to fail to adequately service financial assets transferred to it or to timely pay obliga-
tions due, servicing rights related to assets that it holds, nonfinancial assets obtained
in connection with the collection of financial assets that it holds (but only temporar-
ily), and cash collected from assets that it holds and investments purchased with that
cash (i.e., relatively risk-free instruments) pending distribution to holders of benefi-
cial interests. A QSPE may not purchase assets from the market (unless it is tem-
porarily investing its cash collections).
(iv) Selling of Noncash Financial Assets Held by a QSPE. A QSPE may sell noncash
financial assets only in automatic response to certain conditions. The conditions in-
clude the occurrence of an event that (1) is specified in the legal documents, (2) is
outside the control of the transferor, and (3) causes the fair value of the financial as-
sets to decline by a specified degree below the fair value of those assets when the SPE
obtained them; exercise by a BIH (other than the transferor) of a right to put that
holder’s beneficial interest back to the SPE; exercise by the transferor of a call or a
removal-of-accounts provision (ROAP—a call that empowers the transferor to re-
claim assets subject to certain restrictions) specified in the legal documents; or ter-
mination of the SPE or maturity of the beneficial interests in those financial assets on
a fixed or determinable date that is specified at inception. As one can see, a QSPE has
no discretion as to whether assets may be sold.
(f ) Decision Tree. Exhibit 21.6 provides an example of a decision tree.
(g) Initial Accounting/Gain-on-Sale Calculation. Upon completion of a transaction
that satisfies the conditions to be treated as a sale and avoids consolidation, the gain
or loss from such sale needs to be determined in accordance with FAS 140. The gain
or loss will be recognized on the portion of the assets sold and the interests retained
will be recorded at an allocated book value. FAS 140 requires that on completion of
a sale of financial assets, the previous carrying amount is to be allocated between the
assets sold and any retained interests based on their relative fair values at the date of
transfer. Retained interests in transferred assets consist of portions of the assets that
existed prior to the transfer that the transferor continues to hold subsequent to the
transfer. The most common examples include a servicing contract with respect to the
transferred assets, or a portion of the principal balance or interest collections from the
transferred assets.
Recognition of gains or losses on the sale of financial assets is not elective and the
transferor may not defer in the balance sheet a gain or loss resulting from the sale of
financial assets.
The following example illustrates the gain-on-sale calculation for a transfer that
meets the sale criteria.
Example:Assume a financial institution sells a portfolio of loans with a principal
amount and net carrying amount of $1,000 to an SPE for $900 cash and a residual in-
terest. The financial institution will also continue to service the loans for a contrac-
tual servicing fee of 2% of the outstanding balance annually. The principal and in-
terest collections will be used to pay the investors first. Any remaining cash flow after
losses, prepayments, and expenses will be paid to the residual holder.
Exhibit 21.7 summarizes the calculation. The first step is to determine the compo-
nents—the interests sold and the interests retained. In this example, the financial in-
stitution retained the residual interest and the servicing. The next step is to calculate
21 • 14 ASSET SECURITIZATION