21 • 1

CHAPTER

21

ASSET SECURITIZATION

Lisa Filomia-Aktas

Ernst & Young LLP

CONTENTS

21.1 What is Securitization? 1
21.2 Reasons for Originators to
Securitize 3
(a) Alternative Source of Funding 3
(b) Cost of Funds 3
(c) Risk Transparency 4
(d) Off-Balance-Sheet Financing 4
21.3 Evolution of Securitization 4
21.4 Securitization Process 5
21.5 Structural Aspects 6
21.6 Accounting 7
(a) History 7
(b) U.S. Accounting Overview 8
(c) Sale Criteria 9
(i) Legal Isolation 9
(ii) Right to Pledge or
Exchange 10
(iii) Effective Control Criteria 11
(d) Consolidation 13
(e) Qualifying Special Purpose
Entities (QSPEs) 13
(i) Demonstrably Distinct
Nature of a QSPE 13
(ii) Activities of a QSPE 13
(iii) Assets a QSPE May Hold 13
(iv) Selling of Noncash
Financial Assets Held
by a QSPE 14

(f ) Decision Tree 14

(g) Initial Accounting/Gain-on-

Sale Calculation 14

(h) Subsequent Accounting 16

(i) Consolidation of SPEs 17

(j) Proposed Accounting for

SPEs 19

(k) Bifurcation Issues 20

21.7 Disclosures for Securitization

Transactions and Related Assets 20

21.8 Variations of Securitization and

Related Accounting 22

(a) Overview of Collateralized

Debt Obligations 22

(b) Overview of the Sale of

Future Cash Flows 23

21.9 International Securitization 23

(a) International Accounting

Standards 24

(b) Japanese GAAP 24

(c) Canadian GAAP 25

SOURCES AND SUGGESTED

REFERENCES 26

APPENDIX 26

21.1 WHAT IS SECURITIZATION? Securitization is the process of transforming
predictable cash flows into securities. These securities are tradable and have greater
liquidity than the cash flows themselves. Thus, securitization facilitates the creation
of markets for financial claims that would otherwise not be marketable. Securitiza-
tion also allows for the repackaging of cash flows into different buckets (also called
tranches) with respect to seniority and timing of repayment. Tranches are sized to
minimize funding costs within the needs and requirements of investors.
For investors, securitization makes it possible to invest in tradable financial claims