FASB Proposes Making 'Fair Value' Accounting Optional

A controversial accounting change that had divided the mortgage industry may no longer be very divisive, but details of the new proposal remain uncertain.

That's because the Financial Accounting Standards Board has proposed to let the industry have it both ways by making "fair value" accounting an elective way to treat mortgage servicing rights. The parameters for making that choice, and the details about whether and under what circumstances a lender could change its choice, remain to be determined by FASB staff.

At a May 19 meeting, FASB discussed the accounting treatment of mortgage servicing rights. Under current rules, mortgage servicing rights are generally subject to LOCOM accounting, meaning they are valued at the lower of cost or market value and cannot be raised above the initial cost basis.

This meant that large servicers had to pass certain tests to achieve "hedge accounting" treatment in order to avoid volatility in their balance sheets.

Those large servicers have argued that fair-value accounting for MSRs is more fair, because it allows changes in the value of the servicing asset and the derivative instruments used to hedge servicing rights to naturally offset each other without the complexity of hedge accounting treatment.

But smaller servicers had some objections, fearing that fair-value accounting would add complexity to tracking their MSRs and could increase volatility. The elective nature of the FASB proposal should alleviate those concerns.

"I don't see the proposal disadvantaging any organization due to the elective nature of it," said Lisa Filomia-Aktas, a partner in Ernst & Young's On Call Advisory Services Group.

While details of the proposal have not been determined, Ms. Filomia-Aktas said it is unlikely that lenders will be able to switch back and forth between the two accounting methods from quarter-to-quarter.

Currently, she said that large servicers often felt that hedging their portfolios economically to offset changes in the value of the servicing asset found it time consuming and sometimes difficult to achieve hedge accounting status. Failure to use hedge accounting left them exposed to volatility in their quarterly earnings reports, since MSRs are subject to lower of cost or market accounting treatment. That means servicers have to take writedowns to the assets, but can't write up gains in the absence of hedge accounting.

Fair-value accounting for MSRs would eliminate the need to meet hedge accounting tests, so that MSRs and the hedging instruments used to balance them would naturally offset one another.

Ms. Filomia-Aktas said the change is consistent with the FASB's move toward fair-value accounting for all financial instruments.

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