In a move to simplify accounting for servicing assets and liabilities, the Financial Accounting Standards Board has issued a standard that makes it easier for mortgage bankers and other servicers of financial assets to report on the value of derivatives to offset risks associated with securitizations and other types of servicing.The new standard, SFAS 156, "Accounting for Servicing Financial Assets," amends SFAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" - itself a replacement of FASB Statement No. 125. It allows servicers to choose between fair value and amortization measurements to report the value of derivatives, as well as the assets or liabilities related to them.
The Mortgage Bankers Association is especially jubilant over the change, because its members requested two years ago that FASB consider an elective fair value measurement for these kinds of assets and liabilities. Alison Utermohlen, the association's senior director of government affairs, said that the country's large mortgage bankers were "clamoring" for the statement to be released.
"There was a concern among a lot of our members that the board was going to develop a mandatory fair value measurement approach, and a significant number of our members do not want to mark to market the servicing rights for which they do not use derivatives as a hedge," Utermohlen said. "These larger members are mega-servicers that have huge portfolios that do use derivatives to hedge unexpected changes in the values of their portfolios and have been laboring mightily under SFAS 133 ["Accounting for Derivative Instruments and Hedging Activities"], and it's been a costly, time-consuming burden on them."
While the larger entities were calling for fair value measurement, Utermohlen said, smaller servicers were objecting to any such requirement, as it would increase their earnings volatility, because they would have no unrealized gains or losses on derivatives.
The flexibility of the new statement, Utermohlen said, was "the best of all worlds," not only because it allows two measurement methods, but because it allows servicers to divide assets and liabilities into groups measured under either of the methods.
The new rules go into effect for assets and liabilities acquired or issued after the beginning of an entity's fiscal year beginning after Sept. 15, 2006. The standard applies not only to mortgage bankers, but to servicers of the receivables of securitized credit card receivables and auto loans, among others.
Aiming at simplification
FASB member Edward W. Trott said that the statement was issued as part of an ongoing effort to reduce the complexity of accounting, while allowing hedge-like accounting that is free of some of the complexity of Statement 133.
As the board developed the new standard, it acknowledged that the traditional method of applying the lower of carrying amount or fair value measurement attributed to servicing assets resulted in asymmetrical recognition of economic events, because it requires recognition of all decreases in fair value while limiting recognition of increases in fair value to the original carrying amount.
Under the new standard, all separately recognized servicing assets and servicing liabilities are to be reported at fair value at initial measurement, if that is practicable.
Subsequent measurements, however, may be made under either an amortization method or a fair value measurement method. Fair values will have to be measured at each reporting date, with changes reported in earnings in the period in which they occur.
Entities would be required to recognize a servicing asset or liability for:
* Sales of the servicer's financial assets;
* Transfers of the servicer's financial assets to a qualifying special-purpose entity in a guaranteed mortgage securitization in which the transferor retains all of the resulting securities and classifies them as available for sale; and,
* Acquisitions of obligations to service a financial asset that does not relate to financial assets of the servicer.
At its initial adoption, SFAS 156 permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities, provided the available-for-sale securities are identified as offsetting the entity's exposure to changes in fair value.
The change makes good sense, according to auditors.
"The accounting under Statement 140 motivated many mortgage bankers to hedge the economics of servicing, and they are particularly assets to hedge," said Deloitte & Touche partner James Johnson. "Statement 156 helps you get the best accounting of all by having the true economics of the service and of the hedging instruments marked through the income statement. This is definitely a good move by FASB, and mortgage bankers welcome the possibility of avoiding the difficulties of hedge accounting under Statement 133."
"All constituents benefit from high-quality standards; however, greater consistency and reduced complexity fosters greater transparency and usefulness for investors," said FASB project manager Pat Donahue. "This standard embodies those characteristics."
Though there is some concern over inconsistencies between financial statements prepared under the optional approaches, the Mortgage Bankers Association's Utermohlen said that the extensive new disclosure requirements should allow the users of financial statements to make meaningful comparisons.
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