Recognition of Paydown Loss/Recovery Examples

For ABS paydowns that have proceeds and principal loss factors in the same coupon cycle the principal loss factors are applied first, followed by the paydown cash received. Apply loss factor quantity as a straight par reduction to the extent that there is sufficient unamortized discount to absorb the quantity without reducing any deferred market discount or original cost.

Unamortized discount = Par – Original Cost – Deferred Amortization

If the loss quantity is greater than the unamortized discount then apply the remaining quantity to the accumulated deferred market discount.  This amount is stored on the open lot (Prior Deferred Amort Reduction Local/Base).

If the loss quantity is greater than the total unamortized discount and accumulated deferred market discount the lot will be at par before applying the remaining par quantity.  Apply the remaining quantity to cost and Short Term Loss.  This amount is stored on the open lot (Prior Cost Reduction Local/Base).

Once the principal loss factor has been applied and reduced the appropriate quantity (and deferred market discount and cost when applicable), the cash portion of the paydown should be applied to the position in the manner described in the prior section.

Example 4 - Loss factor is less than the amount of unamortized discount (excluding deferred amortization)

Apply full unit reduction as a decrease in quantity and do not impact the remaining amount of deferred market discount.

No ledger entries are required for the principal loss component as there is no impact on cost.

Pre Paydown Totals

The loss factor of 2,000 is processed as a quantity reduction with no impact on deferred market discount or cost as there is sufficient unamortized discount (i.e. 40,000) to absorb the full loss factor.

Totals after applying loss factor 

Next apply the proceeds quantity of 8,000 as recognition of deferred market discount.  There is no remaining proceeds so no impact on cost or realized gain.

Ledger Postings

Post Paydown Totals

Example 5 – Loss factor is greater than the amount of unamortized discount but less than the total of unamortized discount and deferred market discount

Apply loss factor as a reduction of quantity and reduce deferred market discount for the amount of loss factor that is greater than the unamortized discount.

Pre Paydown Totals

As there is sufficient unamortized discount and deferred market discount to absorb the loss factor there is no impact on cost and no ledger entries for the loss factor amounts.  The amount of deferred market discount is reduced but because the amount has not been posted to income there is no adjustment from an accounting perspective other than to reduce the amount of deferred available for realization as the proceeds portion of the paydown is processed.

The loss factor is applied reducing the unamortized discount by 5,000 to zero and then reduces the deferred market discount by the remaining 12,000 leaving 3,000 available as deferred market discount.

Totals after processing loss factor

The paydown with proceeds (8,000) is then applied to the remaining deferred market discount 3,000 and then cost.

Ledger Postings 

Totals after applying loss factor and proceeds

Example 6 –Loss factor is greater than the total unamortized discount and deferred market discount

Apply loss factor as a reduction of quantity and reduce deferred market discount to zero. The remaining loss factor results in a realized capital loss.

Pre Paydown Totals

The loss factor of 25,000 reduces the market discount by 5,000 to zero, reduces the deferred market discount by 15,000 to zero and reduces cost and creates a realized loss for the remaining 5,000.

Ledger Postings 

Totals after processing loss factor but prior to applying proceeds

As the lot is now at par the proceeds amount of 8,000 will be reduce cost and produce no recognition of income.

Ledger Postings

Totals after applying loss factor and proceeds

Loss Recovery - Continuation of example 6

Recovery factor reverses prior losses, then increases the deferred market discount by the remaining recovery amount.

Pre Paydown Totals

There is a 25,000 principal paydown and a 10,000 non cash increase in quantity for the recovery factor which equates to a 15,000 net decrease in quantity.  The loss recovery quantity will increase the total quantity by 10,000 prior to processing the cash based paydown of 25,000.

Loss factor is processed first which increases the quantity by 10,000 and reverses the total prior loss of 5,000 and then increases the deferred market discount by the remaining 5,000 of the recovery amount reducing the amount of deferred market discount available for future recoveries to 10,000.

Ledger Postings

Totals after processing recovery factor but prior to applying proceeds

Next process the proceeds payment of 25,000 which now will record the 5,000 deferred market discount which was just restored from the loss recovery and then reduce the remaining 20,000 at par.

Ledger Postings

Totals after applying recovery factor and proceeds