Securitization of receivables under U.S. GAAP is the bundling of loans or receivables and sold to a third party. Lenders gain two advantages with this method. The first advantage is the sale of the bundled loans. It reduces the financial risk for the company. It reduces the risk because when the lender sells a portfolio. the buyer or guarantor assumes a portion of the total risk. This way the lender and guarantor share the risk between them. The other advantage from the sale of the bundle loans is that the portfolio can be sold for a profit to the lender.
FASB ASC 860 – Transfers and Servicing
FASB covers the securitization of receivables under ASC 860 – Transfers and Servicing. Under ASC 860, a two-step approach needs to be done in order to transfer a securitized receivable from a lender to a guarantor. The lender would create a securitization entity (SE). This entity can take the form of a trust or a corporation which is separate from the lender. The SE only purpose is to transfer the securitized receivables. The next step is when the lender sells the receivables to the SE. When this happens, several events occur. The receivable is no longer with the lender. The transfer would be considered a sale. In a case where the lender was to go bankrupt, the securitized receivable is safe from repossession.
Advantages in Securitization of Receivables
The advantages in the securitization of receivables are that it allows lenders to hedge or minimize their risk exposure by the loan. While also making a profit from the “sale” of the loan to a SE. In doing so, the “sale” of the loan is a win-win approach. This practice comes with several disadvantages, such as the overvaluation of the “sale”. The sale of the securitized loan has an inflated cost when a SE or a third party purchases it. If the portfolio on receivable has a higher risk, comparing it to the less risky portfolio the value would be higher. The unsystematic risk increases the price of the portfolio while the present value of the loans remains the same. Another disadvantage is how easy it can be for the lender to take the loans that may have the risk to become bad loans on their balance sheets.
In my opinion, I’m recommending the same implementation that took effect after the Great Recession of 2009. The implementation of more stringent disclosures and notes on the financial statements. The consolidation of financial statements between parent and subsidiaries.
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