Last week's article on EITF 99-20 elicited responses from the accounting community.
According to Marty Rosenblatt of Deloitte & Touche, it needs to be clear that EITF 99-20 is related to all interest-only and credit-sensitive MBS, ABS and CDOs, not just residuals. EITF 89-4 only applied to IOs, and, contrary to what was reported, 89-4 also called for a prospective method of interest income recognition. As for the impairment clause - where an asset is considered impaired when the internal rate of return calculated is less than the risk-free rate - previous guidance only applied to IOs. For other assets, it was left to subjective judgement.
To be clear, EITF 99-20 generally applies to securities that have credit risk. An agency bond, like a Fannie Mae or Freddie Mac bond is not viewed as having credit risk, although the senior IO security does carry prepayment risk. EITF 99-20 also applies to that particular IO senior security which has prepayment risk.
Essentially, EITF 99-20 only applies to prepayment risk from the standpoint that if the underlying loans prepay, there can be a loss on investment. Conversely, the impairment provisions of EITF 99-20 will likely not come into play on the senior notes of a CDO, because defaults on the underlying bonds could very likely call for a change in the waterfall and an early payout of principal, which is a good thing, unless the bond was purchased at a premium.