ABS and MBS servicers - particularly those that use derivatives to hedge against fluctuations in the fair value of the assets that they oversee - had another cause to raise a pint on St. Patrick's Day, after the Financial Accounting Standards Board (FASB) issued guidelines that simplified the accounting for servicing assets and liabilities for most MBS deals.
The Statement of Financial Accounting Standards 156, which amends FAS 140, allows servicing companies to record servicing assets and liabilities at their fair value, instead of using the lower-of-cost-or-market accounting method.
Also, the rule allows companies the one-time right to reclassify available-for-sale securities (AFS) as trading securities, as long as they qualify for the fair-value accounting method. They can do this without raising questions about how other AFS securities should be treated, according to the UBS Mortgage Strategist published last week.
Specifically, the FASB laid out three scenarios when FAS 156 applies: when a servicer's financial assets are transferred in a sale; when the servicer's assets are transferred to a special-purpose vehicle in an MBS deal, and the transferor retains all of the resulting securities and classifies them as either available-for-sale securities or trading securities; and when the servicer agrees to handle financial assets that are not their own.
The $5.4 billion MBS market might be particularly interested in FAS 156, because servicers in that market are more likely to hedge their servicing rights than their ABS counterparts. However, the new rule will have little or no effect on the $3.7 billion mortgages outside the securitization market, or ones held on an entity's portfolio, says UBS.
Servicers looking to maintain consistent valuations in their servicing rights especially appreciate FAS 156, because it resolves inconsistencies between the way that the derivatives and the rights are currently recorded, said Marty Rosenblatt at Deloitte & Touche.
Servicing rights entitle an entity such as a mortgage banker to collect principal, interest and escrow payments and carry out other functions involved in managing financial assets in a trust. Currently, the hedging derivatives applied to rights must be recorded at their fair value, but corresponding increases in the fair value of the servicing rights must be recorded at the lower-of-cost-or-market value. This sometimes creates income statement volatility, says David Moline from Deloitte.
Those that currently hedge their mortgage servicing rights choose to avoid those accounting inconsistencies by applying the rules under FAS 133. However, some market professionals find that option difficult or challenging, because the rules under that standard are very strict and onerous, according to the UBS.
"Servicers who hedge will want to adopt FAS 156 as soon as possible," said Lisa Filomia-Aktas, a partner and practice leader on-call at New York City-based Ernst & Young.
In cases where mortgage securitizations can be treated as sales and in which the transferor has the right to service the assets in the trust, FAS 156 also changes how those gains and losses are calculated and booked.
Under FAS 140, the FASB regarded those underlying assets as the transferor's retained interests. Those interests, therefore, were recorded at an amount that represented the carrying amount of the assets prior to the transfer. The allocation was based on the relative fair value of all components retained and sold in the transaction, wrote Moline in last's week edition of Deloitte publication Heads Up. This resulted in the servicing assets being initially recorded at an amount less than their fair value. FAS 156 requires that the servicer record those assets at their fair market value and treat them as part of the sale proceeds.
The new rule does not answer every question, such as how servicers should determine the fair value of their servicing rights.
"As a general rule, fair value is presumptively the price paid or received if the servicing right was purchased or assumed," wrote Moline. If servicers are still in doubt, FASB advises they review paragraphs 68 through 70 in FAS 140 to determine fair value.
FAS 156 goes into effect on Sept. 15, and brings with it an important stipulation. Switching to fair value accounting is irrevocable and applies to all existing and future mortgage servicing rights. There is no turning back to lower-of-cost-or-market accounting after this method is applied.
Market participants expect most servicers to divide mortgage-servicing rights into eight separate classes that correspond to their product types. Those groupings would potentially include fixed-rate prime agency, fixed-rate prime non-agency and hybrid ARM subprime loans, says UBS. Of those eight potential MSR classes, the fixed-rate prime agency and fixed-rate non-agency groups will mostly be handled through fair value accounting, says UBS.
Changes in interest rates and volatility mostly affect those products. Also, servicers use hedging techniques on them more actively, and can calculate their valuations more easily.
At least one part of the FAS 156 makes life easier for servicers and their accountants. The servicing entity can combine certain rights measured under the fair value method and those measured under the amortization method into a one-line item on its balance sheet - as long as the ones measured by fair value are presented prominently in parenthesis on the face of the balance sheet.
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