Guidance Note on Accounting for Securitisation

(The following is the text of the Guidance Note on Accounting for

Securitisation, issued by the Council of the Institute of Chartered Accountants
of India.)

Introduction
1. Securitisation is the process by which financial assets such as loan receivables,
mortgage backed receivables, credit card balances, hire-purchase debtors, lease
receivables, trade debtors, etc., are transformed into securities. Securitisation is different
from ‘factoring’ in that ‘factoring’ involves transfer of debts without transformation
thereof into securities. A securitisation transaction, normally, has the following features:

 Financial assets such as loan assets, mortgages, credit card balances,

hire-purchase debtors, trade debtors, etc., or defined rights therein,
are transferred, fully or partly, by the owner (the Originator) to a
Special Purpose Entity (SPE) in return for an immediate cash payment
and/or other consideration. The assets so transferred are the
‘securitised assets’ and the assets or rights, if any, retained by the
Originator are the ‘retained assets’.

 The SPE finances the assets transferred to it by issue of securities such

as Pass Through Certificates (PTCs) and/or debt securities to investors.

 A usual feature of securitisation is ‘credit enhancement’, i.e., an

arrangement which is designed to protect the holders of the securities
issued by an SPE from losses and/or cash flow mismatches arising from
shortfall or delays in collections from the securitised assets. The
arrangement often involves one or more of the following:

 Provision of cash collateral, i.e., a deposit of cash which in

specified circumstances can be used by the SPE for discharging
its financial obligation in respect of the securities held by the
investors.

 Over collaterisation, i.e., making available to the SPE assets in

excess of the securitised assets, the realisation of which can be
used in specified circumstances to fund the shortfalls and/or
mismatches in fulfilment of its financial obligations by the SPE.

 Recourse obligation accepted by the Originator.

 Third party guarantee, i.e., a guarantee given by a third party by

accepting the obligation to fund any shortfall on the part of the
SPE in meeting its financial obligations in respect of the
securitisation transaction.

 Structuring of the instruments issued by an SPE into senior and

subordinated securities such that the senior securities (issued to
investors) are cushioned by the subordinated securities (issued
 normally to the Originator) against the risk of shortfalls in
realisation of securitised assets. Payments on subordinated
securities are due only after the amounts due on the senior
securities are discharged.

 The Originator may continue to service the securitised assets (i.e., to

collect amounts due from borrowers, etc.) with or without servicing fee
for the same.

 The Originator may securitise or agree to securitise future receivables,

i.e., receivables that are not existing at the time of agreement but
which would be arising in future. In case of such securitisation, the
future receivables are estimated at the time of entering into the
transaction and the purchase consideration for the same is received by
the Originator in advance. Securitisation can also be in the form of
‘Revolving Period Securitisation’ where future receivables are
transferred as and when they arise or at specified intervals; the
transfers being on prearranged terms.

A diagrammatic presentation of a typical securitisation transaction is given in

Appendix I.

2. This Guidance Note deals with accounting for securitisation transactions in the books
of Originator, specially addressing issues such as when to derecognise, fully or partly, the
securitised assets; treatment of securitisation of future receivables; measurement of
consideration received in the form of securities; etc. The Guidance Note also deals with
accounting for securitisation transactions in the books of SPEs. Another issue dealt with
relates to accounting for investments in the securities such as PTCs and/or debt securities
issued by the SPE, in the books of Investors.

Definitions

3. The following terms are used in this Guidance Note with the meanings specified:

Call Option is an option that entitles the Originator to repurchase the financial assets
transferred under a securitisation transaction from the SPE. The Option may be at a
predetermined price or at a value to be determined, for example, fair value on the date of
exercise of Call Option.

Clean-up Call Option is an option held by the servicer (who may be the Originator) to
purchase the remaining transferred securitised assets or the remaining beneficial interests
in the SPE if the amount of securitised assets or beneficial interests falls to a level at
which the cost of servicing those assets or beneficial interests becomes burdensome in
relation to the benefits of servicing.

Interest Strip is a contractual arrangement to separate the right to all or part of the interest
due on a debenture, bond, mortgage loan or other interest bearing financial asset from the
financial asset itself.

Investor is the person who finances the acquisition of the securitised assets or of
beneficial interest therein by subscribing to PTCs and/or debt securities issued by an SPE.

Originator is an entity that owns the financial assets proposed to be securitised and
initiates the process of securitisation in respect of such assets.

Pass Through Certificates (PTCs) are instruments acknowledging a beneficial interest in

the securitised assets such that the payment of interest on such instruments and the
repayment of the principal are directly or indirectly linked or related to realisations from
the securitised assets.

Principal Strip is the right to the remainder of the financial asset net of all rights that
have been stripped therefrom by one or more contractual arrangements such as by an
Interest Strip.

Recourse Obligation is the obligation of the Originator to reimburse or compensate, fully

or partly, the investors for, or otherwise bear the risk of, shortfalls, such as those, arising
from:

• failure of debtors to pay or to pay when due; or

• pre-payments; or

• other defects in securitised financial assets.

Servicing asset is a contract to service financial assets under which the

estimated future revenues from contractually specified servicing fees, late
charges and other related revenues are expected to more than adequately
compensate the servicer (who may be the Originator) for performing the
services. A servicing contract can be either:

• undertaken together with selling or securitising the financial assets

being serviced; or

• purchased or assumed separately.

Special Purpose Entity (SPE) is an entity which acquires the financial assets
under securitisation and normally holds them till maturity. SPE is an
independent entity, usually constituted as a trust though it may be
constituted in other forms, for example, as a limited company, formed with
small capital for the specific purpose of funding the transaction by issue of
PTCs or debt securities.

Accounting in the Books of Originator

Derecognition of securitised asset

4. Securitised asset should be derecognised in the books of the Originator, if and only if,
either by a single transaction or by a series of transactions taken as a whole, the
Originator loses control of the contractual rights that comprise the securitised asset. The
Originator loses such control if it surrenders the rights to benefits specified in the
contract. Determining whether the Originator has lost control of the securitised asset
depends both on the Originator’s position and that of the SPE. Consequently, if the
position of either the Originator or the SPE indicates that the Originator has retained
control, the Originator should not remove the securitised asset from its balance sheet.

5.The Originator has not lost control over the securitised asset, for example, where

a. the creditors of the Originator are entitled to attach or otherwise deal

with the securitised assets;

b. the SPE does not have the right (to the extent it was available to the
Originator) to pledge, sell, transfer or exchange for its own benefit the
securitised asset;

i. where it is entitled to do so by a Call Option, where such Call

Option can be justified on its own commercial terms as a
separate transaction between the SPE and the Originator, for
instance, where the Call Option is exercisable at fair value of the
asset on the date of exercise of the Option; or

ii. where it is entitled to do so by a Clean-up Call Option.

6.Whether the Originator has lost control over the securitised asset should be determined
on the basis of the facts and circumstances of the case by considering all the evidence
available. It would be incorrect to hold that the derecognition criterion prescribed in
paragraph 4 is not met in the following cases:

a. The Originator continues to service the securitised asset. Such

servicing by itself would not lead to a conclusion that the Originator
has not lost control over the securitised asset.

b. An obligation is cast on the Originator to repurchase the securitised

asset at a predetermined price. Such an obligation is not an
entitlement to reassume ownership available to the Originator.
Notwithstanding such an obligation the securitised asset would be
beyond the control of the Originator. The obligation accepted by the
Originator should be accounted for in the manner indicated in
paragraph 10 of this Guidance Note. However, where the Originator is
both entitled and obligated to repurchase the securitised asset at a
pre-determined price, the Originator is not considered to have lost
 control over the securitised asset and, therefore, the same should not
be removed from the balance sheet of the Originator.

7.On derecognition, the difference between the book value of the securitised asset and
consideration received should be treated as gain or loss arising on securitisation and
disclosed separately in the statement of profit and loss. On the other hand, if the
derecognition criterion as prescribed in paragraph 4 is not met, the asset should continue
to be recognised in the books of the Originator and consideration received for the asset so
transferred, should be accounted for as a borrowing secured there against.

8.The consideration received in a form other than cash, e.g., securities issued by the SPE,
should be measured at the lowest of the

a. the fair value of the consideration;

b. the net book value of the securitised assets; and

c. the net realisable value of the securitised assets.

In case the consideration has been received partly in cash and partly in a
form other than cash, the non-cash component of the consideration should be
measured at the lowest of the

a. the fair value of the non-cash component;

b. the net book value of the securitised assets as reduced by the cash
received; and

c. the net realisable value of the securitised assets as reduced by the

cash received.

The fair value is the price that would be agreed upon between
knowledgeable, willing parties in an arm’s length transaction. Quoted market
price in an active, liquid and freely accessible market, if available, is normally
the best evidence of fair value. If quoted market price is not available,
estimate of fair value may be based on the market prices of assets similar to
those received as consideration. In case the market prices of similar assets
are also not available, the estimate of fair value may be based on generally
accepted valuation techniques such as the present value of estimated future
cash flows. These techniques would require estimates and assumptions about
various matters such as estimates of future revenues, future expenses and
assumptions about interest rates, defaults and likely prepayments. Some of
these estimations, e.g., estimation of future cash flows and discount rates
may present significant difficulties. It would be necessary to make the best
estimate based on reasonable and supportable assumptions and projections.
All available evidence should be considered in developing the requisite
estimate and assumptions.
9.In case the securitised assets qualify for derecognition, the entire expenses incurred on
the transaction, say, legal fees, etc., should be expensed at the time of the transaction and
should not be deferred. Where the securitised assets do not qualify for derecognition and,
therefore, the consideration received in respect thereof is treated as a secured borrowing,
such expenses should either be amortised over the term of the secured borrowing or
recognised immediately in the statement of profit and loss.

10. If a securitised asset qualifies to be derecognised as per paragraph 4 and the

Originator has accepted recourse or similar obligation, e.g., the Originator has granted a
Put Option at a predetermined price to the SPE, then the contingent loss arising
therefrom, should be accounted for as per Accounting Standard (AS) 4, ‘Contingencies
and Events Occurring After the Balance Sheet Date’, issued by the Institute of Chartered
Accountants of India. This would require that a provision be made for the contingent loss
arising from the obligation, where the criteria specified in the Standard in this regard are
satisfied.

Future Receivables / Revolving Securitisation

11. Any purchase consideration received by the Originator on the securitisation of future
receivables should be accounted for as an advance, since the assets proposed to be
securitised would not be existing at the time of the agreement, but would arise in future.
The cost of bringing these assets into existence would also be incurred in future. In such
cases, the criterion for derecognition prescribed in paragraph 4 should be applied as and
when the relevant assets come into existence. Till such time the amounts received, if any,
on account of the proposed securitisation should be reflected as an advance. The other
requirements of the Guidance Note also apply, mutatis mutandis, in case of securitisation
of future receivables.

12.In case of revolving period securitisation where financial assets are transferred as and
when they come into existence or at specified intervals and the purchase consideration is
paid to the Originator at the time of such transfer, all requirements of this Guidance Note,
except paragraph 11, apply.

Partial Derecognition

13.An Originator may transfer only a part of the financial asset in a securitisation
transaction instead of transferring the complete asset. Such transfer may occur in two
ways. One way is where a proportionate share of the asset is transferred. For example, the
Originator may transfer a proportionate share of loan (including right to receive both
interest and principal), in such a way that all future cash flows, profit/loss arising on loan
will be shared by the Originator and the SPE in fixed proportions. A second way of
transferring a part of a financial asset arises where the asset comprises the rights to two or
more benefit streams, and the Originator transfers one or more of such benefit streams
while retaining the others. For example, the Originator may securitise the Principal Strip
of the loan while retaining the Interest Strip and Servicing Asset.
14.If the Originator transfers a part of a financial asset while retaining the other part, the
part of the original asset which meets the derecognition criterion as set out in paragraph 4
should be derecognised whereas the remaining part should continue to be recognised in
the books. Similarly, if any new interest has been created as a result of securitisation
transaction, such as a Call Option, the new interest should be recognised in the books in
accordance with the relevant accounting principles.

15.If the Originator transfers a proportionate part of the asset, the previous carrying
amount of the asset is apportioned among the part transferred and the part retained on the
basis of proportion transferred and proportion retained. For example, if the originator
transfers 75% of an asset to the SPE, 75% of the carrying amount of the asset should be
considered as securitised. Where the securitised part of the asset qualifies to be
derecognised as per the requirements of paragraph 4, the entity would continue to
recognise the remaining part of the asset at 25% of the carrying amount.

16.In case the asset comprises the rights to two or more benefit streams and one or more
of such benefit streams is/are transferred while retaining the others, the carrying amount
of such financial asset should be apportioned between the part(s) transferred and the
part(s) retained on the basis of their relative fair values as on the date of transfer. The fair
values of the parts should be determined on the basis described in paragraph 8. If fair
value of the part of the asset that is retained cannot be measured reliably, that part should
be valued at a nominal value of Re.1. Similarly, if any new financial asset, e.g., a call
option, has been created as a result of securitisation transaction and its fair value cannot
be measured reliably, initial carrying amount of the asset should be recognised at a
nominal value of Re.1.

17.An example illustrating the computations and accounting treatment in case of partial
derecognition is given in Appendix II to this Guidance Note.

Accounting in the Books of Special Purpose Entity

18.The SPE should recognise the asset received under a securitisation transaction, if the
Originator loses control over the securitised asset on the basis of the criterion prescribed
in paragraph 4. The asset so received should be recognised at the amount of
consideration, if the consideration has been paid in cash. In case the consideration has
been paid in a form other than cash, e.g., securities, the asset so received should be
recorded either at its intrinsic value or at the fair value of the consideration, whichever is
more clearly evident. If both the values are equally evident the asset should be valued at
the lower of the two values.

19.If the beneficial ownership in the securitised asset has not been transferred to the SPE
or the Originator has not lost control over the asset as per the requirements of paragraph
4, the SPE should not recognise the asset received. In such a case, the consideration paid
should be recorded as a lending secured against the financial asset received under
securitisation transaction.
20.The amount received by the SPE on issue of PTCs or other securities should be shown
on the liability side of the balance sheet, with appropriate description, keeping in view the
nature of securities issued.

Accounting in the Books of the Investor

21.The Investor should account for the PTCs and/or debt securities acquired by it as an
investment in accordance with Accounting Standard (AS) 13, ‘Accounting for
Investments’. However, where in case of an Investor, AS 13 is not applicable because of
the Investor being specifically exempted from the application of AS 13, the investments
in PTCs and/or other securities should be valued and accounted for as per the relevant
accounting principles applicable to the Investor.

Disclosures

22.In addition to the disclosures arising from recommendations made in paragraph 10, the
following disclosures should be made in the financial statements of the Originator:

i. The nature and extent of securitisation transaction(s), including the

financial assets that have been derecognised.

ii. The nature and the amounts of the new interests created, if any.

iii. Basis of determination of fair values, wherever applicable.

23.The following disclosures should be made in the financial statements of the SPE:

i. The nature of the securitisation transaction(s) including, in particular, a

description of the rights of the SPE vis-à-vis the Originator whether
arising from the securitisation transaction or a transaction associated
therewith.

ii. Basis of determination of fair values, wherever applicable.

24.The Investor should make disclosure of investments in PTCs and/or debt securities as
required by Accounting Standard (AS) 13, ‘Accounting for Investments’. However,
where in the case of an Investor, AS 13 is not applicable because the Investor is
specifically exempted from the application of AS 13, the Investor should make such
disclosures as per the relevant requirements.

Appendix I

(This Appendix does not form part of the Guidance Note and is merely
illustrative.)

Diagrammatic Presentation of a Typical Securitisation Transaction

1
Obligor is an entity which has received a loan giving rise to the financial
asset that is securitised by the Originator.
2
can be the Originator also.
3
may be provided either by the Originator or by any third party.

Appendix II

Illustration of Computation and Accounting in Case of Partial

Derecognition

(This Appendix does not form part of the Guidance Note and is merely
illustrative.)

1.Suppose Company ‘C’ holds Rs. 1,000/- of loans yielding interest @ 18% p.a. for their
estimated lives of nine years. Considering the interest rate the fair value of these loans is
estimated at Rs. 1,100/-. The company securitises the principal component of the loan
plus the right to receive interest @ 14% to an SPE for Rs. 1,000/-. Out of the balance
interest of 4%, it is stipulated that half of such balance interest, namely 2%, will be due to
the company as fees for continuing to service the loans. The fair value of the servicing
asset so created is estimated, after taking into account the costs likely to be incurred in
servicing the loan, at Rs. 40. The remaining half of the interest is due to the company as
an interest strip receivable, the fair value of which is estimated at Rs. 60.

2.Since the company has securitised the principal and a part of the interest, it is necessary
to compute the cost attributable to various components assuming that the securitised
components meet the derecognition criteria. This computation can be done by
apportioning the carrying amount of the asset in the ratio of fair values as follows:

Fair Value of securitised component of the loan

Rs. Rs.
Fair value of loan 1,100
Less: Fair value of servicing asset 40
Fair value of interest strip 60 100
Fair value of securitised component of loan 1,000
Apportionment of carrying amount based on relative fair values
Particulars Fair %age based on Total Carrying Amount /
Values Fair Value Cost
Securitised component of 1000 91 910
loan
Servicing Asset 40 3.6 36
Interest Strip Receivable 60 5.4 54
1,100 100 1,000
3. The profit arising on securitisation should be computed as follows:

Rs.
Net proceeds of securitisation 1,000
Less: Cost (apportioned carrying amount) of securitised component of loan 910
Profit on securitisation 90
4. Based on the above, the following journal entries would be passed in the books of
the Originator:
Rs. Rs.
(a) To record securitisation of principal plus right to 14%
interest
Cash A/c Dr. 1,000
To Loans A/c (cost of securitised component) 910
To Profit on Securitisation 90
(b) To record the creation of servicing asset and interest strip
receivable
Servicing asset A/c Dr. 36
Interest strip A/c Dr. 54
To Loans A/c 90

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