Consolidated SPE ratios understand, decrease, question, already

dvilayphet

Hi,

Came across a question from a mock exam asking what are the changes on ROA and ROE after a SPE is consolidated to the beneficiary.

Answer key says both ROA and ROE will decrease. I understand the ROA, but why would ROE decrease? I thought the equity method already bumps up the NI by the proportionate amount, which in turn bumps up Equity. How would consolidating decrease ROE?

Thanks

hassan

consolidating is a balance sheet effect, not an I/S effect. you are thinking about it wrong.

mengxu

NI is the same under all methods of inter corporate investments. ROA will go down because assets are increasing by the additional assets of the consolidated entity. ROE will go down because of the minority interest account being included in equity.

madaochenggong

Hmmm I think more information would be needed.

I think I remember a question somewhere about selling a building and leasing it back but that the parent was still on the hook for recourse on loan used to buy the building from the parent. The trick was that when you consolidated the SPE you had to back a gain (on the sale to the SPE) from Net Income and the offsetting impact on Equity. Since the numerator decreased by a greater % than denominator, the ROE actually decreased.

It seemed like a question targeting someone who memorized the Schweser chart but didn't understand the underlying ratios and impact.

comp_sci_kid

Nope, it's as simple as my answer above. A SPE is treated the same way as proportional consolidation.

ninja1024

what if the parent owns the SPE 100%, like most SPEs are used for in securitization markets? wouldn't that mean there would be no minority interest and that equity would stay the same?

scarecrow

westibbs is correct. almost all bs ratios will worsen when an SPE (VIE) is consolidated.

BelalM

Good question about 100% ownership of SPE. I would have no idea why ROE would increase in that case...

kingstongal

Under equity method, you are not the majority stock holder & you have purchased only a part of equity of the other company. So, there is no need for any minority interest adjustments.