Project Updates

Servicing Rights

Last Updated: February 14, 2006 (Updated sections are indicated with an asterisk *)

The staff has prepared this summary of Board decisions for information purposes only. Those Board decisions are tentative and do not change current accounting. Official positions of the FASB are determined only after extensive due process and deliberations.

Objective
*Most Recent Board Meeting
Exposure Draft
Immediate Plans
*Board Meetings/Public Meeting Dates
History and Background
Contact Information

Objective

The objective of this project is to reconsider the accounting for servicing rights, particularly whether they should be reported at fair value and, if so, whether fair value should be applied upon initial recognition and subsequent reporting or solely for subsequent reporting.

*Most Recent Board Meeting

At the January 25, 2006 Board meeting, the Board discussed two issues related to transition and disclosure requirements forthe draft of a final Statement on servicing rights.. The Board decided to:

  1. Provide transition guidance that requires prospective application of the requirements for initial recognition of servicing assets and servicing liabilities to transactions that occur after the effective date of the draft Statement. Specifically, servicing assets and servicing liabilities that had been recognized under current FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, guidance would continue to be recognized subsequent to the effective date of the amendment to Statement 140. They also would be subject to the subsequent measurement guidance of the amendment to Statement 140.

     

  2. Delete a disclosure requirement that would have required an entity to disclose the direct and indirect impact on income from continuing operations of an election to subsequently measure a class of separately recognized servicing assets and servicing liabilities at fair value in the first fiscal year of each election.

     

Exposure Draft

On August 11, 2005, the Board issued the Exposure Draft, Accounting for Servicing of Financial Assets, for a 60-day comment period. The comment period ended on October 10, 2005. All comments received by the FASB are considered public information and are posted to the website. A summary of the comments received can be viewed here. The proposed Statement would amend Statement 140 with respect to accounting for separately recognized servicing rights. It would:

  1. Require all separately recognized servicing rights to be initially measured at fair value, if practicable.

     

  2. Permit, for each class of separately recognized servicing assets and liabilities, an entity to choose either of the following subsequent measurement methods:

     

    1. Amortize servicing assets or liabilities in proportion to and over the period of estimated net servicing income or net servicing loss. This method, which is currently required by Statement 140, would continue to require an assessment of servicing assets or liabilities for impairment or increased obligation based on fair value at each reporting date.

       

    2. Report servicing assets or liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur.

       

  3. Require additional disclosures for all separately recognized servicing rights.

     

The Board’s decisions included in the proposed Statement are as follows:

  1. All separately recognized servicing rights that result from transfers of financial assets that are accounted for as sales will be initially measured at fair value rather than based on an allocation of the previous carrying amount between the assets sold and the retained rights based on their relative fair values, if practicable.

     

  2. Entities will be permitted to choose either fair value or the lower-of-carrying-amount-or-market (LOCOM) as the subsequent measurement attribute for each class of separately recognized servicing rights.

     

  3. Each class of servicing rights will include all of an entity’s rights to service one major financial asset type (for example, mortgage loans, credit card receivables, or automobile loans).

     

  4. Subsequent changes in the fair value of all servicing rights for those entities that elect fair value measurement will be recognized in earnings.

     

  5. Entities will be allowed an irrevocable one-time election that can be made at the beginning of any fiscal year subsequent to the adoption of this guidance to subsequently measure each class of separately reported servicing rights at fair value (with changes in fair value reported in earnings).

     

  6. For separately recognized servicing rights subsequently measured at fair value the following disclosures will be required (in accordance with paragraph 17(e) of Statement 140 as amended). The same disclosures must also be presented separately for servicing rights subsequently measured at LOCOM (in accordance with paragraph 17(f) of Statement 140, as amended)

     

    1. A description of the classes of servicing assets and servicing liabilities subsequently measured at fair value or LOCOM, management’s rationale for its decision to subsequently measure these classes of servicing assets and servicing liabilities at fair value or LOCOM, a description of the risks inherent in the servicing activity and, if applicable, the instruments used to manage those risks

       

    2. A roll forward of the balance of each class of servicing rights for each period that operations are presented, including a description of where each source of activity is reported in the statement of income

       

    3. Servicing fees earned during each period that operations are presented

       

    4. A description of the valuation techniques used to estimate fair value of the servicing rights

       

    5. A sensitivity analysis or stress test showing the hypothetical effect on the fair value of each class of the servicing rights of two or more unfavorable variations from the expected levels for each key assumption.

       

  7. Quantitative disclosures relative to the fair value, valuation techniques used to estimate fair value, and sensitivity analysis for risk management activities related to separately recognized servicing rights will be encouraged but not required.

     

  8. The initial measurement of all servicing rights at fair value must be applied prospectively to new servicing rights recognized.

     

  9. The option to subsequently measure servicing rights at fair value must be applied prospectively to all new servicing rights recognized after the election to subsequently measure at fair value is made and to all existing servicing rights on the date the election is made with a cumulative effect adjustment to reflect existing servicing rights at fair value upon election.

     

  10. To permit entities in conjunction with the adoption of the final Statement to transfer all securities from the available-for-sale category to the trading category without calling into question an entity’s treatment of such securities under Statement 115.

     

At the November 16, 2005 Board meeting, the Board addressed issues raised by respondents to the Exposure Draft, Accounting for Servicing of Financial Assets. The Board decided:

  1. Under FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, an entity that undertakes an obligation to service financial assets should recognize a servicing asset or a servicing liability for that servicing contract if the servicing obligation is a result of:

     

    1. A transfer of the servicer’s financial assets that meets the requirements for sale accounting.

       

    2. An acquisition or assumption of a servicing contract that does not relate to financial assets that have been transferred by the servicer.

       

      The Board stated that if a servicer transfers financial assets and the transfer does not meet the requirements for sale accounting, a separate servicing right should not be recognized.

  2. To permit a one-time reclassification of available-for-sale (AFS) securities to trading securities, without calling into question the treatment of those securities under FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. This reclassification would be permitted upon initial adoption of the Statement as of the beginning of the fiscal year of adoption.

     

    1. This reclassification is restricted to AFS securities identified as economic hedges of servicing rights that a servicer elects to subsequently measure at fair value.

       

    2. Any gains and losses that are carried in accumulated other comprehensive income at the time of the reclassification should be included in the cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of the adoption of the amendment to Statement 140.

       

    3. A reclassification should be disclosed along with the notional amounts of the reclassified securities and the effect of the reclassification on retained earnings.

       

  3. To allow a risk management approach for identifying the classes of servicing rights to apply the fair value election based on the different valuation and risk characteristics of the underlying assets and the way that the economic risks are managed.

     

  4. Not to readdress initial measurement of separately recognized servicing rights.

     

  5. To adopt the disclosure requirements proposed in the Exposure Draft with the following changes:

     

    1. Delete the basis for management’s decision to subsequently measure servicing assets and servicing liabilities at either fair value or amortized cost but require a disclosure that describes the characteristics that management is using to identify its asset classes under the risk management approach.

       

    2. Modify the requirement to provide contractual servicing fees as a component of the roll forward and require that they be separately reported and to include an illustrative example of roll forward in the final Statement.

       

    3. Delete the requirement to provide a sensitivity analysis or stress test separately for each class of servicing rights.

       

    4. Add the requirement from FASB Statement No. 154, Accounting Changes and Error Corrections, to disclose the effect of the change in accounting principle on income from continuing operations.

       

    5. Require that an election to reclassify securities from AFS to trading be disclosed along with the amount reclassified and the impact of that reclassification on the cumulative-effect adjustment to retained earnings.

       

  6. To make the final Statement effective for fiscal years beginning after September 15, 2006, and to allow early adoption as of the beginning of a fiscal year for which the entity has not previously issued interim financial statements. This is consistent with the Board’s decision on the hybrid financial instruments project.

     

  7. For transition provisions—

     

    1. To clarify when the new disclosure requirements are effective.

       

    2. To clarify that (1) the requirement for the initial measurement of servicing rights at fair value should be applied prospectively and (2) servicing rights should be initially measured at fair value as of the beginning of the fiscal year that this Statement is adopted.

       

    3. To revise the language in paragraphs 6 and 7 to state that the cumulative-effect adjustment should be the difference between the fair value and the carrying amount of the servicing rights that exist as of the beginning of the fiscal year, not as of the date of the entity’s election.

       

    4. To clarify that subsequent measurement at fair value should be a policy decision that is (1) irrevocable, (2) made as of the beginning of the fiscal year, and (3) effective as of the first day of the fiscal year of the election.

       

Immediate Plans

The Board expects to issue a final Statement, which would amend Statement 140, in the first quarter of 2006.

*Board Meeting and Public Meeting Dates

The Board meeting minutes are provided for the information and convenience of constituents who want to follow the Board’s deliberations. All of the conclusions reported are tentative and may be changed at future Board meetings. Decisions become final only after a formal written ballot to issue a final Statement or Interpretation.

The following are links to minutes for each completed meeting:

*January 25, 2006 Board Meeting—Transition Guidance and Disclosure Requirements
November 16, 2005 Board Meeting—Redliberation: Comment Letter Analysis, Disclosures, Transition and Effective Date Provisions
April 13, 2005 Board Meeting—Comment Period, Transition and Effective Date, and Definition of a Participating Interest
September 22, 2004 Board Meeting—Policy election clarification and disclosure requirements
August 4, 2004 Board Meeting—Policy election and disclosure requirements
June 16, 2004 Board Meeting—Initial measurement attribute for servicing rights
May 19, 2004 Board Meeting—Treatment and scope alternatives related to the servicing rights project
March 31, 2004 Board Meeting—Accounting treatment for mortgage servicing rights
March 10, 2004 Board Meeting—Informational Board Meeting
January 14, 2004 Board Meeting—Agenda decision whether to add a project to the Board’s technical agenda

History and Background

A mortgage servicing right (MSR) is a contract to service mortgage loans under which the servicer is obligated to perform specific loan administration functions and is compensated with contractually specified servicing fees. The MSR asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing mortgage loans exceeds the cost of servicing the mortgage loans. MSRs are recorded by a mortgage banking institution as the result of either an outright purchase of the MSR via purchase of the servicing contract from an existing servicer or the creation of the MSR via sale of a loan to an investor with servicing retained (transferor undertakes an obligation to service the loans). The accounting guidance for MSRs is provided by Statement 140.

Aside from guaranteed mortgage securitizations, whenever an entity undertakes the obligation to service financial assets, it must recognize a servicing asset or liability for the servicing contract. For MSRs purchased, the initial asset recorded will be its fair value, presumptively the amount paid. MSRs created via a loan sale are initially measured at an allocated amount based on the relative fair values of the MSR and the loan that was sold, because a servicing asset or liability is inherent in all financial assets, but it is not a distinct asset or liability until contractually separated from the financial asset. Additionally, the MSR must be assessed for impairment based on its fair value at each reporting date, essentially recording this right at the lower of carrying amount or market LOCOM. Mortgage banking institutions generally ascribe value to their individual MSR assets using valuation models. Fair values of MSRs are most significantly impacted by changes in interest rates and the corresponding effect those changes have on prepayment speed estimates and other interest-rate-based assumptions (such as discount rates and float earning rates).

Mortgage banking institutions typically enter into derivative instruments to mitigate the risks inherent in MSRs. The derivative instruments entered into are accounted for at fair value in accordance with FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. As MSRs are carried at LOCOM, unless a company applies hedge accounting to the derivatives, the company is exposed to income statement volatility in rising interest rate environments because the derivatives’ values decrease with the fluctuation reflected in the income statement, while the increase in the MSRs’ fair values are unable to be reflected in the income statement. As described in Statement 133 Implementation Issue No. F8, "Hedging Mortgage Servicing Right Assets Using Preset Hedge Coverage Ratios," the Board noted the difficulties of hedging, for accounting purposes, MSRs because the fair value of MSRs do not change in a linear fashion as interest rates change due to the nature of prepayment estimates. This causes MSRs to lose value at a faster rate when interest rates decline than the rate at which MSRs gain value when interest rates increase. By reporting MSRs at fair value, mortgage bankers would be provided relief from the substantial record-keeping requirements needed to obtain hedge accounting treatment.

*Contact Information

Patricia Donoghue
Project Manager
padonoghue@fasb.org