The following are examples of when the objective of an entity’s business model may be to hold financial assets to collect the contractual cash flows. This list of examples is not exhaustive. Furthermore, the examples are not intended to discuss all factors that may be relevant to the assessment of the entity’s business model nor specify the relative importance of the factors.
An entity holds investments to collect their contractual cash flows. The funding needs of the entity are predictable and the maturity of its financial assets is matched to the entity’s estimated funding needs.
The entity performs credit risk management activities with the objective of minimising credit losses.
In the past, sales have typically occurred when the financial assets’ credit risk has increased such that the assets no longer meet the credit criteria specified in the entity’s documented investment policy. In addition, infrequent sales have occurred as a result of unanticipated funding needs.
Reports to key management personnel focus on the credit quality of the financial assets and the contractual return. The entity also monitors fair values of the financial assets, among other information.
Although the entity considers, among other information, the financial assets’ fair values from a liquidity perspective (ie the cash amount that would be realised if the entity needs to sell assets), the entity’s objective is to hold the financial assets in order to collect the contractual cash flows.
Sales would not contradict that objective if they were in response to an increase in the assets’ credit risk,
for example if the assets no longer meet the credit criteria specified in the entity’s documented investment policy.
Infrequent sales resulting from unanticipated funding needs (eg in a stress case scenario) also would not contradict that objective, even if such sales are significant in value.
An entity’s business model is to purchase portfolios of financial assets, such as loans. Those portfolios may or may not include financial assets that are credit impaired.
If payment on the loans is not made on a timely basis, the entity attempts to realise the contractual cash flows through various means—for example, by contacting the debtor by mail, telephone or other methods. The entity’s objective is to collect the contractual cash flows and the entity does not manage any of the loans in this portfolio with an objective of realising cash flows by selling them.
In some cases, the entity enters into interest rate swaps to change the interest rate on particular financial assets in a portfolio from a floating interest rate to a fixed interest rate.
The objective of the entity’s business model is to hold the financial assets in order to collect the contractual cash flows.
The same analysis would apply even if the entity does not expect to receive all of the contractual cash flows (eg some of the financial assets are credit impaired at initial recognition).
Moreover, the fact that the entity enters into derivatives to modify the cash flows of the portfolio does not in itself change the entity’s business model.
An entity has a business model with the objective of originating loans to customers and subsequently selling those loans to a securitisation vehicle.
The securitisation vehicle issues instruments to investors. The originating entity controls the securitisation vehicle and thus consolidates it.
The securitisation vehicle collects the contractual cash flows from the loans and passes them on to its investors. It is assumed for the purposes of this example that the loans continue to be recognised in the consolidated statement of financial position because they are not derecognised by the securitisation vehicle.
The consolidated group originated the loans with the objective of holding them to collect the contractual cash flows.
However, the originating entity has an objective of realising cash flows on the loan portfolio by selling the loans to the securitisation vehicle, so for the purposes of its separate financial statements it would not be considered to be managing this portfolio in order to collect the contractual cash flows.
A financial institution holds financial assets to meet liquidity needs in a ‘stress case’ scenario (eg, a run on the bank’s deposits). The entity does not anticipate selling these assets except in such scenarios.
The entity monitors the credit quality of the financial assets and its objective in managing the financial assets is to collect the contractual cash flows. The entity evaluates the performance of the assets on the
basis of interest revenue earned and credit losses realised.
However, the entity also monitors the fair value of the financial assets from a liquidity perspective to ensure that the cash amount that would be realised if the entity needed to sell the assets in a stress case scenario would be sufficient to meet the entity’s liquidity needs. Periodically, the entity makes sales that are insignificant in value to demonstrate liquidity.
The objective of the entity’s business model is to hold the financial assets to collect contractual cash flows.
The analysis would not change even if during a previous stress case scenario the entity had sales that
were significant in value in order to meet its liquidity needs. Similarly, recurring sales activity that is insignificant in value is not inconsistent with holding financial assets to collect contractual cash flows.
In contrast, if an entity holds financial assets to meet its everyday liquidity needs and meeting that objective involves frequent sales that are significant in value, the objective of the entity’s business model is not to hold the financial assets to collect contractual cash flows.
Similarly, if the entity is required by its regulator to routinely sell financial assets to demonstrate that the assets are liquid, and the value of the assets sold is significant, the entity’s business model is not to hold financial assets to collect contractual cash flows. Whether a third party imposes the requirement to sell the financial assets, or that activity is at the entity’s discretion, is not relevant to the analysis.