why -
I'm not just talking about financial analysis.
Hitting equity implies a loss. In this problem you might need to buy back assets - it may be because their value is impaired, or it may be becuase there was some contractual defect.
This happens every day with companies that sell assets into securitizations. A pool of assets is sold (mortgages, credit card receivables, auto loans, etc.) and some of them are found to be ineligible because of a missing signature or other documentation problem, or in the cases of what has put many of the subprime lenders under, a missed first (or one of the first three) loan payment.
Analytically you project the estimated amount of potential putbacks and those items are reflected as assets (possibly net of some reserve) and the liability for the repurchase. They are not analytically charged to equity because to do so would imply a FULL loss on future sale or liquidation of the repurchased assets.
Take a company that has $100 of receivables and $100 of equity. They then sell those assets into a securitization with recourse. Thye know that historically they will have some repurchases and some losses so they record a $1 liability and chargeto retained earnings . Their balance sheet is now $100 of cash, $1 liability and $99 of equity. Would you reflect the contingent repurchase of the receivables by analytically adjusting their balance sheet and recording another $99 of liability and completely wiping out their equity? A realistic adjustment would be to say that they would have to repurchase those assets for $100 and record the $100 liability for the cash that they would pay. The only possible additional adjustment affecting equity would be to say that you think the company's $1 reserve is not adequate for the loss they might record when they ultimately resell those assets at a discount, so you might analytically book something like a $5 contra-asset and a $5 reduction in equity in addition to putting the receivables back on the balance sheet.
Edited 1 time(s). Last edit at Saturday, April 14, 2007 at 01:46PM by Super I.
I'm not just talking about financial analysis.
Hitting equity implies a loss. In this problem you might need to buy back assets - it may be because their value is impaired, or it may be becuase there was some contractual defect.
This happens every day with companies that sell assets into securitizations. A pool of assets is sold (mortgages, credit card receivables, auto loans, etc.) and some of them are found to be ineligible because of a missing signature or other documentation problem, or in the cases of what has put many of the subprime lenders under, a missed first (or one of the first three) loan payment.
Analytically you project the estimated amount of potential putbacks and those items are reflected as assets (possibly net of some reserve) and the liability for the repurchase. They are not analytically charged to equity because to do so would imply a FULL loss on future sale or liquidation of the repurchased assets.
Take a company that has $100 of receivables and $100 of equity. They then sell those assets into a securitization with recourse. Thye know that historically they will have some repurchases and some losses so they record a $1 liability and chargeto retained earnings . Their balance sheet is now $100 of cash, $1 liability and $99 of equity. Would you reflect the contingent repurchase of the receivables by analytically adjusting their balance sheet and recording another $99 of liability and completely wiping out their equity? A realistic adjustment would be to say that they would have to repurchase those assets for $100 and record the $100 liability for the cash that they would pay. The only possible additional adjustment affecting equity would be to say that you think the company's $1 reserve is not adequate for the loss they might record when they ultimately resell those assets at a discount, so you might analytically book something like a $5 contra-asset and a $5 reduction in equity in addition to putting the receivables back on the balance sheet.
Edited 1 time(s). Last edit at Saturday, April 14, 2007 at 01:46PM by Super I.