks and rewards have not been transferred, derecognition is not permitted and the transaction is accounted for as a secured loan. If neither the risks and rewards are retained nor transferred, derecognition may only occur if the buyer has the option at any time to sell the receivable to a third party without the seller's consent. In this case, there is a transfer of control and derecognition of the receivable is permitted. Otherwise, the receivable must continue to be recognized to the extent that the seller bears the risks and rewards (continuing involvement).

To ensure that the desired accounting effect can be achieved, it must be analyzed in detail whether the program design can meet the aforementioned prerequisites for derecognition. In this context, the type of receivables transfer and the risk/reward profile that remains with the seller after the transaction are key factors. Collateralization techniques must also be taken into account.

Our Finance & Treasury experts will be happy to answer any questions you may have on the accounting treatment of ABS transactions.

Source: KPMG Corporate Treasury News, Edition 135, August 2023
Authors:
Ralph Schilling, CFA, Partner, Head of Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG
Frederik Richter, Manager, Finance and Treasury Management, Treasury Accounting & Commodity Trading, KPMG AG