New Accounting Choice Could Vex Servicers

There is good news for the mortgage industry. The Financial Accounting Standards Board - source of many industry headaches over the years - has acquiesced to industry requests that fair market accounting be allowed for mortgage servicing rights.

But not everyone is likely to take the FASB up on that offer. Some lenders are just fine with the present LOCOM (lower of cost or market) limitation on servicing values, coupled with the option of using hedge accounting if your hedging strategy qualifies.

On the other hand, fair market accounting simplifies the treatment of the servicing asset and probably provides a better economic picture of the asset.

But at what price? Lenders that choose fair market accounting may find themselves trying to explain greater swings, both up and down, in the assets value to investors.

The servicing asset consists of some 50 cash flow items, according to executives from PricewaterhouseCoopers who spoke at the recent Mortgage Bankers Association national servicing conference in Phoenix. Those cash flow streams include items such as corporate advances, escrow advances and other mortgage banking income.

Marking mortgage servicing rights to market might ease the burdens associated with hedge accounting rules under FASB's current guidelines.

"Essentially, this proposed amendment can reduce some of the risk of hedging the asset from an accounting perspective," said Bryan Heft, senior associate at PwC.

While fair value accounting for MSRs may be a better match with the derivative instruments commonly used to hedge MSRs, the choice of a different accounting method has a downside, too, Mr. Heft said. With companies choosing between two different ways of treating MSRs, comparing companies across the industry will become more difficult.

Fair value accounting may mitigate the hassle of explaining amortization and impairment on quarterly financial reports. But mortgage servicers that choose to apply fair value accounting to their MSRs will see that choice affecting their reports in different way.

"It actually does bring on more fair value volatility because essentially what you have done is taken off this cap on fair value," Mr. Heft said.

Steve Davies, co-chair of the consumer finance group at PwC, said that underlying the accounting debate is the fact that servicing loans remains a fundamentally sound and profitable business. He said that servicing is a cash flow and customer service business, and lenders should use cash flow analysis to guide how they manage their customer relationships.

"At the end of the day, what we are trying to do is account for all the cash flows that come through servicing."

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