Continuing involvement in part only of a financial asset
An entity has a portfolio of prepayable loans whose coupon and effective interest rate is 10% and whose principal amount and amortised cost is €10 million. It enters into a transaction in which, in return for a payment of €9.115 million, the transferee obtains the right to €9 million of any collections of principal plus 9.5% interest.
The entity retains rights to €1 million of any collections of principal plus interest at 10%, plus the remaining 0.5% (‘excess spread’) on the remaining €9 million of principal. Collections from prepayments are allocated between the entity and the transferee proportionately in the ratio of 1:9, but any defaults are deducted from the entity’s interest of €1 million until that interest is exhausted.
The fair value of the loans at the date of the transaction is €10.1 million and the estimated fair value of the excess spread of 0.5 per cent is €40,000.
The entity determines that it has transferred some significant risks and rewards of ownership (for example, significant prepayment risk) but has also retained some significant risks and rewards of ownership because of its subordinated retained interest (Figure 50.1, Box 7, No) and has retained control (Figure 50.1, Box 8, Yes). It therefore applies the continuing involvement approach (Figure 50.1, Box 9).
The entity analyses the transaction as:
- a retention of a fully proportionate retained interest of €1 million, plus
- the subordination of that retained interest to provide credit enhancement to the transferee for credit losses.
The entity calculates that €9.09 million (90% of €10.1 million) of the consideration received of €9.115 million represents the consideration for a fully proportionate 90% share. The remainder of the consideration (€25,000) received represents consideration received by the entity for subordinating its retained interest to provide credit enhancement to the transferee for credit losses. In addition, the excess spread of 0.5% represents consideration received for the credit enhancement. Accordingly, the total consideration received for the credit enhancement is €65,000 (€25,000 received from transferee plus €40,000 fair value of excess spread).
The entity first calculates the gain or loss on the sale of the 90% share of cash flows. Assuming that separate fair values of the 10% part transferred and the 90% part retained are not available at the date of the transfer, the entity allocates the carrying amount of the asset pro-rata to the fair values of those parts (see 5.1.1 and 5.1.2 and 5.3.5 above). The total fair value of the portfolio is considered to be €10.1 million (see above), and the fair value of the consideration for the part disposed of €9.09 million. The carrying amount of the whole portfolio is €10 million. This implies a carrying amount for the part disposed of €10m × 9.09/10.1 = €9 million, and for the part retained €1 million. The gain on the sale of the 90% is therefore €90,000 (€9.09 million – €9 million).
In addition, IAS 39 (IFRS 9) requires the entity to recognise the continuing involvement that results from the subordination of its retained interest for credit losses. Accordingly, it recognises an asset of €1 million (the maximum amount of the cash flows it would forfeit under the subordination), and an associated liability of €1.065 million (the maximum amount of the cash flows it would forfeit under the subordination, i.e. €1 million, plus the consideration for the subordination of €65,000). It also recognises an asset for the fair value of the excess spread which forms part of the consideration for the subordination.